Corporate Venturing, Networking, and Franchising

Key Learning Objectives:

Corporate Venturing

4  understand what intrapreneurship is and why some corporations adopt it

4  understand the differences between intrapreneurship and entrepreneurship

4  understand the obstacles to intrapreneurship

Networking

4  understand the motivations for a business to form a joint venture

4  understand the factors to consider in selecting a joint venture partner

4  understand the major types of business alliances

Franchising

4  understand the motivation for franchising from the point of view of the franchisor and the franchisee

4  understand the major types of franchises

4  understand the potential problems franchises can present for franchisees

Summary

This chapter is divided into three major sections which are somewhat related through their focus on relationships.

The section on intrapreneurship begins by defining the term and discussing its importance in today’s competitive marketplace.  Intrapreneurship is then compared and contrasted with entrepreneurship.  A five-stage model of the intrapreneurship process is presented, followed by some practical observations concerning obstacles and guidelines for success. 

The section on networking and alliances opens by outlining the main benefits and motivations for forming networks and alliances.  Several network concepts are introduced, including informal versus formal networks, personal networks, strong versus weak ties, and extended networks.  Four types of alliances are described and guidelines for selecting partners are presented.

The section on franchising begins by introducing the franchising concept and reasons for its rapid acceptance.  Motivations for employing franchising as a growth strategy are discussed and several types of franchises are identified.  The section concludes by discussing some of the problems and pitfalls of franchising from the perspective of the franchisee.

INTRAPRENEURSHIP

Introduction

Intrapreneurship refers to the development within a large corporation of internal markets and small, autonomous business units that commercialize innovations by employing the firm’s resources in a unique way.  Rather than merely extending an existing product or brand, it usually somehow represents a break with the past.  Intrapreneurship is increasingly being recognized by large firms as important for survival in the turbulent and rapidly changing environment we now face.  Intrapreneurship also permits a firm to diversify and thus reduce its risk.  Traditionally this has been accomplished through mergers and takeovers but history has shown these often result in failure; moreover, intrapreneurship affords the corporation a greater degree of control over the expansion process.

Intrapreneurship versus Entrepreneurship

There are both similarities and differences between these two processes.

a)   Both intrapreneurs and entrepreneurs want and need autonomy and freedom, but the intrapreneur must work within the existing corporate hierarchy. 

b)   Intrapreneurs already have an existing support system in place which they can access; entrepreneurs more or less have to start from scratch. 

c)   Whereas entrepreneurs need to look to themselves and outside to obtain resources for the new venture, intrapreneurs usually look inside their existing organization and try to co-opt under-utilized resources. 

d)   Entrepreneurs face personal financial risk whereas intrapreneurs face career risk in the event of failure.

e)   In the case of intrapreneurship, the parent corporation can lend its substantial visibility and reputation to the new venture; in the case of entrepreneurship, image and reputation must be created gradually. 

f)    Ownership and control also constitute an important difference: entrepreneurs own and control their own enterprises whereas intrapreneurs are still employees of their parent firm. 

g)   There are also some differences between an intrapreneurial business plan and an entrepreneurial business plan: i) the intrapreneurial business plan does not need an ownership section;  ii) the intrapreneurial plan does not seek outside financing;  iii) the intrapreneurial plan needs to identify the nature of the relationship between  the corporation and the new, internal venture.

The Process of Intrapreneurship

The intrapreneurship process consists of five stages:

      1)   Problem/opportunity definition - may come from inside or outside the firm.  Includes information gathering.

      2)   Coalition building - developing relationships within the corporation to build support for the project.  A business plan is used.

      3)   Resource mobilization - resources are often acquired by borrowing from other projects

      4)   Project execution - the start-up of the internal corporate venture (IVC)

      5)   Venture completion - if successful, the IVC assumes a permanent position in the corporate structure; if unsuccessful, the project is dismantled and its resources are reabsorbed by the corporation.

