Franchising as a source of competitive strength: the case of IKEA

Introduction  

Business expansion can be done using approaches such as investing in wholly owned subsidiaries, joint venture, strategic alliances, and franchising. Franchise is an arrangement where the business brand licenses another (franchisee) to market its brands. Under the franchise arrangement, both parties to the agreement benefit mutually: the franchisor enjoys the benefits of risk sharing and the franchisee benefits from the advantage of marketing a known brand (Webber, 2013). To the franchisor, this approach enables them to expand quickly while keeping their operational costs at bay. It is a model that enables them to charge lower for their products without compromising on the quality of the same. This expansion model can be associated with some of the expansive businesses including the giant food chain McDonalds (Retail Square, 2013). The speed with which such companies expand illustrates the rational for the choice as a strategic option to pursue organisational expansion.

One of the companies that are known for effectively employing the franchising strategy to expand their business is IKEA. The company has the vision to better everyday life for many people (Inter IKEA Systems, 2013). This means that its main aim approach to strategy is to provide goods to the market at an affordable price. While price sensitivity may make it necessary for the quality of products to be eroded, IKEA’s idea of cheap pricing does not extend to having them be of a lower quality (Johansson and Thelander, 2009). That is why it chooses an operational model that keeps its cost at the bare minimum using the franchising model. As a matter of fact, IKEA is one of the few organisations whose main approach to strategy in terms of business expansion is almost exclusively through the franchising approach. The franchising model is just but one of the approaches used to keep operation costs at bay. The company also reinforces this through design where designing is strategically done to lower the cost of the products (Jonsson and Foss, 2011). Through this model, the company has been able to expand to more than 40 countries around the world offering affordable products.

Background, structure and strategy of IKEA      

IKEA is a multinational that has become a household name in reference to products such as furniture, accessories, kitchenware, and bathroom items around the world. It operates in more than 40 countries around the world (Jonsson and Foss, 2011). The company was founded in 1943 with the aim of providing affordable home furnishing products with the company’s vision being: “to create a better everyday life for many people” (IKEA, 2012). In consistence with this vision, the company’s operational strategy has consistently been dominated by the desire to keep operational costs low hence enabling them to maintain their prices at the bare minimum. The company provides a wide range of products and are hence able to impact lives in every facet of home living.

In consistency with its low cost low pricing strategy, the organisation embraces the use of product design in order to come up with functional and quality products that are very cost effective. The products are designed in a manner that eliminates unnecessary elements without compromising on their beauty and functional capacities (Jonsson, Rudberg and Holmberg, 2013). They are also designed in a manner that facilitates low cost manufacturing. The main competence of the company is therefore the concept of designing. Products are manufactured at a lower cost because the design is good and not because they are of an inferior quality (Li, 2010). Further efforts to contain the cost of the products are done in the transportation of the same. The designing is done in a manner that enables the products to be transported in bulk hence lowering the cost of transporting the same.

One of the main hurdles of low pricing is that it tends to be associated with inferior quality. The general consumer psychology is such that it perceives expensive products as being of a higher quality than the cheaper products. This makes it necessary for IKEA to mount campaigns to emphasise on the quality of their products even though they are yet to be very successful in attracting the higher end markets (Jonsson, Rudberg and Holmberg, 2013). Nevertheless, the demand for low-priced home furnishing is still very high among the low and middle income earners hence driving the company’s performance to success. The company sustains its low cost operational model by minimising its risks and also producing many of its products from developing countries where the cost of labour and raw materials continue to be relatively low.

In reinforcing its low cost approach to business, IKEA embraces an operational model that allows quick expansion while keeping its business risks at the bare minimum. IKEA strongly embraces the concept of franchising where businesses with the financial strength to establish nationwide networks are granted franchises to sell its products. The franchisees are able to retain 3% of the cost of the products (Inter IKEA Systems, 2013). By using this model, it is able to take advantage of the knowledge and experience of the franchisees in the markets in question. Franchising can have many merits and demerits. There are also questions on whether franchising can be used by any organisations as a source of competitive advantage.

Evaluating the concept of franchising as applied at IKEA          

One of the main considerations made by a business when pursuing expansion is the franchising option. A franchising agreement entails licensing an independent business to stock and market the products of the franchisor (Alon, 2012). The main advantage of the franchising business to the franchisor is the fact that it reduces the risks associated with expansion. In any expansion venture, there is the risk of failure. Where expansion is through fully owned subsidiaries, the whole cost is borne by the organisation. However, in a franchise arrangement, the risk is borne between the franchisor and the franchisee. The franchisor is therefore able to expand its business network at only a fraction of the total expansion cost (Norman, 2006). This enables them to maintain a wide distribution network at a relatively low cost. These low cost benefits can then be passed on to the consumer through lower prices.

