Teaching Objectives
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Discuss opportunities and challenges franchisors face when entering emerging economies.
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Understand how to analyze a foreign market opportunity using the PEST analysis framework.
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Explore how franchisors choose an entry strategy when entering an emerging market.
Introduction
Navigating emerging markets poses a distinct challenge for first-mover emerging franchisors, given the scarcity of guidance in this relatively uncharted territory. The theoretical challenge has been that learning from first-hand experience may be impossible when the firm seeks to replicate its international strategy from developed countries in emerging markets (Kelepouris, 2023). Most emerging franchise firms operate as privately owned entities, resulting in limited accessible data concerning their decisions, outcomes, and motivations. Consequently, emerging franchisors entering these markets find themselves in a knowledge gap. Considering this, they can derive invaluable insights from the world’s largest franchisor, McDonalds, which has successfully negotiated the complexities of entering new and diverse markets. Drawing on the experiences of this industry leader becomes an essential strategy, enabling emerging franchisors to decipher the unique challenges and capitalize on the opportunities that arise in the dynamic landscape of emerging markets.
Consider the intricate circumstances surrounding McDonald’s deliberation on entering or abstaining from involvement in the unpredictable Moldavian economy during the 90s. Despite the apparent scarcity or ambiguity of information, it mirrors the exact conditions and data available to McDonald’s during that era. This scenario closely parallels the challenges contemporary emerging franchisors encounter when venturing into specific emerging markets.
McDonald’s Business Model & Expansion Strategy
Franchising, as an organizational structure, arises from a contractual agreement between the Franchisor (Parent Company) and the Franchisee (Company or Individual granted a license to use the Parent Company’s intellectual property). This arrangement typically involves the franchisor granting the franchisee a license in exchange for a yearly flat fee and royalties or sales commissions (Shane, 1996).
The widespread success of franchising is evident in its substantial impact, accounting for an estimated $800 billion in gross sales in the U.S. alone and representing forty percent of retail trade (Swartz, 2001). Its pervasive influence extends to markets in the US, Canada, and parts of Western Europe, making emerging markets an enticing focus for international franchise investment. The growth of franchising in emerging markets has been remarkable since the 1980s, exemplified by the surge in franchisors in Brazil and the substantial international sales of top U.S. food chains (Welsh et al., 2006).
McDonald’s, a prominent player, operates its franchised restaurants under three structures: conventional franchise, developmental license, or affiliate (McDonald’s, 2015). The conventional approach involves McDonald’s owning the land and building, while the developmental license approach requires licensees to provide capital for the entire business, and the affiliate approach involves equity investments in limited foreign affiliated markets. McDonald’s various structures align with two primary categories for franchises expanding into international markets: direct investment, where the franchisor operates a company-owned store, and indirect investment, which includes the developmental license or affiliate approach. The latter, especially the Master Franchisee model, is favored by international firms entering emerging markets due to its benefits such as local market knowledge, resource access, faster adaptation, and expedited development of prospective franchisees (Nair, 2001; Welsh et al., 2006).
Opportunity
Moldova, a former USSR country nestled in Eastern Europe between Romania and Ukraine, declared its independence in 1991. Initiating a shift toward a market economy in 1992, the country replaced the Russian Ruble with the Moldovan Leu in 1993 (The World Factbook: MOLDOVA, 2023). Amidst its strategic foray into Eastern Europe, McDonald’s directed its attention towards Moldova in the mid to late 1990s, contemplating foreign direct investment and singling out the capital city, Chisinau, as its initial target (McDonald’s Press Office, 2017). The decision for McDonald’s to enter Moldova wasn’t a matter of if but rather when and how. The dilemma encompassed considerations of direct or indirect investment, potentially incorporating a hybrid strategy akin to the approach taken in Belgrade, Yugoslavia. Given Moldova’s status as a transitioning economy, characterized by specific challenges for foreign investors due to structural issues (Estrin & Meyer, 1998), McDonald’s drew upon lessons learned from previous experiences in emerging markets.
