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Legislation is urgently needed to monitor this sector, which in Peru, moves nearly 900 million dollars a year. Is a franchise really ‘big business’, or is it a high-risk market due to the lack of regulation?

Simply amazing- Every fifteen minutes a new franchise opens around the world and in Latin America, countries with the largest number of local franchises are, in this order: Brazil, Mexico, Venezuela, Argentina, Uruguay, Colombia, Chile and Peru, although globally the United States is the undisputed leader in franchising, ahead of Canada, Japan, Australia, England and France, with over 900 million establishments operating with this business system, directly generating 11 million jobs, equivalent to 8.1 % of jobs across the U.S. private sector.

RAIN OF MILLIONS IN THE FRANCHISE MARKET

The total franchising market in Peru, according to official figures, moves about 860 million dollars per year, with 140 million of that corresponding to Peruvian franchises with establishments in the country and abroad. Also, at least some 100,000 Peruvian companies have the conditions and are waiting for an opportunity to franchise their brands. This system of trade expansion has been relaunched with great force in recent years, so today, the domestic market is experiencing a second boom in franchising. It’s no surprise that 170 franchises currently operate in our country, of which 48 are Peruvian and 122 are foreign brands, mostly American.

Today, Peruvian franchises have managed to open 311 locations nationwide, 67% in Lima and 33% in domestic cities such as Arequipa, Ica, Piura, Trujillo, Cajamarca, Cusco, Chiclayo, Huancayo, Ayacucho, and others, as well as 75 stores in 16 countries, six of which constitute 67% of the international presence in Peru. Also, when a Peruvian franchise is taken abroad, it produces a 'drag factor' that also benefits those who trade Peruvian products that foreign investors need to implement their projects.

However, incredibly, this profitable business model that since 1993 has operated in our country, has not been properly or timely regulated by the Peruvian State through laws, that besides promote and protect private investment, are able to control and monitor both franchises and franchisers, as well as the franchisees, thereby preventing millions of dollars a year to continue to circulate under the rules of informal game, tailored to specific economic interests and imposed by the franchisers themselves without formal recognition of a Law by the Peruvian State.

This irregular situation would be causing the relationship between franchisers and franchisees and the franchise business in general, to be headed down a fragile mantle of 'apparent formality' and not, as it should be on solid legal foundations endorsed by the Executive and Legislative powers of our country to ensure not only fair trade, but mainly, clear rules that are publicly known, as all the laws of our country, which advocate a responsible and consistent behavior on the part of franchisers and, above all that facilitate the implementation of tools to assist the competent authority for the proper monitoring of each and every one of the agents involved in the wealthy and growing world of franchising in Peru.

A LITTLE HISTORY ON FRANCHISING

The franchising business is a format aimed at the marketing of goods or services, by which a company that has achieved commercial success in a particular sector, known as a franchiser or independent-franchiser transmits to another employer or franchiser-franchisee- all the acquired 'expertise' (know how, manuals, experience and knowledge) and the right to use its trademark, in exchange for an upfront payment plus a percentage of royalties. In other words, it’s the cloning of a successful business in the hands of another.

Kentucky Fried Chicken was the first international franchise to enter Peru, despite during periods of domestic war that were inappropriate for Peruvian and foreign investors. The American brand had to endure 25 years of terrorism and political instability. Its first store, located on Avenida Arequipa, in the district of Miraflores, was twice the target of bombings by the guerrilla group Sendero Luminoso.

However, the dedicated investors of fast food decided to put on a brave face and so, more franchises from United States started to arrive, such as Pizza Hut, Tony Roma's and Burger King brands with an image already established in our country. Indeed, between 1993 and 1996 the first boom of franchises in Peru was established, although 95% of these were foreign, mainly from the United States, they achieved high rates of development in our country, but subsequently, following the Asian crisis, suffered a serious impasse.

What business can become a franchise in Peru? According to trade and business management experts, any business concept that works and that is commercially attractive can become a franchise brand and generate high levels of sales, advertising, and provide nationwide coverage. However, the business must demonstrate its sustainability by ensuring that the investment can be recovered within a period not exceeding three years. Also, for this franchise business to be franchisable abroad, again, it has to be distinguished by its brand, image and path, besides being sufficiently tested in the domestic market, opening up to 20 franchises of its brand across the country.

HIGH RISK BUSINESS DUE TO LACK OF REGULATION

Although a franchise is not a novel approach and, rather, it is a well known business and recurring at the international level, in Peru it has just become a boom in recent years, achieving sustained growth rates and it’s even considered that by the year 2012, our country would be recognized as a leading provider of franchises in Latin America. Today, entrepreneurs in Chile for example, are willing to pay up to $40,000 to purchase the franchise from a Peruvian restaurant- the Chilean public demand for Peruvian cuisine is truly impressive and they invest up to $200,000 more to open such a place in Santiago or another city.

But is this a business of high or low risk? While the initial investment to acquire a franchise in Peru is low compared with other countries, does the Peruvian State protect the investor, supervise closely the contracts between franchisers and franchisees, or impose sanctions when a party fails to meet its trade obligations? Does the foreign investor interested in a franchise in Peru know that the Peruvian government only plays a shy promoter-role and not an active watchdog one over any irregularity in this kind of business?