The franchise strategies help the franchisor to limit risks. The risk of failure is always high where an organisation is expanding into a new market. The franchisees tend to be experienced businesses that are already operating in the targeted markets (Lowell, 2007). They tend to have extensive knowledge about the markets being entered into. The franchisor is therefore insulated from the risk of failure that comes from failure to know the local customers. At IKEA, one of the main qualifications of a franchisee is experience in the market (Inter IKEA Systems, 2013). Experience tends to be a confirmation that a prospective franchisee does understand the market. Theoretical knowledge of a market can be misleading as there are elements of the market that can be learned only through experience. The other strategic application of franchising is by ensuring that the greatest realisable benefit is obtained.

The main rationale for franchising is market expansion. This goal can be achieved by getting into franchise arrangements with numerous partners. However, having greater numbers poses a challenge in terms of monitoring and ensuring that there is compliance with the franchise agreement. IKEA has tough qualifications for prospective franchisees including the fact that they must have the financial strength to roll out operations nationally and they ought to have a demonstrable national presence (Johansson and Thelander, 2009). This implies that with each successive franchise arrangement, IKEA gains access to a nationwide market. This model therefore leads to a higher chance of success.

The probability of success is further enhanced by the fact that the franchisees have experience and with a national presence. From the basic understanding of the business evolution processes, it can be concluded that a business that has a national presence is one with an established and loyal clientele (Alon, 2012). Since the franchisor retains the human and non-human resources, they are able to easily retain their traditional customers in addition to having knowledge on how additional market segments can be reached (Lowell, 2007). They therefore complement the efforts of the brand as it markets itself globally and regionally.

Under a franchise arrangement, the franchisee is semiautonomous (Norman, 2006). They are able to maintain a limited level of independence with the franchisor only providing a limited range of restrictions such as the requirement that only its products are stocked by the franchisee. The franchise arrangements mostly require profit sharing on an agreed proportion and this means that the franchisor makes more money with each additional sale (Welsh, Alon and Falbe, 2006). This motivates the franchisor to do all they can to boost sales and realise greater profits. The franchisor doesn’t therefore find it necessary to apply further monitoring or punitive measures to push sales except in cases where poor performance is sustained. IKEA takes precautionary measures to guarantee the success of their franchises by requiring that the franchisees have sufficient business experience (Li, 2010). This experience is crucial in management and pursuing sustained performance.

While the franchising arrangement helps in driving down the operational costs of businesses, it is not always that they are applied by businesses that only seek to pursue the low pricing strategy. Fast food chain McDonalds uses franchising extensively hundreds of franchise arrangements around the world (Retail Square, 2013). However, it does not pursue the low price strategy. Instead, it uses the savings made in operational costs to improve on its profit margins.

In relation to human resources, franchising plays a very important role in encouraging diversity in the entire organisation’s workforce. In most cases, the franchisees are allowed to retain their pool of employees albeit with the condition that training is done if necessary to educate them to embrace the operational models of the franchisor. The diversity across the entire organisation is crucial in attracting a diverse pool of customers. A good example of this advantage is the franchise model at McDonalds and the impact it had in terms of globalising food chains (Retail Square, 2013). Franchisees would be able to attract their initial customers even in countries where fast foods were not yet popular hence leading to an emergence of a global food culture in urban areas around the world where McDonalds and related fast food companies operate from. The same advantage is attributable to IKEA which has been able to record a strong performance in the 40 countries it operates in (IKEA, 2012). They have been able to have an image of diversity and have been able to attract a wide range of customers despite the fact that they have been known to be quite conservative in their employee recruitment practices.

Challenges of franchising and how to overcome them                 

The franchising arrangements have a number of limitations. The first of them is the fact that the franchisor is often forced to disclose important information to franchisees. These pieces of information that is crucial for the maintenance of a competitive advantage for the organisation could be leaked to competitors or even used by the franchisees when they pull out to operate independently (Hoffman and Preble, 2004). IKEA is yet to be faced with such a situation but it remains a standing concern.  The best way of minimising this risk is by signing contracts that oblige the franchisee to avoiding leaking essential secrets or using them to their benefit outside the framework of the franchise. However, information leaks are difficult to prove and the impact of the leak is always high even where no specific party can be found as being the culprit.

The other danger of franchising is the risk of losing business to a franchisee. This is especially the case where the franchisee is involved in the production of all or some of the products of the franchisor. After they have gained the competence they need to produce the products or come up with close substitutes, many of the organisations tend to pull away from the franchisor (Syed, 2011). They become strong rivals as they will have already mastered the strengths of the franchisor. In many of the cases where franchisees enter into franchise agreements, they do so with the goal of gaining experience before venturing out on their own. Research on the attitudes of franchisees indicate that most of them only view franchises as the starting point and never really consider operating as franchisees in the long term (Syed, 2011). In the case of IKEA, the risk is even higher because they emphasise on forming franchises with organisations with sufficient financial strength to mount nationwide operations.

