VF Franchise Consulting

South Korean franchises seek overseas growth on tougher domestic regulations

Jul 23, 2013

Large South Korean franchises will strengthen their focus on overseas market entry due to the restrictions on domestic growth from the Korea Fair Trade Commission (KFTC) and the National Commission for Corporate Partnership (NCCP), according to two industry sources and two Seoul-based lawyers.

While entry into new foreign markets has been on the agenda for South Korean franchisors for a while, it has become more important since the advent of president Park Geun-hye’s “economic democratization” program, which seeks to promote small- and medium-sized enterprises while limiting large companies, the sources said.

Caffe Bene, the country’s largest coffee chain, is actively seeking overseas expansion via joint ventures with local partners or master franchise agreements, a person familiar with the situation said. The franchisor wants to boost its business overseas because of domestic regulations, the person said.

The company is seeking to enter Saudi Arabia and Indonesia this year, followed by other countries in Southeast Asia, as previously reported by this news service.

The restrictions on domestic expansion by large franchises are likely to propel domestic companies that haven’t yet entered overseas market to become more active, said a spokesperson at CJ Foodville, which runs a string of franchises including A Twosome Place cafes, Cold Stone Creamery ice cream parlors and VIPS steakhouses.

Mango Six, a South Korean dessert cafe franchise, has been seeking joint ventures and business partners to help it open stores in Japan, Australia, Thailand, the United Arab Emirates and France, this news service reported in March.

The Frypan, a fried chicken and beer franchise, is seeking partners for expansion into the United States, as previously reported by this news service.

The KFTC issued a string of regulations in April, July and November last year restricting new store openings by large franchises such as bakery, chicken, pizza and coffee shop chains with over 100 existing outlets. Large coffee chains with over KRW 50bn (USD 43.3m) sales and bakery chains with over KRW 100bn sales cannot open new outlets within 500 meters of an existing store. Large chicken franchises cannot open new outlets within 800 meters of an existing location, while pizza chains cannot open new outlets within 1.5 kilometers of existing locations. The new regulations came amidst increasing conflicts over business operation areas due to the increased number of shops, which often go to different franchisees.

Likewise, new guidelines earlier this year from the NCCP, a government advisory panel, set distance restrictions and prohibited active M&A activity among large franchises. Under the guidelines, large franchises, as well as the restaurant units of large conglomerates, can only open new stores within 100 meters of a subway station, while SMEs are allowed to expand at a greater distance.

Another NCCP guideline says food franchisers can only open up stores in shopping malls or buildings with floor area of at least 20,000 square meters, which limits growth because there is only a limited number of buildings that size in South Korea, the first industry source noted.

These regulations, when added to the already mature franchise and food market in Korea, will encourage companies to look overseas for further growth, said a person at Orion, which runs “Market O” restaurants in addition to its core confectionery business. The legal and market environment will make it difficult for companies to beef up further in Korea, he said.

Franchisee rights

The KFTC’s regulations on franchises highlight a potential conflict between the multiple mandates the agency oversees, two Seoul-based antitrust lawyers said. The restrictions on the expansion of large franchise operators could be seen by some as limiting competition, as they are restricting companies putting in a fair effort to grow legally, one of the lawyers said.

However, the regulations could be seen as positive from a social point of view, as they would help promote social harmony and reduce complaints about SMEs being hurt by larger companies’ business practices, the first lawyer said.

The KFTC’s role is to promote competition, strengthen consumer rights, create a competitive environment for SMEs and restrain concentration of economic power, as noted on its website.

The regulations are aimed at protecting franchisees from unfair business practices by franchisers, the second lawyer said. While the regulation is not purely an antitrust regulation, recent public sentiment and the new government’s policy objectives have pushed the competition to pay closer attention to this issue, he said.

The purpose of the franchise regulations is to protect the rights of franchisees and provide increased business opportunities, a KFTC source said. The regulations are purely designed to promote competition and should not be seen in a different light, the source said.

The KFTC’s distance regulations are only logical, as opening two outlets under the same brand in close proximity would not benefit the franchisee in terms of sales, he added.

The regulations coincide with the Park administration’s focus on “economic democratization,” although this was unintended, the source said.

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