Evaluation of Franchising as a mode of entry by analyzing Subway's expansion strategy

Term Paper, 2015

16 Pages, Grade: 2,0


List of Contents

List of Abbreviations

List of Figures

1 Introduction

2 Market entry modes
2.1 Basics
2.2 Overview
2.3 Franchising as a mode of entry

3 Subway
3.1 Profile of the company
3.2 Franchising as an expansion strategy
3.3 Market entry in China as an example

4 Conclusion


List of Abbreviations

List of Figures

1 Introduction

Internationalization of economy is one of the most important topics of recent times. It is characterized by globalization of the business world which means that more and more companies compete with foreign ones by entering new markets or introducing new products that are available everywhere through disappearing barriers and boundaries. As a consequence the question arises how companies follow their expansion strategies. A central issue linked to this question is the entry mode decision, because it is essential for the success of the globalization activities of a company.

One possible entry mode is called franchising which is used by a lot of well-known companies worldwide. The focus of this term paper is to evaluate this type of entry mode based on the example of Subway, an international operating fast food chain.

To accomplish this purpose, the theory of market entry modes is explained in the beginning. Further an overview of the different entry modes is given in order to highlight the differences between them. After that franchising as a mode of entry is explained in detail. As a result of presenting the theory a profile of Subway follows. Furthermore the market entry strategy of Subway is analyzed regarding the fact how franchising influenced the expansion of the company in general. After that the market entry into the Chinese market and its challenges is explained. To conclude the term paper, the theory and the practical example is summarized in order to outline whether Subway enters new markets efficiently and how franchising as a market entry mode influences the expansion of the company against the backdrop of the example.

2 Market entry modes

2.1 Basics

The term ‘market entry mode’ describes different arrangements realised by a certain company that permit the transfer of products, technology, management, human capital and other resources into a foreign country.[1] In general the question how to enter a chosen market is answered. Additionally the choice of market entry mode determines to a large extent the level of involvement in the chosen country.[2]

Generally the entry mode decision can be described as one of the most critical decisions in international business, because of its effect on all future decisions and operations in the target market.[3] Furthermore the impact of a chosen entry mode on the success of foreign operations in general is great.[4]

2.2 Overview

In business literature multiple entry modes are discussed. In the following the differences are highlighted in order to understand the special attributes of franchising as a mode of entry into a foreign market. The different entry modes can be classified by degrees of resource commitment, risk exposure, control and profit return.[5] Further studies have shown that the choice of entry mode depends on industry-specific and country-specific factors too. The following figure shows the different entry modes divided into three groups: The export, contractual and investment modes.[6]

Figure 1: Overview of the different entry modes

illustration not visible in this excerpt

The given categories can be broken down into several distinctive entry modes. The first group of the export modes permits a market entry through exporting which describes the process of sending goods from one country to another for distribution, sale and service.[7] Further the group can be divided into the direct and indirect export modes. Within the direct export the company sells its products directly to the customer, while the indirect export is performed with the help of a distributor between the seller and the customer in the foreign target market. Generally speaking this group of entry modes is characterized by a low degree of control of the activities in the foreign market, a low risk exposure and low resource commitment, because of the named direct shipping or the cooperation with an intermediary.[8]

Besides that the second group contains the contractual entry modes and it can be broken down into licensing, joint ventures and franchising. The term licensing describes the right of a third party to use a company’s knowledge to do business in another market.[9] The third party obtains the right after it has bought licenses to use intellectual property, brand, and design or business programs of the offering company. Further the entry into foreign markets through joint ventures belongs to the contractual entry modes. A joint venture is a special form of strategic alliance which is normally made up of the creation of a new business in a foreign market by two or more partners.[10] The last entry mode that belongs to this group is franchising which is explained in detail in the next chapter. Generally the contractual modes give the company a higher control over its activities while taking compared to the export modes a higher risk because of the binding contract between the firm and the agent in the foreign country.

The third group within the entry modes consists of the investment modes. This kind of entry modes can be described as an investment in new facilities in a foreign market or a purchase of stock of an existing company in order to exercise control over that company.[11] The investment modes are structured into the Greenfield and Merger & Acquisition entry modes. The Greenfield entry mode can be described by the fact that new facilities are set up in order to enter a foreign market while M & A transactions enable the entry though an investment in an existing company. Choosing these methods in order to enter a foreign market is associated with the highest resource commitment, risk and control of the activities.[12]

2.3 Franchising as a mode of entry

Essentially franchising as a contractual entry mode can be described as a type of licence agreement which means that an organization wants to enter a foreign market quickly with a low degree of risk and resource commitment.[13] In addition to the normal license process a company provides assistance with the design, equipment, organization and marketing of a contractual partner in the target market.[14] The selling company in the contractual partnership is called franchisor while the partner company is called franchisee.[15] In return for the services of the franchisor the franchisee is obligated to pay a lump sum payment and a share of his future profits called royalty payments.[16] Through this contractual relationship the success of the operations are interdependent but the franchisor gains other advantages from the partnership than the franchisee.

