I came across a piece co-authored by my former colleague Ratan Jalan in ‘Marketing Health Services’ (Eye on The Indian Market, Spring 2009 edition)of the prestigious journal of the American Marketing Association. I have known Mr. Jalan since he hired me to work for him at Apollo Health and Lifestyle Ltd., many years ago and hugely respect his scholarship and knowledge about the business of healthcare in India. However, I must confess that I do not quite agree with Mr. Jalan’s portrayal of the opportunities in franchising healthcare services in India and his conclusions about Apollo Health and Lifestyle’s successful franchising of the Apollo Clinics.
Apollo Hospitals is one of the largest chain of hospitals in India. It has in its network more than 41 hospitals and manages over 8000 beds mostly in the secondary and the tertiary healthcare space. I met Ratan in the year 2001, when he was setting up Apollo Health and Lifestyle, which was to get into franchising of the Ápollo Clinics, the primary healthcare services chain, which were supposed to complement Apollo’s large secondary and tertiary care network. These clinics were envisaged as a franchised operations, supported by the Apollo Hospitals group. They were to leverage Apollo’s excellent brand equity and knowledge about the healthcare in India and help franchisees run a profitable enterprise.
The Apollo Clinics were well conceived. The service mix was essentially OPD consultations, a collection centre for pathology samples, radiology services (X-Ray, Ultrasound) and basic cardiology diagnostics (ECG, TMT and Echo). The clinics also had a 24 hour pharmacy and basic preventive health packages were also offered. We worked hard on the look and feel of the clinic (Ratan had Alfaz Miller design the clinic interiors), Ravi Bajaj was to do the staff uniforms, and the clinics were to hire smart and well-trained youngsters to be the face of the clinics. The consultants were to from the local areas and it was thought that Apollo Hospital’s senior consultants will also run their OPD’s from these clinics.
On the business side of things a franchisee needed to invest close to Rs. 20 MN upfront. The business plan included a fixed percentage payout by the franchisee of the revenue that he made. Apollo was to handhold the franchisee through the setting up of the clinic, purchase of medical equipment, development of the software to run the clinic, recruitment of the employees both medical and non medical, and selection of doctors. Apollo was also to provide an exhaustive set of instructions and guidelines on the management of the clinic to the franchisees and it was responsible for monitoring the quality of the services delivered at these clinics.
While on paper the model looks perfect, it has some serious infirmities.
A franchised operation by definition has to be a replication of an existing successful model. In Apollo’s case, they had nothing to show in the area of Primary Healthcare. They used to run a clinic in Mumbai, which they owned. Just about the time Apollo decided to go the franchise route, their own clinic shut shop. It was losing money hand over fist and the management decided to shut it down.
In the franchised model that was now envisaged Apollo had no financial stake. The money was to be put up by the franchisee, he was to bear all the costs including a revenue share with Apollo and it was not clear how Apollo will contribute to bringing in new patients to the clinic. It was expected that Apollo’s name itself will pull in patients. Thus the franchisee was to fend for himself as far as developing the business was concerned. Apollo could have contributed by investing in the brand ‘Ápollo Clinics’ and by forcing some of its leading doctors to run the OPD’s from the franchised clinics. Apollo made lofty promises of investing millions in the brand but just didn’t. As far as doctors were concerned, some feeble attempts were made to get Apollo doctors to attend these clinics but hardly anything materialised. The problem really was that in Apollo system the senior doctors are not paid firm salaries and they work on a revenue share model. Thus, Apollo’s control over these doctors is minimal. The senior doctors with a busy practice had no reason to sit in the newly opened Apollo Clinics, which in any case did not have any patients of their own.
The selection of the franchisees too threw up issues. The franchisees were largely businessmen with hardly any experience of healthcare. Neither did they have any particular love or passion for the healthcare business. I remember meeting and offering franchises to computer hardware merchants, aluminium dealers, a golf ball manufacturer, a real estate player and the like. All of them were driven purely by a profit motive. Some also saw healthcare as a more respectable business for their children. We sold the franchises indiscriminately, (at least in the beginning) to anyone willing to put up the money. A network was thus born that had no glue except the brand name that each franchise shared with the other.
