CHAPTER 2

LITERATURE REVIEW

2.0 PREAMBLE

The purpose of this chapter is to provide the outlook of the world and Malaysian franchise

industry and review on the literature relevant to the research. It will give better understanding

about this research by explaining on franchising overall outlook and current scenario of

franchise industry in Malaysia. Furthermore, the franchise failures factors as variables for this

research being explained briefly in relating to the essential factors that drive PNS to enhance

their capability and role as franchise business partner.

2.1 THE WORLD AND FRANCHISE INDUSTRY

Franchising is the fastest growing method of doing business (Miranda, 1995) and has

become the most important and popular method of creating new businesses (Justis, 1995).

Franchises contribute about 10% of the world’s Gross Domestic Product (GDP) and 14% of

the world’s total retail sales (Mendelsohn, 1999). Franchising has been extensively

researched for more than 40 years. It started in the United States and spread to other parts of

the world (Alon & McKee, 1999). Franchising in the United States has been growing rapidly.

International Franchise Association (Combs, Michael & Castrogiovanni, 2004) stated that in

the United States franchising represents over 40% of retail sales.

Over the last few decades, franchising has become an increasingly popular organizational

from throughout the world. The development has rich history and has become a trend that

threatens many independent stores. It is generally believed that the concept of franchising

was first introduced in the US by the Singer Sewing Machine Company. At the end of the

American Civil War in the mid-1800s, Singer developed a network of franchised dealers
(Mendelsohn, 19991). These early franchises were effectively distribution arrangements so

that the franchisees could service machines upon the demand of customers.

Although Singer declined before the end of the nineteenth century, others believed that

franchising is a good way to increase market penetration (Stanworth & Smith, 1991). In

1989, General Motors used franchising to increase the number of its distribution outlets. The

franchisee (dealer) was granted rights to sell the vehicles and a protection was given to avoid

competition from franchisees. Moreover, a large volume of sales could be guaranteed

(Stanworth & Smith, 1991). From the 1950s, many companies operated their businesses as

franchises and franchising was viewed as an efficient way to distribute products and services

(Stanworth & Smith, 1991). Therefore, it appears that franchising is a superior alternative to

independent business management, providing the excellent combination of resources and

experiences of large company (Hing, 1995). Additionally, franchising is a successful business

concept, enabling the investor to operate under an established and proven system (Frazer,

2003).

2.2 OUTLOOK OF FRANCHISE INDUSTRY IN MALAYSIA

In the earlier stage, many of the earlier success stories in Malaysia franchise business

involved foreign companies like McDonald's, KFC, Seven Eleven and few others. This has

become a catalyst for home-grown franchisors to be part of the growing franchise business

system.

In 1980s, Marrybrown Family Restaurant became the first local fast food chain to franchise

its business system in Malaysia. This has allowed the fast food chain to grow at a speedy rate

while maintaining its service and food quality. Marrybrown is also one of the earliest local

franchises which expand their business overseas. It is said that their current overseas business

is more popular than the local business (Skor Career Malaysia Website)
Marrybrown's success was followed by a few other local players who were starting to make it

big in the franchise business scene in Malaysia. Examples are Smart Reader Worldwide in the

education industry, 1901 in the fast food, Sports Planet in sports and England Optical Group

in the optical field.

In 1994 Malaysian Franchise Association was formed to support the government program to

promote entrepreneurship through franchise (MFA Website).

Franchising is expanding very fast compared to other forms of business with intensifying

competition (Hoffman & Preble, 2004) not only in developed countries but also developing

countries (Lado & Vozikis, 1996) such as in Malaysia.

In 1992, the Malaysian government adopted franchising as one of the strategies to spearhead

the development and growth entrepreneurship in the country, especially amongst the

indigenous Bumiputera community. Indeed, franchising has been regarded as an “effective

vehicle for entrepreneurial development‟ for the Bumiputera community (Hoe, 2001). By

1995, there were 125 franchise systems and 800 franchisees operating in Malaysia,

contributing a total of US$609.5 million in retail sales. This constitutes 2% of Malaysia total

retail sales volume of US$30,474 million. Today, there are about 268 franchise systems with

slightly more or less than 6,000 franchisees. As in Malaysia, the government has promoted

the Malaysian’s franchise industry aggressively since 1992 (Adzmi 1999). The Malaysian

Franchise Act 1998 was introduced to protect the franchise industry, and it requires every

new franchise system to be registered.

To make Malaysia one of Southeast Asia’s fastest growing franchise markets with the market

growth trend of 15% per annum for the past decade is expected to continue into the next
decade (U.S. Department of Commerce, 2007). Surveyed by the MFA recorded growth of

815% within 10 years, in which franchise outlet numbers grew from 413 in 1993 to 3,781 in

2003.