The franchisor benefits from a possible rapid growth of the company because of the fact that potential franchisees use their own capital in order to set up their facilities.[17] These investments are like a capital infusions for the running business of the franchisor since the dissemination of the company in general rises. Besides the advantage of the capital infusion the wider allocation of the business leads to a spread of business risk across geographical markets.[18] Further the publicity of the brand in general rises. Like already mentioned the franchisee is obligated to pay a certain amount to the franchisor what generates a steady income stream for the franchisor. Additionally the know-how of the local partners can be used in order to cope with the local habits.

The franchisee gains advantages from the contractual partnership, too. From his perspective one of the biggest benefits is the trade mark strength of the franchisor which gives immediate access to customers through an externally managed and well-known brand.[19] The external managed brand is linked with the next advantage because the major marketing activities are planned and realised by the franchisor. Additionally the franchisor supports the franchisee with technical advice and other support services.

3 Subway

3.1 Profile of the company

Subway is a USA based fast food chain which was founded in Bridgeport in Connecticut in 1965 by Fred DeLuca and sells specialty sandwiches and salads.[20] The core products are the made-to-order sandwiches where customers can choose the type of bread and the other ingredients.[21] Today Subway consists of a network of 43981 restaurants in 110 countries which is operated by different franchisees.[22] Regarding the number of the restaurants Subway is the worldwide market leader in the fast food industry and close to the market leader, McDonalds, in terms of revenue.

3.2 Franchising as an expansion strategy

Subway is a company that has spread worldwide through its expansion strategy. This strategy is based on franchising, the market entry mode, Subway used in order to enter foreign markets. In 1974 the company started franchising in the USA and later it was uses in order to expand globally.

An important point is that the franchising strategy is based on a strong brand, which helps to attract new franchisees. The strong brand is based on above-average customer satisfaction values, which help to retain the buyer's loyalty to the brand.[23] This recognition value of the brand helps to attract possible partners, which want to benefit from a proven business concept, without having the effort to seek after ones in potential target markets. In the case of Subway the first international franchise was opened in 1984 in Bahrain, because a domestic investor wanted to use the brand for his purposes and approached the company about opening a sandwich shop on the Persian Gulf Island.[24]

Besides taking advantage of the know-how of domestic investors the store costs of Subway accelerate the growth of the franchising network. A Subway store costs much less to open than other franchises. While a typical Taco Bell demands a $1 million investment and a $600,000 net worth (exclusive of residential property), an average Subway purchaser must come up with just $100,000, and no minimum net worth is required.[25] This fact is summarized by Tony Pace, chief marketing officer of Subway’s Franchisee Advertising Fund Trust, who argues: “the smaller-format stores cost less to open and operate than other chain restaurants”.[26]

Another positive aspect of the market entry mode triggered a rapid growth. Subway opened almost 8.000 outlets in nontraditional locations such as a showroom in California, an appliance store in Brazil, a ferry terminal in Seattle, a boat in Germany, a zoo in Taiwan, a goodwill store in South Carolina, a high school in Detroit and a church in Buffalo.[27] The point is that the franchisee takes the risk while the business partners carry out such investments and Subway as a franchisor can accelerate its growth without a higher risk exposure.

Further there is the profitability of Subway which is heavily influenced by the fees franchisees have to pay. Subway demands 8% of gross sales plus an amount of 4,5% as an advertising fee, which are combined the highest royalty in the food franchise industry.[28] As a result Subway can generate solid returns from the operating business.

3.3 Market entry in China as an example

Subway entered the Chinese market in 1995 by opening the first restaurant. In the first years Subway was faced with a challenging environment because of the fact that the local eating habits were different from the traditional countries Subway used to serve. Chinese people did not like to eat with their hands. Eating with hands is necessary for nearly every product Subway offered and a common habit in the USA. At this point the standardized company faced difficulties with the product range. Therefore Subway developed in cooperation with their franchisees a least one item which is tailored to Chinese tastes e.g. soups.[29] This special know-how of the franchisees helped Subway as a franchisor to overcome the difficulties and with this move Subway became a truly “glocalised” company. The term “glocalisation“ first appeared in the late 1980s and means that a company acts on a global level while adapting to the local needs of potential customers. This was exactly done by using the know-how of the franchisees and brings Subway especially regarding the expansion into more rural areas where western eating habits are totally unknown in a better strategic position.