The biggest casualty in all this was of course the quality of healthcare services that each clinic rendered. There was no uniformity as each franchisee left to fend for himself became increasingly desperate for revenue. He hired doctors on his own many of dubious quality, started offering cuts for referrals, set his own prices and started indulging in all kinds of practices that would help him get the extra money that he needed to stay afloat. As most of these franchises were not businessmen with deep pockets, they were willing to cut corners as their very survival was at stake. In-spite of all this many had to close down operations.
Apollo gradually lost control over these franchises. Since, it did not add any value to the franchise’s life he decided not to pay the monthly royalty. Many refused access to Apollo personnel on their premises and are now pretty much operating as stand-alone entities. They continue to use the Apollo name, as that is the only thing, which adds value to their operations.
Creating a franchised healthcare network is fraught with danger. Apollo failed by not first establishing a successful chain of primary healthcare centres of its own. It had no proven learnings in that space and it undertook to make money at its franchisee’s cost. It lost the trust of not only its franchisees, but also of many of its patients who certainly expected a lot better from Apollo.
Tags:Apollo Franchise, Healthcare franchise, franchising healthcare, successful franchising, Apollo Clinics, franchised operations, Ratan Jalan, alfaz miller,ravi bajaj,franchised model,franchised clinics,
Source: Ana's Weblog: The Apollo Clinics-The Perils of Franchising Healthcare Services in India.
Showing posts with label Ratan Jalan. Show all posts
Showing posts with label Ratan Jalan. Show all posts
Monday, May 3, 2010
Monday, March 8, 2010
Hospitals take to franchising In India For Their Expansions
Considering the huge investment needed for establishing the necessary healthcare infrastructure in the country,franchising is emerging as a viable option for hospitals to expand to newer geographies.
According to estimates, the healthcare industry in India is short of one million beds and this requires a capital investment of $30 to $40 billion. This is where franchising comes as a model for healthcare franchise to attract investments from non-medical investors.
Apollo Hospitals is one among the pioneers to have sought franchisee model for its clinics. According to Ratan Jalan, former CEO of Apollo Health and Lifestyle and in-charge of the Apollo Clinics, ‘responsible franchising’ is a successful model for developing healthcare infrastructure.
“Careful choice of franchisee and increased involvement of the franchisor, training, technologies and people selection is needed in healthcare more than any other business. Less than 10 per cent of Apollo’s franchisees have any medical background. But they have a passion for healthcare, quality and focus, besides financial resources. Substantial involvement from the part of franchisor, at least in the initial stages is crucial,” he said.
According to Gaurav Marya, president of Franchise India, the franchisee brings in capital, local know-how and entrepreneurial enthusiasm to the business. “Currently, only five per cent of the hospitals in the private sector are franchisee-operated. But the potential is huge as healthcare is a highly capital-intensive business,” he said.
V Vijayakumar, MD of V V Dentistree sees franchising as an option to replicate standardized protocols and practices in smaller towns. The dental chain with six centres in Chennai is looking at having a network of franchisee-operated clinics after it builds up the brand in all the four metros.
However, Dr Amar Agarwal, CMD of Dr Agarwal’s Eye Hospital finds that transferring the vision and ensuring the same-level of quality are major challenges in a franchising model.
According to estimates, the healthcare industry in India is short of one million beds and this requires a capital investment of $30 to $40 billion. This is where franchising comes as a model for healthcare franchise to attract investments from non-medical investors.
Apollo Hospitals is one among the pioneers to have sought franchisee model for its clinics. According to Ratan Jalan, former CEO of Apollo Health and Lifestyle and in-charge of the Apollo Clinics, ‘responsible franchising’ is a successful model for developing healthcare infrastructure.
“Careful choice of franchisee and increased involvement of the franchisor, training, technologies and people selection is needed in healthcare more than any other business. Less than 10 per cent of Apollo’s franchisees have any medical background. But they have a passion for healthcare, quality and focus, besides financial resources. Substantial involvement from the part of franchisor, at least in the initial stages is crucial,” he said.
According to Gaurav Marya, president of Franchise India, the franchisee brings in capital, local know-how and entrepreneurial enthusiasm to the business. “Currently, only five per cent of the hospitals in the private sector are franchisee-operated. But the potential is huge as healthcare is a highly capital-intensive business,” he said.