In 2009 record, franchising contributed 6% of retail sales in Malaysia (Damodaran, 2009) at

the same time franchise businesses contributed to about 3.5% of the GDP. With its desire to

be a regional franchise hub, as well as a developed nation by 2020, Malaysia needs to double

its income level and national capital base from the current per capita income of US$14,000

(adjusted for purchasing power parity). Translated, the upside to demand growth for the

franchise industry is very high (U.S. Department of Commerce, 2007).

2.3 NATIONAL FRANCHISE DEVELOPMENT BLUEPRINT (NFDB)

2.3.1 OVERVIEW OF NFDB

PNS has involved with the National Franchise Development Program (NFDP) since 1991.

The main objectives are to create awareness of franchising as an alternative mode of entry

into business and entrepreneurship. The program also include plan to train entrepreneurs,

franchisees and franchisor on franchise business at the same time promoting franchise

business opportunities and homegrown franchisors and franchise products nationwide and

internationally. NFDP gave birth to the Malaysian Franchise Association in 1994 and the

legislation of the Franchise Act 1998.

Malaysia’s franchise trade is a comparatively new business method that was first promoted

and supported by the Government since the early 1990s. National Franchise Development

Blueprint (NFDB) is been visualized to provide clear and specific goals and strategic

directions aligned with the National Development Agenda in achieving developed country
status and ensuring a high income economy. It is the first blueprint to be established for the

sector in Malaysia, and it was created to be a platform for the development of the industry

with the aim for Malaysia to be a franchise hub in South-East Asia and Central Asia by 2020.

One of the main objectives and strategies is to develop an industry that advocates Franchising

for All. NFDB looks to contribute to the achievement of those objectives through the support

and understanding of NFDB’s vision, mission, goals and implementation of its strategic

thrusts.

NFDB vision is to be vibrant and robust domestically and positioned as a franchise hub for

the South East Asia and Middle East markets and with the mission to contribute towards

national economic development agenda and creation of a high income society.

2.3.2 DIRECTION OF NFDB

NFDB covers a broad spectrum of stakeholders and target groups that include the existing

franchise fraternity, youth, women, the disabled, pensioners and many more, to provide

economic opportunities. The five years NFDB spans the period from 2012 to 2016 is to set

the overall strategic direction of the franchise industry in Malaysia. The NFDB lays out three

phases to help Malaysian franchise industry move forward and achieve its target:

 Phase 1 starts from 2012 to 2014 (3 years) and involves strengthening the franchise

players/industry and the franchise development framework.  Phase 2 starts from 2015 –

2016 (2 years) and involves working towards a vibrant and robust domestic franchise

industry, in line with the vision of NFDB.  Phase 3 starts from 2017 to 2020 (4 years) and

involves creating Malaysia as a Franchise Hub.

From the plan, we can summarize that the NFDB also aims to expand the focus from

traditional sectors (such as food and beverages, clothing, health & beauty), to new sectors

that have also been emphasized in New Economic Model (NEM) & Tenth Malaysia Plan

(10MP) such as education, green products & services, medical tourism, as well as Shariah

compliant products & services to penetrate the Middle East and other Muslim markets.

FIGURE 1 Sector Mix for the Next 10 Years Will Include Targeted Sectors

Source: National Franchise Development Blueprint 2012-2016

2.3.3 NFDB FRAMEWORK

The strategies and initiatives implemented in Phase 1 and Phase 2 will initially contribute to

positioning Malaysia as a franchise hub. NFDB already outlines four (4) Strategic Thrusts

(ST) to be achieved consists of:

ST 1: Enhance Competitiveness of Malaysian Franchise ST 2: Transform Malaysian Business

through Franchising ST 3: Develop a Competent Franchise Human Capital ST 4: Establish a

Dynamic Franchise Ecosystem These Strategic Thrusts that being set are mainly covering

Phase 1 and Phase 2 of NFDB. These Strategic Thrusts being supported by 36 Strategies and

140 programmes & initiatives which include in NFDB with the support of MDTCC, PNS,

MFA, the private sector and other related and relevant parties.

FIGURE 2 NFDB Timeframe

Source: National Franchise Development Blueprint 2012-2016

All recommendations and strategies highlighted in NFDB are being utilized as guidance and

association towards the development of the internal franchise industry across the prosperous
implementation. Furthermore, NFDB concentrated towards confidential sector-led

development alongside the power yet tolerate to frolic an act by bestowing the suitable

ecosystem for franchise companies and safeguard that franchise members are incentives-

driven. Hence, the involvement of supplementary relevant associations and parties are vital to

safeguard the prosperous of this blueprint. Brief explanation on the NFDB is available in

Appendix 2.