Barriers to Intrapreneurship

On the surface, IVC’s would seem to possess some powerful advantages over ventures created by entrepreneurs, especially with regard to access to the vast internal resource pool and the public image and reputation of the parent corporation.  Despite these advantages, however, intrapreneurship appears to be extraordinarily difficult for large corporations to accomplish.  Failure is far more common than is success.  Some reasons for this are:

      4  corporate bureaucracy - can result in decisions being made too slowly or being “watered down” and diminished in effectiveness as they move through the hierarchy

      4  existing managers may feel the new project threatens the status or resource base of their product line and therefore put up resistance

      4  people often tend to resist any type of significant change since it presents more uncertainty

      4  the absence of venture capitalists who can provide valuable contacts and knowledge of new industries

      4  a tendency for large firms to focus on short term efficiency and profitability rather than long term success

      4  lack of ownership by the intrapreneur reduces personal commitment

The internal structural forces inherent in large corporations are often too strong for fragile new ventures to overcome without a radical change in thinking on the part of the parent firm.  Some guidelines for overcoming these obstacles are provided by Pinchot in the form of a bill of rights (p. 411-412 of the textbook).

NETWORKING AND ALLIANCES

Network Concepts and Terminology

Networks consist of relationships.  A personal network is an informal network that consists of all the people you know and have direct contact with, including family, friends, fellow students or co-workers and acquaintances.  Relationships in personal networks are based on trust, predictability and voice (the implicit permission to disagree, argue and dispute problems).  Relationships can be characterized by their tie strength.  Strong ties represent relationships where there is frequent contact and where the relationships are close and enduring due to a family relationship, a long shared history, shared values, etc..  Weak ties describe relationships where contact is infrequent and the relationship is looser, more temporary and more instrumental.  Weak ties can be very useful because they allow our networks to be much larger than they otherwise would be, and because they contribute increased diversity.  Extended networks consist of relationships between firms and are established through boundary-spanning activities of the owners/managers. 

Entrepreneurs need to cultivate both strong and weak ties in the process of developing a venture.  Strong ties can be very useful.  Because strong ties are based on trust, information and other resources can flow more freely and quickly, with fewer demands and constraints.  But weak ties are also very powerful because of the diversity they bring.  This diversity may be reflected in the new information they provide.  Research has demonstrated, for example, that weak ties are more important than strong ties in the process of finding a job.  Because strong ties tend to be associated with people more like ourselves, the resources they offer may often be redundant.  Weak ties, on the other hand, offer the potential for providing a broader range of resources.

Motivations for Using Personal Networks

Informal network relationships can be invaluable in the process of starting a new venture.  The assistance they provide tends to be valued highly by entrepreneurs.  This can include capital, labour, information about the environment (opportunities, competitors, customers, regulations, etc.), advice, expertise, additional network contacts, credibility and legitimacy, acting as a sounding board, and encouragement and emotional support.

From the perspective of the actors comprising a personal network, the motivation for providing informal support can stem from the personal relationship with the entrepreneur or from being captivated by the entrepreneur’s vision and wanting to provide assistance to help make that vision a reality (this latter motivation becomes even more important in the case of weak ties).

Joint Ventures

A joint venture is formed when two (or more) firms come together to create a new organization that is jointly owned by both firms.  The textbook uses the term formal network participation to describe this process.  The motivations for forming joint ventures can be classified according to four types.

4  Internal motivations - stem from the desire to cut costs or reduce risks

4  External motivations - relate to an opportunity to enhance current market or industry position.  Joint ventures are often used, for example, to enter foreign markets.

4  Strategic motivations - similar to external motivations, but with a long term view to strengthening strategic position in the future

4  Social motivations - enhance the values and social concerns of the entrepreneur

Forms of Reciprocal Agreements

      alliance - an informal agreement between two or more businesses for a specific purpose

      partnership - a formal bilateral agreement with pooled assets between firms for a specific purpose

      collective - a group of businesses organized to work together as one unit

Alliances

There are four types of alliances in which entrepreneurs engage.  These can be classified according to two dimensions:  1) whether the relationship is direct or indirect;  2) whether the relationship is with a competitor or non-competing firm.

