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Buyer Beware in the Malaysian Franchise Industry
by Murray Hunter
2013-12-10 12:15:44
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Buyer Beware in the Malaysian Franchise Industry
Murray Hunter & David Teoh

The possibility of becoming a successful entrepreneur in Malaysia is a dream shared by many. This avenue was widened through encouraging the formation of franchises where potential entrepreneurs could easily purchase a 'proven' business model and benefit from that successful business concept.

In the mid 1990s the Malaysian Ministry of Domestic Trade and Consumer Affairs was given the responsibility under the Franchise Act 1998 to develop and regulate the industry.

malay01_400Singer was the first company to introduce franchising to Malaysia in the 1940s. The first F&B successful franchise in Malaysia was the US A&W, which opened its first outlet in Petaling Jaya in 1963. Very soon afterwards many other successful outlets were opened all around Klang Valley. In the following decades, MacDonalds, KFC, Pizza Hut, and Kenny Rogers were established in Malaysia.

The concept of franchising was soon seen as a means of creating new Bumiputera entrepreneurs. Under the then Mahathir Government, retired public servants were encouraged to  become entrepreneurs through buying into a franchise. The then deputy domestic trade minister Abdul Kadir bin Sheikh Fadzir became the public proponent of franchising, organizing seminars and workshops on the concept all over the country.  

Franchising in Malaysia became a massive growth industry with the setting up of the Malaysian Franchise Association in 1994, attracting a number of consultants and brokers into the action. A screening and selection system, as well as a number of bureaucratic requirements were enacted, making the procedure to become either a franchisor or franchisee very cumbersome. Consequently, after a very hopeful beginning, the combination of bureaucracy, regulation, procedure, and plain dishonesty among some franchisors has brought misery and suffering to many unsuspecting franchisees. Franchising was seen by some as a means to make quick money.

The Franchise Development Program (FDP) requires franchisors to undertake a number of steps and procedures before they can be registered under Section 6 of the Franchise Act. Registration enables a company to be eligible for a grant, RM 100% for Bumiputera companies, and RM50% for non-Bumiputera companies. The catch here is ministry officials require franchisors to employ a consultant, usually of their choosing to aid the process, where fees may be as high as 40% of the total grant available. Many unhappy franchisors have suggested to the authors that some collusion exists in this process between consultants and officials.

Most consultants are not registered with the US based and internationally recognized International Franchise Association (IFA). These consultants commonly approach potential franchise businesses promising to expand their businesses through franchising. They arrange for grants without much scrutiny over the franchising viability of the businesses they have been engaged to develop franchise models. Consequently the market is full of many dubious business models.

This results in franchises that have little real potential for franchisees to make a go of it. Successful SMEs that go down this track are poorly advised and often fall into financial difficulties. Franchisees who sign up with them don't last long in business. The only group who has profited out of this process is the consultant.

The problem today is there are so many franchises up for sale, some bona fide and some non-bona fide, the quality on offer varies widely. Nascent entrepreneurs with little or no experience make the assumption that regulated franchises have been screened for business model viability. What more, some franchises like TuitionMall.com or Pusat Bahasa Titian Jaya imply that the company has a connection with Cambridge, when this is not the case.

The Malaysia franchise Association vetting system lets down unsuspecting potential franchisees. It's really buyer beware in the franchise market.

A number of franchisors see franchising as a means to extract money from franchisees, rather than a means to develop a brand and business. For example two Kuala Lumpur entrepreneurs signed a franchising agreement with an F&B franchisor based in Johor. The franchisor encouraged the franchisee to install a music box and have a band at the venue for extra franchisee costs outside the royalty agreement based on sales turnover. As a result the franchisee business became commercially unviable and the franchisor insisted on a legal remedy which cost the two entrepreneurs their full investment of over RM600K. This appears totally irresponsible for any franchisor who is interested in nurturing its brand and business, but rather only interested in extracting as much as it can through franchise fees without concern for long term viability.

Most franchise agreements have been drawn up in favor of franchisors and when a business becomes unviable, franchisor requirements put the business into financial trouble.

A litigation lawyer disclosed to the authors that due to the unfairness of the Franchise Act in its favoritism towards franchisors, very few franchisees have been successful in gaining any legal remedy from unscrupulous franchisors. Most court decisions have been made in favor of franchisors.

The franchise industry has made many successful consultants like Abdul Malik Abdullah of D'Tandoori fame, but unfortunately there are a large number of local franchise failures, that are tend to be hidden with all the hype about the success of the industry. Even though the industry can point to the success of many local franchises like Nelson's and Marrybrown, the vulnerability of any successful branded franchise can be seen in Secret Recipe going into receivership in Australia.

There has also been criticism of the Malaysian Franchise Association lack of effort in promoting ethics within the industry by its membership.

Part of the problem may appear to be in the way the Perbadanan Nasional Bhd (PNS) is promoting grants and start-up loan packages to businesses. The question is whether this is encouraging predator consulting practices within the industry.

The industry is full of consultants and brokers, who conduct courses and workshops which may encourage the vulnerable into inappropriate products and businesses. Many franchisors are reckless and over sell their ideas to gullible people who lack any sense about doing due diligence on a business concept.

Some consultants are charging up to RM160K to secure company registration as an approved franchisor.

The onus is on the Malaysian Franchise Association, as many within its membership desire, to do its part in cleaning up the industry. One of the franchise traps that is bringing many small franchisees undone, are the extra charges over and above royalties that crafty franchisors are demanding from franchisees. 

Potential franchisees need to look very closely at any franchise they may consider signing up to. This will require a review of how the business model works and scrutiny about both how much the business would cost to operate on a monthly basis, the potential revenue, and total payments required to be paid to the franchisor through the agreement. Is the planned location suitable for this franchise? Potential franchisees should go and look at the operations of other franchisees and talk to them about the franchise business, focusing particularly on the relationship between franchisor and franchisee.

Potential franchisees should look at what they are getting for the fees they pay. How much is the franchisor putting back into brand support and promotion? They should ask who is the franchisor and do they really have the affiliations they claim to have? Is the franchisee entitled to new products? if so, are there any extra, one up fees besides royalty payments? In the event of financial difficulties or the need to close down for any reason, can the franchise agreement be easily terminated? Does the franchisee have the necessary skills and knowledge to run the business and what sort and duration of training is offered by the franchisor? Most importantly, does the franchisee have sufficient financial backing to undergo this venture?

Surprisingly, these types of questions are rarely asked by new entrepreneurs.

Finally what should also be considered from the national perspective, is the affect on national creativity and innovation from the franchising phenomenon. Although, the thinking behind franchising is that those who engage in franchising are less likely to fail in a new business, the framework of franchising itself frowns upon franchisees who themselves innovate. Thus franchising on a wide scale may have the effect of suppressing entrepreneurial creativity. Franchising kills creativity.

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