V Vijayakumar, MD of V V Dentistree sees franchising as an option to replicate standardized protocols and practices in smaller towns. The dental chain with six centres in Chennai is looking at having a network of franchisee-operated clinics after it builds up the brand in all the four metros.
However, Dr Amar Agarwal, CMD of Dr Agarwal’s Eye Hospital finds that transferring the vision and ensuring the same-level of quality are major challenges in a franchising model.
Monday, March 1, 2010
Franchise Industry Reforms Road Map : A Wish List to Govt Of India.
Franchising paves way to entrepreneurship
The magnitude as well as the future potential that Indian domestic consumption exhibit makes it an attractive destination for investments. However, statistical trends give a wider perspective of the potential of the Indian market. Yet the investments, both domestic as well as international have had always taken a conservative pace. Presently, liberalisation and market openings have facilitated the business dynamics to become more conducive for entrepreneurial activity. There has been a positive entrepreneurial activity in the business environment which is extremely important as the economic studies have repeatedly proven that innovation as well as entrepreneurship can propel the fiscal machinery of the nation.
India has presented a curious case as entrepreneurial activity here always had its own implication. It has been observed that 90 per cent of start ups fail in the first year of their inception. There are many reasons for it. Firstly, the Indian market is testing waters in terms of readiness for newer business concepts and formats. Moreover, mature business systems are yet to be developed in terms of redesigning the whole process of starting a business which ideally should be a seamless process. Unfortunately, in India the burden of regulatory procedures as well as processes makes it strenuous for the entrepreneurs as well as innovators. As a result, most of the entrepreneurial activity is reduced to low involvement as well as low risk models. Franchising as an entrepreneurial route is extremely interesting and successful. The acceptability of franchising has been quite prolific amongst Indian business minds. According to the figure, 90 per cent of the franchising ventures have a huge probability of success. This attracts many investors to invest in proven business models and concepts which involve less risk as well. This however is just the tip of the iceberg, although, there is a lot more to franchising than the apparent. Also, franchising in the Indian market becomes much more intricate rather than just being a low capital expansion mode.
Industry status to franchising
India is an attractive market for franchising. The expanded market size seeks deeper as well as broader market penetration. However, the demographic variables make this expansion a risky proposition, especially in a capital constrained market like India. India, as any developing country seeks investment, technology as well as business know-how from the developed countries. Foreign investments have repeatedly done wonders in turning the market game around as it tends to make markets more competitive for IT, retail, manufacturing or service sectors.
The franchise industry in India is currently an anonymous contributor to the country's economy, which is not favourable for a sustainable growth. As Arun Khetan, Managing Director, The New Age Knowledge Solutions (NAKS) explains, "The status will not only have a detrimental impact on further proliferation of franchising but will also deprive excellent local brands the opportunities to come up with products/services that are of relatively superior value proposition compared to many foreign brands, which are much new to the Indian turf, in terms of knowledge of local preferences and delivery mechanism, but score out heavily in terms of resource deployment and hence are able to reap away most of the benefit." He further adds , "The need of the hour is that the Indian franchising be formally recognised as an industry, which would propel the action plan and processes of the industry and set the ball rolling, that would have a cascading effect on all the interfaces that are related to it either directly or indirectly."
The policy makers must recognise the fact that this is a format segment that cuts across all the industries and that its presence in the Indian backdrop is real. Granting legitimacy would not only put an end to the shadow war but also make the world wake up to the fact that Indian policy makers are serious about the franchising business. This would have mammoth implications in terms of perception that overseas market carry about Indian franchisors and franchising products / services and bestow credibility (which, due to lack of Government sanctity currently rests mostly on private players who have forayed abroad on their own grit, merit and strength).
Pave way to FDI reforms
Historically, Indian policy makers had been skeptical about Foreign Direct Investment or FDI. A limit of 51 per cent on foreign investment in retail has brought in a lot of innovation in the market. International investors have always come up with India-centric policies. The importance of the franchising process is reflected in the retail and industries where nearly every retailer (in malls) and every major restaurant are franchisees of international as well as major national chains. Internationally, franchising is very well accepted and is entrenched deeply within USA, Western Europe, South Africa, SouthEast Asia.