4  Confederate alliance - direct contact with a competitor (e.g. convenience stores forming a buying group to obtain bulk discounts)

4  Conjugate alliance - direct contact with a non-competing firm (e.g. joint advertising with a supplier)

4  Agglomerate network - a set of indirect relationships among competitors (e.g. industry associations)

4  Organic network - an indirect relationship between non-competing firms (e.g. chamber of commerce)

Partner Selection Criteria

If you ask the Newfoundland firms who are planning for major growth how they intend to accomplish it, most will tell you they are planning to export (in order to access larger markets) and that they intend to partner with other firms.  Partnerships are very popular these days, but that is not to say that they’re easy.  Only one out of four partnerships is successful.  Those firms who have experience in partnering often say they learned a lot about what not to do in their first attempt.  For many firms, the first partnership they enter into is often the result of what seems to be a unique opportunity – an expression of interest from a willing firm!  Firms with experience in partnering, however, have learned that this approach, which entails minimal search and investigation up front, usually results in a great deal of frustration and wasted time, effort and money over the next few years.  Instead, a partner should be searched for according to criteria that you have developed.  These criteria normally include:

      4  strong commitment to the partnership

      4  compatible top management

      4  shared goals

      4  complementary skills

      4  mutual dependency

      4  good communication

      4  strong reputation

FRANCHISING

Franchising is defined as a marketing system where the owner of a service, trademarked product or business format grants exclusive rights to an individual for the local sale of the product in return for a franchise fee, royalties and the promise to adhere to quality standards.  The franchisor is the seller of the franchise and the franchisee is the buyer of the franchise.

The Franchisee Perspective

The growth of the franchise industry has been phenomenal.  Several powerful statistics are cited on page 424 or the textbook which attest to the popularity of franchising.  In Canada there are over 1100 franchisors, with franchise sales representing roughly half of all retail sales.

For the franchisee, the purchase of a franchise has the potential to provide a number of important benefits:

      4  established brand name appeal

      4  proven track record

                  Ÿ    providing stronger forecasts based on similar operations (reduces risk)

      4  training & guidance, which can help to overcome barriers to entry such as...

                  Ÿ    industry experience

                  Ÿ    management experience

      4  financing assistance

                  Ÿ    from franchisor, sometimes

                  Ÿ    from banks, sometimes...

                           -   lower interest rates

                           -   higher level of loan funding

      4  possible lower working capital requirements, due to...

                  Ÿ    tighter control systems

                  Ÿ    better forecasts

                  Ÿ    volume purchase  discounts

These are, of course, potential benefits.  It is the responsibility of the franchisee (or rather, potential franchisee) to investigate thoroughly the extent to which each of the above benefits exists.  If the franchise is priced fairly, the price should reflect the extent of the benefits and corresponding reduction of risk.  The potential benefits will vary with the individual circumstances of the entrepreneur.  It may be, for example, that the costs of the franchise fee and royalties outweigh the benefits in the case of someone with substantial industry experience.  Moreover, potential franchisees need to carefully assess their motivations for going into business themselves.  If the primary motivation is independence or autonomy (which is, in fact, the case for the majority of start-ups), a franchise may represent a poor choice because the entrepreneur is legally obliged to operate the business in a prescribed manner.  In a number of respects it represents a managerial role rather than an entrepreneurial role.

The Franchisor Perspective

For the franchisor, franchising represents a special kind of growth strategy.  Franchising provides a mechanism for the franchisor to:

      4  multiply rents

      4  grow more rapidly by using other people’s money than would be possible by financing growth from firm profits

      4  achieve increased economies of scale

      4  establish a regional or national image for the firm

      4  achieve superior performance through local ownership and the corresponding higher commitment that ownership provides

The latter benefit listed above is achieved by solving the agency problem.  An agency problem is created when ownership and control of the firm are separated (as in the case of publicly-traded firm, for example, where the firm is owned by external shareholders and controlled by internal managers).  This is because the goals and interests of owners are often not the same as those of managers.  Because franchising places both ownership and control in the hands of the franchisee, the agency problem is minimized or eliminated.

Types of Franchises

1)   Business format - A product or service is marketed under a common trade name from standardized outlets.  Based on “cloning” the format.  Very common in fast foods, retail and car tuning sectors.  Examples include Tim Hortons, MacDonalds, Speedy Muffler.

2)   Exclusive right to trade - Based on providing access to a market where access is restricted, creating a monopoly situation.  Examples include outlets located in airports and along highways with restricted access.