Besides, the NFDB also looks to contribute to the achievement of the National Development

Agenda objectives through the realization of NFDB’s vision, mission and KPI targets sets

forth as well as through the implementation of the four (4) Strategic Thrusts with the support

of MDTCC, PNS, MFA and other related parties. Key Performance Indicators set for

Malaysia Franchise Industry are presented below:

TABLE 2

NFDB’s Key Performance Indicator

Vibrant and Robust Franchise Industry

Target

Baseline Phase 1 Phase 2

2010 (2012-2014) (2015-2016)

Number of franchisors 492 650 860

Number of franchisees 4,838 6,050 6,715

Number of outlets 10,720 15,710 23,140

Source: Summary of National Franchise Development Blueprint 2012-2016

KPIs set for NFDB are meant for Malaysia Franchise Industry as a whole. However, PNS

only providing loan for Bumiputera franchisee and franchisor. Thus, a different set of

KPI with lower number of franchisors and franchisee has been set by PNS based on targeted

number in NFDB’s KPI.

TABLE 3

PNS’s Key Performance Indicator in line with NFDB

PNS

Target Actual

2012-2016 2012 - May 2013

Number of franchisors 80 16

Number of franchisees 800 354

Source: PNS Management Monthly Report as of 31st May 2013

2.4 THE ADVANTAGES OF FRANCHISING

There are two most usually counseled reasons for working a franchise, namely resources

constraints and efficiency (Frazer, 2003). A little firm onset franchising in order to attain

quick marketplace penetration lacking demanding admission to the capital marketplace,

because the vital capital can be endowed from franchisees. Resource constraints inspire them

to franchise (Caven & Murphy, 1976). It can additionally be extra effectual to increase via a

franchise web (Rubin, 1978). Inside the franchise arrangement, the franchisor provides the

start-up, ongoing and marketing assistance to franchisees. Additionally, the franchisor

monitors the quality manipulation of the produce or services. Therefore, below the franchise
web, the franchisee can be believed as the client of the franchisor (Frazer, 2003). The

franchise arrangement additionally provides countless momentous gains to the franchisor and

franchisee (Monroy & Alzola, 2005). The gains to the franchisor denote to countless points:

a) Franchising enables the franchisor to increase the number of businesses on a national or

international scale, and provides access to new markets by creating a distribution channel at

low cost.

b) It ensures the development of brand images and public relations since the franchisor

retains control of the distribution channel.

c) A franchisor has less staff problems, because the franchisor is not involved in the staff

problem of each individual outlet. The nature of the operations requires franchisees to be self-

employed. Franchisees are responsible for staffing management and operating costs of their

own outlet.

d) It will also be easier to develop areas that are not within the territory of an organization, as

franchisees with local interests and knowledge can be obtained.

Meanwhile, there are various advantages of franchising to the franchisee (Monroy and

Alzola, 2005). These advantages are:

a) The franchisee can access a proven business and sell a product or provide services with a

well-known brand name.

b) The franchisee needs less capital than if the franchisee were to start a new business

independently. This because the franchisor provides training programs and assists franchisees

in all aspects of setting up and opening their businesses.

c) The franchisee can obtain the benefit of the franchisor’s continuous research and

development programs to improve the business.

d) The profits earned as an independent business person. The franchisee has own business

through the background of assistance from the franchisor. The franchisee is an independent

business person within the frame of the franchise arrangement and the success of their

business relies on the amount of effort they put into it.

2.5 FACTORS CONTRIBUTING TO THE FRANCHISEE’S FAILURE

Failure, according to the Wikipedia it is described that the state or condition of not encounters

a desirable or aimed goal, and could be believed as the opposite of success. Thus, franchisee

wreck might be denoted as ineffective or non-performing person in working the

franchise company that emerging the franchise accord to be terminated or not been restored

on expiration date.

According to Mohd Harif, Hoe and Mahad Nor (2011), there are assorted factors that give to

the franchisee failure that have been debated from the Western and Malaysian literature as

follows:

a) Rapid expansion of the franchise business This factor could contribute to franchisee

failure when the franchisee could not fully adopt with the system guidelines and had

underestimated the market condition (McCosker 1995). When the franchise business grows

too fast, franchisee sometimes does not have enough capacity especially financial strength to

survive.
b) Franchisee greed Greedy franchisee according to McCosker (1995) and Mendelsohn

(1999) also a factor that contributed to franchisee failure. Lack of ability and strategy to

manage more than one franchise business owned by the franchisee would end up being

terminated because the business is not performing in achieving the business goals and

standards.