Navigating this opportunity involved a nuanced analysis of Moldova’s institutional landscape, where strong market institutions could potentially allow reliance on internal resources or joint ventures with local firms leveraging in-country networks (Meyer et al., 2009). Recognizing the inadequacy of a resource analysis alone, McDonald’s delved into understanding the formal and information institutions of Moldova. This approach aligns with the tenets of New Institutional Economics, emphasizing the role of institutions in reducing transaction and information costs, establishing stability, and facilitating interactions (Hoskisson et al., 2000). The intricate differences in institutional infrastructures between emerging and developed markets played a pivotal role in shaping McDonald’s strategic orientations.
To craft a suitable entry strategy for Moldova, McDonald’s engaged in a comprehensive analysis. This involved assessing internal resources for competitive advantage, conducting a PEST analysis (political, social, economic, technologic) to gauge the opportune timing, and evaluating the pros and cons of direct and indirect strategies concerning both resources and Moldovan institutions. This meticulous approach allowed McDonald’s to tailor a strategy that not only capitalized on its strengths but also aligned with the unique dynamics of Moldova’s transitioning state.
PEST Analysis
Political Institutions
The dissolution of Communism in 1989 ushered in a new era of rapid-growth countries in Central and Eastern Europe known as transition economies. Committed to bolstering their market mechanisms through liberalization, stabilization, and the encouragement of private enterprise, these nations, including the Republic of Moldova, sought transformation (Hoskisson et al., 2000). Designated as an emerging market by the European Bank for Reconstruction and Development in 1998, Moldova faced a unique paradox in its political landscape.
Despite being the poorest country in Europe, marred by ethnic conflicts and undergoing a significant economic downturn, Moldova maintained a commendable commitment to free speech for over a decade. Its elections, deemed free and fair by post-Soviet standards, and a relatively independent judiciary highlighted the complexities of its political environment (Solonari, 2003). The newly independent Republic of Moldova exemplified “pluralism by default,” where elites benefited from weak networks inherited from Soviet times. Characterized by strong individualism amid political polarization on identity issues, the civil war conflict between Moldova and Transnistria played a pivotal role in shaping political discourse throughout the 1990s.
As Romania progressed towards Council of Europe membership in the summer of 1993, Moldovan parliamentarians faced a dichotomy between “West” and “East.” This choice influenced the country’s trajectory towards Romania, Europe, or Russia and former Soviet republics (King, 1994). Stalled reforms, a stagnant economy, and persistent political instability tarnished Moldova’s image in the late '90s (Solonari, 2003).
The public administration in Moldova grappled with challenges, marked by a lack of trained personnel, unclear appointment rules, and perceived corruption and incompetence. Loyalty to the Communist party, a relic from Soviet times, ceased to exist after independence, leaving a void filled with unclear and non-transparent rules. Low administrative capabilities were identified as a fundamental cause of Moldova’s difficulties, with little effort to address the issue (Solonari, 2003).
In navigating these challenges, Moldova passed the “Law of the Republic of Moldova on Franchising” (No. 1335) on January 1, 1997. While this law didn’t explicitly outline required disclosure documents, it specified essential contents of the franchise agreement (Peters, 2015). Moldova’s franchise law, encapsulated in Law 1335 (1997), outlined key provisions, including the obligation for all parties to deal in good faith, the necessity of clear statements on reciprocal obligations, contract duration, termination, and extension. Additionally, it delineated the franchisor’s duties related to licensing and supporting the franchisee, along with the requirement for the franchisee to pay recompense calculated based on the franchising program’s contribution to sales volume.
Economic Institutions
Economic Trends
Moldova faced severe economic challenges in the aftermath of the USSR’s dissolution, ranking among the hardest-hit post-Soviet countries with a staggering 40% to 50% deterioration in terms of trade. The year 1992 witnessed a significant surge in the costs of petrol, natural gas, and coal, posing formidable challenges. In response, earnest economic reforms took root in the latter half of 1992-1993, culminating in the successful introduction of the national currency, the leu, which effectively curbed inflation (Solonari, 2003).
The GDP of Moldova experienced a sharp decline in 1992 and 1994, attributed largely to drought and war. Following the Russian economic crisis in August 1998, prices for food rose by 33%; for non-food by 38%; and for services, such as energy, public utilities, and telecommunications, by 63%. The CPI (consumer price index) of food increased from 168.8 in January of 1995 to 257.2 by December 1999 (International Monetary Fund, 1999). As McDonald’s contemplated entry into Moldova in the mid-1990s, expectations of economic resurgence were palpable both domestically and internationally.