Under the circumstances, in our country a franchise is definitely a low risk business but on the contrary, mainly due to the absence of Franchise Law to serve as a stimulus for a safe and reliable investment within the national territory to protect and defend the rights of investors against the voracious appetite of unscrupulous businessmen or “greedy franchisers” who, eager to earn more money, could offer a brand as a franchise when it’s not, or charge for the use of a trademark without providing the franchisee the knowledge, expertise, technical and legal support in case problems arise, leaving the investor to its own fate since there is no state regulator and supervisor of the international business model that moves millions dollars a year in Peru and the world.

“JUNK” FRANCHISES AND STATE INACTION

Officials linked to the Ministry of Foreign Trade and Tourism (Mincetur) and the Commission on the Promotion of Peru for Exports and Tourism (PromPeru), incredibly have said, countless times and in different forums that this model of business expansion called 'franchising’ is a low risk system that almost never generates losses, which works like a Swiss watch and it only takes a median investment to implement it, since 90% of the franchises with the greatest demand in Peru require only an initial expenditure of between 10 thousand and 100 thousand dollars, costs relatively affordable compared to other countries in the region, where awarded a franchise business depending on type and location could cost up to $500,000.

That is, these government representatives have systematically concealed information from the public and established, by error or omission, the level of commercial risk of a franchise prioritizing only the cost of the investment, without taking into account that an investment without laws to regulate and protect it is a real leap in the dark. In other words, they exclusively defend the rights and interests of franchisers or owners of the brand, but do not show the same interest when it comes to defending the investment of those who buy the right to use a trademark (franchisees).

In this millionaire franchise business there is a varied terminology that, in it, separates the good franchises from the bad. For example, a franchise of undisputed reputation and proven performance, offered by businessmen who, despite the absence of a specific law on the matter, act responsibly and within the law, may give rise to a master franchise (which give rights to franchisees to sub-franchise within a region, country or continent, acting on behalf of the exclusive franchisee in the territories defined in the contract); multi-franchisee (where the franchisee has several franchises belonging to the same brand is often a good indicator of the success of a franchise, because no one would invest in another store of the same brand if it wasn’t successful) or a multi-franchise (where the franchisee manages franchises or brands that are often complementary and not competitive).

However, in this concrete jungle called 'franchise market' and given the zero control by the competent authority, there are also so-called 'junk franchises', which for some franchises would not be appropriate, rather, 'greedy franchises' like brands that unscrupulous businessmen launch and promote in the market for franchises without having the expertise or sufficient support, consequently resulting in the franchisee losing, in whole or in part, their investment.

INFORMALITY, BIG BUSINESS FOR LOBBYISTS AND BUSINESSMEN

Indeed, the Peruvian government doesn’t seem to care about this irregularity flavored fraud, let alone its officials related to the subject, who do not promote or advocate the immediate legislation for a Franchise Law, which debated and promulgated conveniently by Legislatures, could become an indispensable tool for detecting and punishing offenders even with sentences, but on the contrary, they act as 'lobbyists' or lobby members that seek to preserve the status quo by any means, proclaiming to the four winds that a Franchise Law could result in excessive requirements, significantly raising costs and generating a constant supervision by authorities; a situation that will ultimately drive away private investment, killing the 'goose that lays the golden eggs’

It seems that very few people should talk about the proliferation of 'junk franchise,' or investors or franchisees that lost everything because of the disinterest and lack of advice from franchisers or owners of the brands. Indeed, Peruvian franchising is not a bed of roses as some institutions and powerful interests seek to convince the public and investors willing to venture into this business. And the informality that prevails in the world of franchising in Peru appears to be a 'good deal' for some influential businessmen who know the system's weaknesses and exploit the helpless condition of the franchisees to make a killing at their expense.

For example, it is known (but usually hidden) that most Peruvian franchises are not internationally competitive, as they are far below the standards of excellence that are required elsewhere and do not have ISO 9001 quality certification, making their entrance into the most demanding markets in the world where laws do exist to oversee and monitor franchisers and franchisees, little more than a utopia.

Only a handful of Peruvian franchises have managed to overcome the tough legal hurdles imposed in other countries, for which present domestic and foreign investors are willing to pay amounts in excess of 50 thousand dollars to buy one of these Peruvian successful franchises, especially those recognized not only our country but also abroad. But those brands, whose investment will be recovered within a maximum period of three years, are only a select few.

A FRANCHISE LAW AGAINST ‘GREEDY CULTURE’

The first step to ‘put the house in order' on franchises in Peru would be to protect the franchiser and the franchisee through the creation of an ethical code that self-regulates this sector in legal limbo while preparing a bill to give transparency to this lucrative business, watching through this legal instrument so fundamental for the success of a franchise like the quality of service provided, the actual solvency of the business franchise, and public information on the company, to avoid millionaire fraud.

