BY WANGUI WACHIRA
Hero Honda Motors Limited (as it was known until 2011) was a joint venture between Honda Motor Company of Japan and the Hero group of India orchestrated in 1984. Honda, as independent entity, could not successfully invest in India since Indian policy dictated that it merges with an existing Indian company in order to access the Indian market. The merger created the world’s single largest two wheeler company and one of the most successful joint ventures worldwide. While India’s franchising policy requires that foreign franchises enter the Indian market in partnership with an existing Indian company trading in a similar product, Kenya’s policy is a free market. Franchises are allowed access to the market freely and independently, sometimes rendering existing Kenyan franchises obsolete.
Although there have been successful joint ventures in the franchising sector in Kenya such as the HACO –Tiger brands, which was a joint venture partnership between Chris Kirubi’s HACO industries Kenya and South Africa’s Tiger Brands limited; it appears as though Kenya offers a free market to foreign investment franchises to trade and take the large share of profits back to their home countries.
Kentucky Fried Chicken (KFC), an American franchise that started its operations in Kenya in 2011, imports its potatoes from Egypt claiming the appropriate varieties are unavailable locally. Potato is the second most important crop in Kenya and it is incomprehensible that the government of Kenya would allow KFC to import potato tubers for the making of French fries instead of requiring that they be purchased locally to promote the agricultural sector.
Uganda’s President Museveni introduced the ‘Buy Ugandan Policy’ to grow the country’s manufacturing sector, to stem a growing trade deficit and to strengthen the shilling. The policy requires that Ugandans buy goods locally instead of importing finished products from abroad. Kenya’s is a sorry situation, that a country that claims agriculture as the backbone of its economy, imports potatoes from Egypt, a desert country. Is Kenya being short-changed in receiving benefits from franchise investments?
In a franchise agreement, a minimum of two parties is involved; a franchisor – who lends his trade name and the business system and the franchisee that pays agreed royalty fees for doing the business using name of franchisor.
Types of Franchising agreements include in the first limb: those on the basis of format including; product or distribution franchise, Manufacturing, Production or processing franchise – the franchisor sells the franchisee an essential ingredient, which enables the franchisee to manufacture or process the final product and sell it to retailers and consumers, Coca cola operates in this manner. Business format franchising – where the owner of the franchisor licenses to the franchisee the right to use the particular model including intellectual property rights associated with it, for example, The Hilton.
The second limb is on the basis of control over the franchisee: including; direct franchising where the franchisor enters into individual franchise agreements for each outlet thereby having direct control over each franchisee. A Master Franchise Agreement is where another entity is given the right to sub-franchise the franchisor’s business concept within a given territory, the franchisee acts as the franchisor in the target country.
International franchising refers to the way in which a franchise system may be expanded overseas, the franchisor grants individual franchises to franchisees in the target country.
Historically India has always had a restrictive foreign direct investment (FDI) policy; the Indian market particularly the retail sector has been frustrating for many internationally recognized brands. Aspects of the India FDI policy toward retail trade that affect franchising include; favouring Indian ownership and mandating that certain percentages of products be sourced in India.
Prior to 2012, India’s FDI policy prohibited foreign investment in multi-brand retail entirely and allowed only up to 51% foreign investment in single-brand retailing. In 2012, the government of India made changes to liberalize India’s FDI policy with respect to multi-brand and single-brand retail, notably: Single-brand retail allows up to 100% foreign investment. Multi-brand retail allowed up to 51 percent foreign investment.
Single-brand retail operations with greater than 51% FDI must be locally sourced with at least 30% of the value of goods purchased from Indian firms (preferably from micro, small and medium enterprises, village and cottage industries, artisans and craftsmen in India). All multi-brand retail operations with FDI must be locally sourced with at least 30% of the value of manufactured/processed products from Indian “small industries,” which have a total investment in plant and machinery not exceeding $1 million.
India does not have a specific legislation regulating franchising, it is governed by multiple allied legislation including the Indian Constitution, Intellectual property laws, contract law, Foreign Exchange Management Act, Competition Act, Consumer Protection Act, labour laws, taxation laws and the Transfer of Property Act
Philip Zeidman, a partner in the Franchise and Distribution Group of DLA Piper in Washington, D.C finds the franchising or joint venture approach (like the Hero Honda partnership) likely to remain the most attractive option for foreign retail franchisors. It has concluded that, notwithstanding the hurdles, the best way to enter the market is with a local partner.
Kenya, like India has no specific legislation on franchising. It, however, has laws regulating franchise agreements, including; the Competition Act, Consumer Protection Act and the Trademarks Act. There is also the Kenyan Franchise Association (KEFRA), which is part of a private local initiative.
The international franchise market in Kenya has grown extensively.
Although there is an inexistence of specific laws on franchising, the business activities fall under regulatory statutory provisions on the relevant Acts and Statutes. The Competition Authority of Kenya (CAK), being a regulatory and supervisory institution, relies on the Competition Act in carrying out is mandate. Franchises may fall under the supervision of the CAK on requirements regarding market entrance. CAK also outlines certain restrictions on marketing practices but cannot fix purchase or sale prices, limit or control production or investment, distort or restrict competition. Parties to a master franchise agreement however are not restricted by any regulation and are free to set up transfer restrictions subject to the Competition Act.
With regard to the Income Tax Act, withholding tax on royalties’ payable by the franchisee is charged at 5% paid to a resident and 20% paid to a non-resident. A 10% withholding tax is also charged on technical transfer fees paid to a resident and at 20% paid to a non-resident. Foreign franchisors are occasionally non-resident and fall under the 20% withholding tax rate. VAT is also chargeable at 16% regardless of whether or not the franchisor has a place of business in Kenya.
Local franchisors are liable to corporate tax at the rate of 30% and a rate of 37.5% is applicable to the taxable profits of non-resident foreign companies. The obligation to pay withholding tax will fall with the franchisee operating the business in Kenya before remittance of the royalties to an international franchisor.
The Consumer Protection Act (CPA) defines a consumer to include a franchisee in terms of a franchising agreement; hence franchise agreements are to be made in accordance with the provisions of the CPA. The Act also provides for protection of the franchisee from unfair practices.
Kenya being a common law system relies heavily on common law principles, it therefore concludes, in the absence of a specific law on franchise agreements common law practices shall be utilised. Relations, such as terms, guarantees and boilerplate clauses will be bound by principles under the law of contract.
Developments in the franchising industry are rapidly growing despite the lack of a specific legislation. Franchises are being run as normal corporate companies subjected to the laws used in regulation of local companies. This is not the issue in contention regarding Kenya, seeing the lack of efforts in implementing a regulatory framework for the franchising agreements. However, it is my view that being a developing country, it is best to use the example of India for economic growth and inclusion of the Kenyan populace by creating new market for locally produced crops and increasing employment opportunities by using Kenyan labour forces and factors of production.