Following this approach Subway assumes that China could handle around 20.000 restaurants. [30] The potential benefits from this enormous demand for Subway’s products are too great to ignore for a leading company in the fast food segment especially because of the high market and GDP growth rates in China which cause a growth rate of nearly 20% p. a. of the fast food sector in China.

Besides that Subway had to jump some more hurdles because of weak intellectual property enforcement in China. Uncovering the secrets of the company in order to support the franchisees was connected with a high risk exposure because of the fact that many US brand had seen local companies take their names and logo and open fake, unapproved restaurants and stores.[31] The use of franchise gave Subway the opportunity to access loyal intermediaries in order to avoid the described problem.

Although there were these opportunities of franchising in China the search of adequate franchisees is still one of the most important parts of the business. Especially in China due diligence is essential for the success of the operations in the foreign market.

4 Conclusion

Subway used franchising in order to grow rapidly. In the years from 1988 until 1997 Subway was the fastest growing franchise system worldwide.[32] In terms of restaurant numbers the company managed to out-compete the major competitors worldwide and there is no end in sight for this growth.

Through the franchising system the company was able to use the know-how of their franchisees in order to adapt the offered products to the local requirements. Due to that the company benefits from advantages as well from the globalisation as well as from the localisation.

This shows that this kind of entry mode is definitely a way towards a successful and universal market entry into different countries. In addition to that Subway managed to generate high profits by structuring its business activities based on the model of franchising. This shows that franchising is an efficient market entry mode and definitely should be considered in the entry mode decision of a company.


[1] Cf. Root, F. R. (1988), p. 4.

[2] Cf. Dony, A. (2013), p. 22.

[3] Cf. Terpstra, V., Sarathy, R. (1991), p. 361; Kumar, V., Subramaniam, V. (1997), pp. 53-54.

[4] Cf. Wind, Y., Perlemutter, H. (1977)

[5] Cf. Pan, Y., Tse, D. K. (2000), p. 535.

[6] Cf. John, R., Gillies, G. I. (1996), pp. 263-266.

[7] Cf. Ireland, D. R., Hoskisson, R., Hitt, M. (2008), p. 157.

[8] Cf. Anderson, H., Gatignon, H. (1986), p. 3.

[9] Cf. Glaum, M. (1996), p. 23; Ireland, D. R., Hoskisson, R., Hitt, M. (2008), p. 158.

[10] Cf. Cook, F. W. (1976), p. 278.

[11] Cf. Kumar, V., Subramaniam, V. (1997), p. 54.

[12] Cf. Ireland, R. D., Hoskisson, R. E., Hitt, M. A. (2008), pp. 157-159.

[13] Cf. Mühlbacher, H., Leihs, H., Dahringer, L. (2006), p. 421.

[14] Cf. John, R., Gillies, G. I. (1996), p. 265.

[15] Cf. Nagel, C. (2012)

[16] Cf. Murray, B., Smyth, H. (2011), p. 625; John, R., Gillies, G. I. (1996), p. 265.

[17] Cf. Murray, B., Smyth, H. (2011), p. 625.

[18] Cf. Murray, B., Smyth, H. (2011), p. 625.

[19] Cf. Mühlbacher, H., Leihs, H., Dahringer, L. (2006), p. 421.

[20] Cf. Subway (2015a)

[21] Cf. Bagchi, S. N., Olimattel, V. (2015), p. 25.

[22] Cf. Subway (2015b)

[23] Cf. Weißenborn, C. (2008), p. 50.

[24] Cf. Vinu, J. (2009)

[25] Cf. Behar, R. (1998), p. 129.

[26] Hayan, H. (2011)

[27] Cf. Hayan, H. (2011)

[28] Cf. Behar, R. (1998), p. 128.

[29] Cf. Hitt, M., Ireland R. D., Hoskisson, R. (2006), p. 281.

[30] Cf. Hitt, M., Ireland R. D., Hoskisson, R. (2006), p. 281.

[31] Cf. Edwards, W. (2011), p. 42.

[32] Cf. N. N. (2006), p. 12.

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Evaluation of Franchising as a mode of entry by analyzing Subway's expansion strategy
University of Applied Sciences Essen
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evaluation, franchising, subway
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Tim Borneck (Author), 2015, Evaluation of Franchising as a mode of entry by analyzing Subway's expansion strategy, Munich, GRIN Verlag, https://www.grin.com/document/320276


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