To enter other countries, franchisers are required to deliver franchisees within at least 30 days before signing the franchise agreement or during the negotiation period, something known as the Franchise Offering Circular (FOC), or now known as the Franchise Disclosure Document (FDD), in Mexico, behind Brazil, the second most important country in Latin America for franchises, and other markets, they have managed to avoid abuses and fraud in the sale of franchises.

The FDD contains the financial, technical, economic, and legal information on the franchise that allows the franchisee to know in advance the real capabilities, limitations, resources, and levels of organization of the company offering the franchise to have a clearer idea of the quality and scope of services they will receive when operating the franchise. The franchiser, through the Franchise Disclosure Document, acknowledges its obligations and also allows the franchisee to know its rights.

One of the main aspects of the FDD is the chapter relating to trademark registrations. In this, the franchiser is required to prove the legality of the threshold showing originals and certified copies of these franchise trademark records while supplying the numbers of those records. Failure to have these documents or the agreement to use the trademark license issued by the owner, would be committing fraud.

In this Franchise Disclosure Document, the franchiser must provide the franchisee, in a mandatory and unavoidable manner, a list of names, addresses, and telephone numbers of all franchisees, so that the potential buyer of the franchise may verify or discover, before signing the contract, if the vendor is really reliable and serious, and what problems or conflicts other franchisees have had, making phone contact, and even interviewing them personally to ask for references and make the decision to buy or not to buy the franchise.

Also, the information provided in the Franchise Disclosure Document must exactly match that in the franchise agreement, especially regarding the three concepts of payment that the franchisee must make to the franchiser and the time that it shall comply. These three concepts are: the initial payment (franchise fee and initial investment for the pre-opening of the franchise), payment of royalties (royalties, and whether the amount is calculated based on gross or net profits) and payments for advertising. If the data of the franchise agreement differ from that contained in the FDD, the franchisee could presume fraud by the franchiser and refuse to sign the contract.

ABUSE, CORRUPTION, AND TAX EVASION

In the U.S., the International Franchise Association (IFA) has consistently opposed through the years, to support any attempt by governments to specifically legislate on franchises, a recommendation that has spread to every country in the world under the premise that a law specifically designed for this type of business could undermine the benefits of the system. However, the IFA has made it clear that it disagrees with Franchise Law, unless the particular country “has demonstrated the need” to implement a law of this kind.

Peru is a country with a very special cultural syncretism, through customs, practices, codes, and standards of behavior different from those of the United States and other nations. In our country the abuses and corruption of our public and officials, and the informality are like daily bread, a situation that is exacerbated by the alarming lack of control by authorities and by high levels of corruption that are evident, even in branches of the government itself.

In our country, the ‘greedy culture’ rules, many sociologists would add some distinctive features and call it a ‘combi culture’, while the prevention, protection, and dependability cultures continue to lag behind, both for ordinary standing citizens and for businessmen, either because most Peruvians do not know their rights, or simply because the laws are not rigorously applied.

Also, the levels of tax evasion in Peru are still very high, as well as the rate of piracy (software, publishing, record companies and so on). Peru is also a paradise for counterfeit money, identity cards, certificates, diplomas, fake stamps and signatures, all this, amid thick permissive legislation and gaps, and a Court System known worldwide for incompetence; situations that allow the commission of crimes even without the risk of sanctions.

In a country like Peru, whose values are in a state of criticality, to leave a millionaire business like franchising without a specific law to regulate it and without bodies supervising it, that would audit and impose sanctions, would favor the ‘combi culture’ that through the years, has caused much damage to our country and would leave local and foreign entrepreneurs to decide to invest in a Peruvian franchise, exposed to any attempt of fraud and without a legal framework that supports them and gives them confidence to invest.

Therefore, the controversial philosophy of “laissez faire” (let do) that the International Franchise Association (IFA) strictly defends and that has been adopted, thanks to millionaire lobbyists-sponsored by franchising salesmen, mainly in most countries in the world where there exists a profitable business strategy, could well become a reality like those of the U.S. and European countries where legal frameworks are less defective and ‘greedy culture’ is not rooted in the idiosyncrasies of the citizens or in the agenda of the authorities- but not in a country like ours.

Those who impose their own rules, defend the prevailing informality in Peruvian franchising and deny any possibility of supporting a Franchise Law, and recognize that this business is unusual in our environment, because it is not specifically regulated by law. These same individuals indicate that Legislative Decree No. 662 (Foreign Investment Promotion Act), Legislative Decree No. 823 (Industrial Property Act), Legislative Decree No. 807 (Powers, Rules, and Organization of Indecopi Act), and Decision No. 291 of the Cartagena Agreement Commission (Treatment of foreign capital and trademarks, licenses, and royalties) are more than enough legal instruments to prevent any irregularity in this business- nothing could be further from the truth.

In short, the only way to increase competitiveness and excellence, and to ensure that at least 80% of Peruvian franchises get the ISO 9001 quality certification in the coming years, is to push for a Franchise Law based on modern and efficient legislation, perfected over time, to promote and defend this business concept so profitable and with much projection, but also to monitor, detect, and impose restrictions on those seeking to turn franchising into a fraudulent money-making mechanism.