3)   Distributorship - Where the manufacturer grants rights to a dealer.  Examples include automobile dealers, gas stations, Coke and Pepsi distributors.

4)   Registered trademark franchise - Where the franchisor grants the use of its name in return for a promise to meet certain standards.  e.g. Best Western hotels.

5)   Master franchise – Franchisor sells the rights to a master franchisor to sell individual franchises in a large geographic area (e.g. Australia or Newfoundland & Labrador).  Allows rapid expansion for the franchisor but sacrifices control.

Franchisor Considerations

Not all kinds of businesses are suited to franchising.  Those that are tend to exhibit the following characteristics:

4  a product for which there is continuing demand

4  a mechanical, routine system of operation

4  measurable standards for quality

In addition, the franchisor should possess strength in the following areas:

4  a name that is easily remembered

4  marketing and advertising

4  site selection

Before implementing a franchise strategy, a potential franchisor usually opens and operates a series of pilot stores.  While operating these units, the franchisor must learn what key factors are needed to make the business successful so that they can train others how to be successful too.  They also need to assemble the capital needed to cover the costs of franchising, which include:

      1)   research & development

      2)   creation of the franchise package (especially legal costs)

      3)   marketing the franchise

      4)   working capital

Franchisee Considerations

Potential franchisees should begin by performing a self-assessment to see whether they are suited for becoming a franchisee.  Some of the considerations will overlap with the requirements for entrepreneurs starting a business (e.g. capital, commitment, energy, etc.) but some will differ.  Becoming a franchisee, for instance, offers less freedom and independence than starting your own business.  Potential buyers of a franchise must always investigate the franchisor thoroughly to ensure they are not buying into a “fly-by-night” operation.  It’s important to talk to other franchisees to see how satisfied they are with their relationship with the franchisor.  Sometimes franchisees have higher costs than normal because their contract requires them to purchase their supplies from the franchisor, who may use this as an additional means of generating profits.  Sometimes franchisors buy back their most successful units at the end of the contract, leaving the original franchisee with little to show for building up a successful business.  This has happened to many local service station operators in recent years as major companies such as Esso and Irving have reacquired control over their units.  It is important to realize that their is little legislation in Canada concerning franchisor obligations and the rights of franchisees.  Alberta is the only province having specific legislation that addresses these issues.

Discussion of Selected End-of-Chapter Questions

Intrapreneurship

1. What benefits can corporations gain through successful intrapreneurship?

Intrapreneurship provides large corporations with the opportunity to adapt to the increasingly dynamic, hostile, and heterogeneous environment businesses face today and to conduct market experiments. It also allows them to diversify from their core business through internal processes, overcoming possible aversions to “foreign” technologies, products, and processes. It may even be possible for a corporation to give birth to a new industry through intrapreneurship.

3. How is the intrapreneurial business plan different from the entrepreneurial business plan? Why is this so?

Intrapreneurial business plans differ from entrepreneurial ones in three ways:

•   The intrapreneurial plan does not have an ownership section.

•   The intrapreneurial plan does not seek outside financing, relying instead on internal capital.

•   The intrapreneurial plan needs a section describing the relationship between the corporation and the internal corporate venture. (ICV)

The primary reason for these differences is that the corporation owns the venture.

4. What impediments do large corporations impose on intrapreneurial efforts?

Corporate-imposed impediments include the following:

•   The major barrier of corporate bureaucracy.

•   The new venture may threaten an existing product line, so other managers may resist the change.

•   Structural impediments may exist.

•   Internal capital markets lack venture capitalists who can contribute technical expertise, contacts, and experience in initiating new ventures.

•   Intrapreneurs do not own the ICV, so the incentives and risks differ from those of the entrepreneur, and an important motivational force is removed, resulting in either premature project abandonment or escalation of commitment to failing causes.

•   It is difficult to pay the rewards of intrapreneurship without incurring the resentment of other employees and managers.

Franchises

01  (Note: This question is not in the textbook.)  Approximately 30 percent of franchises are company-owned.  A company-owned franchise is a franchise owned by the franchisor and run by a manager rather than owned and operated by a franchisee-owner.  Research has shown that these company-owned franchises are less profitable, have lower sales and are more expensive to administer than units owned by franchisees.  Why?