Unemployment Rate and Workforce Factors
Moldova endeavored to attract foreign investors by offering special tax incentives and a low-cost labor pool. In 1998, the country ranked as the second-poorest in the region, with an average monthly wage of $47 USD. Government statistics revealed that around 80% of the population lived below the poverty level, with 10% of the rural population earning less than one-quarter of that level. A majority of citizens struggled to afford basic necessities like fish, meat, milk, and dairy products regularly, leading to minimal excess spending (US Department of State, 2000).
While the officially reported unemployment rate was less than two percent, a mid-1998 labor force study found that 1.7 million people, constituting 49% of Moldova’s total population, were employed, resulting in an unemployment rate of approximately 9.5% (International Monetary Fund, 1999). The International Monetary Fund cautioned that this figure substantially understated the actual unemployment rate, with agriculture being the largest employer, representing about 40% of total employment.
Social
After 50 years of Soviet propaganda the national identity of citizens is torn between being Moldovan or Romanian (Ma-Ni, 2017). Regardless of ethnic identification, there is a sentiment of disarray as an independent state whose output has diminished since the fall of the Soviet Union. Factors such as the GDP dropping as much as 50% and inflation raising as high as 2,200% has led individuals to still rely on the barter system in the 90s (International Monetary Fund, 1999). The economic hardships caused a steep contraction in birth rates and also a migration both legally and illegally out of the country looking for work and a better life (Makhanov, 2024).
Technology Resources
Moldova underwent varying stages of infrastructural development following the dissolution of Communism in 1989. Resistance to privatization lingered among the Communists, particularly in key sectors like wine production, tobacco, and telecommunications. The privatization of these enterprises moved forward hesitantly due to unattractive offers and the enterprises’ poor condition after a decade of mismanagement by the state (Solonari, 2003).
In the late 1990s, significant institutional reforms enhanced the regulatory environment and performance of Moldova’s electricity and gas sectors. Two-thirds of the electricity distribution network underwent privatization, marking improvements in the energy sector (The World Bank, 2016).
Unsustainable land use and lack of proper waste management during the Soviet era had severe consequences on Moldova’s water quality. Over 90% of wells, the primary source of rural drinking water, exceeded national standards, with high E. Coli counts. Infrastructure deterioration, minimal maintenance, and inadequate investment led to severe interruptions and increased pipe breaks (Michel, 2011; The World Bank, 2004).
Moldova witnessed the establishment of its first internet service provider (ISP), Relsoft, in 1992, with the .md domain recorded in 1994. The first “Fiber to the Building” internet connection, linking Bucharest and Chisinau, was established in 1996, while Relsoft began offering dial-up internet in 1995.
The agriculture-dependent economy faced challenges due to poorly maintained roads, trucks, and railways. Aging trucking fleets, poor-quality rolling stock in railways, and limited air services hampered trade. Leasing arrangements for trucks were underdeveloped, and the transportation infrastructure faced setbacks due to damage and thefts during transit (Bouton et al., 2004).
The agricultural sector’s transformation saw collective and state farms owning 90% of agricultural land in 1990, reduced to 10% by individual farms in 2001. Livestock production declined significantly, and the agri-food production chain faced challenges due to a lack of collaboration, critical infrastructure, and technological advancements (Coser, 2012; Moroz et al., 2014).
Questions
Equipped with the information outlined above, McDonald’s confronted pivotal decisions. How would you advise them to proceed? Would your recommendations differ if you were consulting for an emerging franchise system?
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Would you recommend McDonald’s expand into Moldova in the mid 90s? Why or Why Not? Explain in detail.
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Should McDonald’s enter the Moldova through a direct or indirect investment? Why? Explain in detail.
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How can McDonald’s provide a consistent product offering and experience in a country with no franchise infrastructure?
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In 1998 McDonalds entered Moldova through a corporate-owned store, subsequently transitioning to a developmental license. Presently, as of 2023, there are nine McDonald’s outlets in Moldova. What can emerging franchisors learn from McDonald’s expansion into Moldova that can be applied to their own foreign market expansion strategy?
These questions underscore the complexities of international expansion, particularly in emerging markets, offering valuable lessons for emerging franchisors seeking to navigate similar challenges.