c) Attitude of the franchisee Mullner, Bernardi Glattz and Schnedlitz (2003) stated that lack

of entrepreneurial initiative and responsibility of the franchisee, lack of commercial

knowledge as well as negligent behavior were franchisee attitude that contributed to

franchisee failure. McCosker (1995) and Mendelsohn (1999) also supported this factor and

added that franchisee who experienced difficulty in adhering the format or the business

formula fixed by the franchisor are those with high potential to fail. Sometimes, franchisee

might developed attitudes of maverick and become non-conformist, thus disrupting the

franchise chain (Miranda, 1995).

d) Poor service Based on McCosker (1995) and Mendelsohn (1999), poor service rendered to

customers is one of the main reasons for franchisee failure even if the franchise business is

well recognized. e) Mismanagement of the franchise business In order to ensure the standard

of quality, services and goods are maintained, good leadership and management practiced by

franchisee and also good support staffs employed to render assistance is also a challenge

(McCosker 1995, Mendelsohn 1999, Miranda 1995). Even though, franchise business is a

proven business concept and assistance is continuously provided by the franchisor,

franchisee’ skills and knowledge to manage the business efficiently still the most important

ingredient to avoid failure. This includes ability to keep proper financial records, ability to
achieve goals, ability to handle management problems and sufficient preparation during

establishment (Mullner, Bernardi Glattz & Schnedlitz, 2003).

f) Bad relationship with franchisor Based on McCosker (1995) and Mendelsohn (1999),

franchise business is based on people relation and to develop or maintain good relationship

between franchisor and franchisee is crucial. The franchisee license would normally end up

been terminated or not been renewed after the expiration if serious conflict occurred.

According to Mullner, Bernardi Glattz & Schnedlitz (2003), lack of capacity of teamwork

and different perceptions of franchisor and franchisee would produce conflict that contributes

to franchisee failure. g) Legal imperfection Generally, franchising is an under-researched

area and the industry suffers from a lack of reliable information especially in legal aspect

(Mohd Harif, 2002). The legal aspect is considered important in order to develop and secure

the business code and conduct. In Malaysia, law of franchise is very much depends on

Malaysia Franchise Act 1998 and the Act does not provide for any usage of Alternative

Dispute Resolution as a method to settle any dispute in franchising industry compared to

other countries. Many

issues could contribute to conflict or disputes such as misunderstanding between franchisees,

undercutting among franchisees, refusal of franchisees to participate in group activities /

events and franchisees violating franchise rights. Failure to provide fair justice and improper

channel that could effectively resolve the conflict would be considered as factor that could

contribute to franchisee failure.

h) Wrong selection of the location A wrong selection of location also could be the factor that

contributes to franchisee failure (Mullner, Bernardi Glattz & Schnedlitz 2003) where it can

influence the product or service acceptance by the customers. If more than one of the same
franchise businesses exists in one territory it indirectly will increase the competition stiffness

and failure risk among the franchisee.

i) External factors External factor also been discussed by McCosker (1995) and Mendelsohn

(1999) as one of the factor contributed to franchisee failure which is beyond franchisee

control. For example, currency devaluation, aggressive and cheaper competitors, downturns

in the economy, government rules or regulation and diplomatic relationship between two

countries.

j) Under capitalization of the franchisee This factor is considered as main factors discussed

by all authors in their literatures. Based on Sherman (1995), operating capital must be

sufficient especially in the early stages of the business as it is required for development and

implementation of franchising program as well as the ongoing costs of support. The larger

and more successful the business, the larger capital is needed. When the business prospered,

franchisee that is under capitalization will be facing difficulties when the capital became

inadequate for funding its debtors and stock, purchasing new equipment or coping with

unexpected financial surprises.

k) High overhead expenses In the franchise business, besides startup costs or initial fee need

to be paid to franchisor, franchisee also is obligated to bear other monthly payments such as

royalty, contribution for promotion fund, refurbishment fund, utilities payment and other

expenses. Franchisee who is not capable to abide with the high expenses would likely to fail.

l) Cash flow mismanagement This factor also been discussed by Sherman (1995) that

contributed to the franchisee failure when the cash flow is being misdirected and mismanaged

in order to pay for operating expenses and support costs.

m) Bad payer’s franchisee Bad payers showed an indicator that the franchisee is ineffective

in managing the franchise business that could endanger the franchise reputation (Spicer &

Pegler, 1985).

2.6 SUMMARY OF THE CHAPTER

This chapter is important in order to provide insights on the Franchise industry in Malaysia

and the relevant data that is needed for the study. It also provides the factors that might

influence and drive PNS to enhance their capability and role as franchise business partner and

to assist PNS in developing their strategy. To answer our research questions, the research

methodology will be discussed in Chapter 3.