There is also the risk of the reputation of the organisation being spoilt by franchisees who fail to live up to the expectations of the franchisor. In most cases, the franchisor tends to have a strong brand with a brand identity that all can relate to (Tarnovskaya, and de Chernatony, 2011). It’s crucial that the actions of the company and all affiliates including franchisees to behave in a manner that reinforces this image. Failure to comply soils the reputation of the company and undoes the gains made in terms of branding. The main weakness in enforcing full compliance is the fact that the franchisees are semi-autonomous and that they may not mind moving out of the franchises (Weber, 2013). This disillusionment is closely related to the fact that franchisees could wield sufficient power to pressure the franchisor into changing their policies. This can be the case where the franchisee is strong in a market and desires to alter the guidelines offered to them in favour of what they find most sufficient. While IKEA is yet to face this situation to a level that precipitates dispute, it is a risk that could happen in future.

Can franchising as a source of competitive advantage     

Having determined that franchising is a very important component of the business strategy for IKEA, it is necessary to gauge whether it is a source of competitive advantage for them. This determination is crucial in determining whether franchising is ought to be the core strategy or if it just needs to reinforce the core strategies. The concept of competitive advantage is one that is used to understand the competitiveness of organisations in the market. A source of competitive advantage is one that can sustainably give the organisation an edge over other organisations (Stasch, 2010). These sources can either be resources or competencies that an organisation has mastered over time. According to the VRIN framework, a resource or competence can be a source of competitive advantage only where it is valuable, rare, inimitable and non-substitutable (Paley, 2008). These elements can be applied to the franchising strategy at IKEA as shown below.

The franchising approach at IKEA is subject of evaluation due to the success with which the organisation has managed to exploit franchising to grow and become a major player in global business. The term franchise is almost synonymous to IKEA as they have proved to be able to get it right over decades. In terms of value, the competence in franchising at IKEA has been very valuable. It has enabled them to expand their branch network while managing to keep their operation costs low. It has also been useful in enabling them share risks with the franchisees whose financial strength is among the important requirements for franchising. Notwithstanding the fact that the franchise approach may have its challenges, the question as to whether or not it is valuable must be answered as yes.

Rarity implies that a competence or resource is not easily available. Successful franchising requires research capabilities in order to determine the quality of the prospective franchisees before the appropriate ones are chosen (Alon, 2012). Factors such as experience, knowledge of market, financial strength and their organisational cultures can only be determined after due diligence is done. After the due diligence, the evaluation involves comparison with the aspirations of the franchisor before implementation can be rolled out. While these aspects of franchising require very high levels of organisational intelligence, they are not rare. Any serious franchisor should be able to do the same.

In terms of inimitability, franchising can easily be imitated by other market entry options such as strategic alliances, joint ventures and even investment in direct subsidiaries provided that the element of risk is taken care of (Weber, 2013). The franchising competence is also not non-substitutable. On the VRIN framework, the competence of franchising at IKEA is valuable but it is not rare, not inimitable and not non-substitutable. This means that the organisation is at competitive parity as far as this competence is concerned. The only source of competitive advantage as far as franchising is concerned at IKEA is the synergy that is brought about by their approach to design, transportation, and branding. It is the combination of these elements that is responsible for the organisation’s competitive edge and not any of the elements mentioned in isolation.

Conclusion    

 In conclusion, IKEA pursues organisational growth using the franchise strategy. This approach enables it to mitigate its risks as the franchisees get to assume some of the risks of expansion. It also enables them to keep their costs of operation low. In essence, this approach reinforces its strategy of providing cheaper products to the market hence improving the lives of its customers. In addition to franchising as a cost effective approach to growth, the organisation also keeps tabs on its operational aspects such as design of products where the same is done to keep cost of manufacturing and transportation low. The emphasis of the company is that the low cost of its products can only be attributed to the unique designing that they embrace and not on the element of quality. This emphasis counters the general beliefs in the market that cheaper products tend to be less expensive.

IKEA takes all the necessary precautions to ensure that its franchises are run as efficiently as possible. It does this by defining the minimum requirements for its franchisees with factors such as experience and financial strength as among the considerations. Through consistent and diligence in the application of this expansion approach, the company has been successful since its inception. However, the ability of IKEA to form and maintain successful franchises cannot be termed as a source of competitive advantage. Instead, it is a part of a wider strategy and it is only the synergy that is brought about by a combination of franchising, product design, pricing and marketing that brings out the competitiveness of the organisation.

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