Franchisee-owned units can be expected to out-perform company-owned units because the problem of agency has been resolved in franchisee-owned units whereas the agency problem still exists in company-owned units.  Franchisees have invested their personal savings in order to acquire a unit and therefore have a greater stake in its ultimate success.  Consequently, franchisees are likely to have a higher degree of commitment to the business and be willing to work harder to ensure the business is successful.

A second potential reason for the poorer performance of company-owned outlets (and one which was not discussed in the textbook or chapter notes) is that franchisors may be tempted to buy back under-performing units in an effort to disguise the fact that some of their franchises are not successful.  This again highlights the need for the potential franchisee to carefully investigate the franchisor so as not to be fooled by advertising claims and bogus statistics.

6. Why has franchising been so successful in the United States? Does it have the same potential worldwide?

Franchising has become so successful because it allows the franchisor to expand the business boundaries using another person’s capital and to exploit the franchisee’s local knowledge and willingness to work hard. From the franchisee’s point of view, franchising is attractive, since it allows her to buy into a new firm that has a better chance of success, due to the work on the part of the franchisor, than does the average new start-up.

      There is no reason why franchising should not be as successful internationally as it is in the United States as long as the franchisor is able to understand the markets it is attempting to enter. While the local franchisee’s knowledge will help make the company strong, especially in the international setting, it is possible that there is no demand at all for the franchisor’s product or service in the geographic into which the franchisor wishes to expand.

7. Why is the pilot store so important for the potential franchisor?

The pilot store allows the franchisor to bear the cost of developing the elements of the formula for success, including accurate site selection, efficient operations, internal and external financial keys and ratios, operating cost control, a consistent and workable pricing policy, and training procedures for both potential franchisees and their employees. It also helps determine how much to charge for the franchise to allow the franchisee to make a fair profit.

      In effect, the pilot store allows the franchisor to iron out the bugs prior to offering the concept to franchisees, increasing the chances for success on both parts.

10. What should a franchisee look for in evaluating a franchise opportunity?

A franchisee should look for

•   proven operation locations to serve as a prototype and prove the do-ability to the customer;

•   a credible, supportive, experienced top management team;

•   a skilled field support staff;

•   a distinct and protected trade identity, including trademarks, signage, slogans, trade dress, and overall image;

•   a proprietary operations manual;

•   training programs for the franchisee and management;

•   disclosure and offering documents that meet all federal and state regulations;

•   advertising, marketing, public relations, and promotions plans that are prepared and available;

•   a communications system with ongoing dialogue between the franchisor, franchisee, and the entire network of units;

•   sufficient capital to get the franchise off the ground.

DISCUSSION CASE - FRANCHISE

Oniisan is Watching.

1. Do you think electronic controls represent the “most advanced” retailing methods in the world today? What other methods typify successful retailers now?

Frankly, it is pretty advanced. But without training and incentives to use the systems, they will not work. And, although the systems can tell you everything you need to know about current inventory, it tells you nothing about what you don’t carry. In other words, it doesn’t follow innovative trends, fashions, and fads. For that, you need personnel in the stores to listen to customers.

2. How do you think most 7-Eleven franchisees in the United States will respond to Ito-Yokado’s methods? How much will they be swayed by the prospect of doubling sales?

Since franchising is an “in-between” enterprise — not truly entrepreneurial and not truly corporate, I would expect that some folks will be pleased to see the new system and indifferent to its negative effects, as long as it doubles sales and decreases investment in inventory. Reducing turnover from 25 to7 days is remarkable and has a direct impact on profits (see cash flow management in Chapter 10). But there are some franchisees who did go into business for increased autonomy, and they may chafe at the prospect of being monitored all the time.

3. What could Ito-Yokado do to promote their methods and electronic management to U.S. operators?

They need to hold sessions explaining the systems and, perhaps, making them voluntary at first. Training is required. And if the systems are paid for by the franchisee, low cost financing would be a plus. If the system produces the results it promises, more and more volunteers will be forthcoming and, eventually, the system can be made mandatory.

4. What message does the Ito-Yokado model send to other franchisers?

The message is that Ito-Yokado intends to be the most profitable franchisor and that will help it attract the best franchisees. It is the game within a game.