Ratan Jalan, Founder and Principal Consultant, Medium Healthcare Consulting Pvt. Ltd recommends, "The expected foreign investment reform in the forthcoming budget is likely to encourage international players to enter the Indian market. Hence, it would be pertinent for the Government to ease borrowing for players interested to open outlets for these international players." Currently, there are also restrictions on the number of shares a foreign company or person can hold in an Indian company if the joint venture option is considered. There are restrictions on payment of royalties if it is a technical collaboration agreement between the foreign master franchisor and Indian master franchisee. In the forthcoming budget, the Government would need to address some of these issues also in addition to the foreign investment reforms. Sonali Dey, Fox & Mandal shares, "Assuming that the current sectoral limit remains unchanged, FDI up to 51 per cent, may be brought under the automatic route. In addition, the prevailing ambiguity over FIIs should be clarified."
Improved legal and regulatory framework
While India has no specific legislation regulating franchise arrangements, there are a number of laws that affect the franchisor-franchisee relationship. Intellectual property, taxation, labor, competition, property, and exchange control regulations all influence franchising. Lack of appropriate format for franchising agreements can have far fetching impact on the Industry. Dey agrees it is seen several times that due to absence of any franchising laws or any Government guidelines in India, franchisors tend to follow formats which are approved or followed in other countries. Also, it is seen that most of the times the franchisees do not have much bargaining/negotiating capacity in front of the giant franchisors. In view of the circumstance, it may be advisable if the Government frames certain guidelines taking care of the needs and concerns of both the franchisors and franchisees.
Adding further, she said that it is important to have mandatory disclosure requirements. This will ensure transparency. Countries with specific franchising legislations or guidelines make it mandatory for parties to a franchise agreement to disclose certain factual information pertaining to their businesses. A franchisor should be required by law, to make certain disclosures to the prospective franchisee, via details regarding pending litigation and bankruptcy history, financial position, etc. In India, in the absence of any such Government guideline, a prospective franchisee is rendered helpless as the franchisor is under no statutory obligations to make disclosures.
Facilitate an industry centric credit infrastructure
New-age small and medium businesses in India are seeing a transition from manufacturing to the service industry. There are 35 million SMB units in India of which retail sector constitutes 18 million units and service sector has 9.5 million units respectively covering almost 75 per cent of the SME sector. Franchising has been responsible for bringing structural growth and modernising the formats in both the service and retail-based small businesses. However, the mechanism for financing the franchise formats has not evolved, as the banks don't render industry specific funding options due to lack of knowledge. In order to bring an orderly growth in these sectors, it is important that the government makes a special budgetary allocation to franchising businesses in its SME finance allocated to the financial institutions. As new unit franchisees, growth in 2010 is expected to be 40 per cent. Credit is a major hurdle in the growth of franchising obtaining capital to finance single or multi-unit operations has been relatively difficult for franchisee entrepreneurs. No more than five per cent of the entire franchise financing requirement in India is met by financial institutions. Industry believes that as the risk involved in a franchise business model is optimised to a large extent, banks must offer an easy interest rate.
A sound mechanism of franchising funding is hence very essential as non-availability of third party guarantee often proves to be a hurdle to obtain required funds. Internationally, particularly in United States, U.S. Small Business Administration (SBA) financing has played a significant role in helping new or small operators secure the necessary capital to start or acquire franchise units. The SBA and its sponsored loan programs are one of the best sources of capital to open a start-up franchise unit or purchase an existing resale unit for small-business franchise operators that would otherwise experience difficulties in qualifying for conventional financing or loans. Ninad Kapre, Managing Director & CEO of Aptech Ltd recommends that a lot more effort is required to institutionalise the funding infrastructure.
Khetan agrees, "The current ambiguity in the Government's policy guidelines with respect to the franchising industry has left the franchisor and the franchisees at the mercy of the bankers /financial institutions that use their discretion to interpret and regulate the funding propositions from the franchising industry and are quite passive in their response towards franchising as a business model. This is a sad state and would be addressed immediately once the Government confers franchising with industry status."
Remove dual taxation policy on the franchise systems
Under Notification No. 7/2003 dated 20.06.2003, service tax is payable on the gross amount charged by the franchisor from the franchisee in relation to franchise. However, the definition of franchise services flawlessly comprehends the scope of the business activity. The implementation triggers a lot of impact on the operationalisation of the format. Today, Indian franchisor is subjected to dual taxation of service tax and sales tax. Product franchising is a mode of product distribution. Therefore, from cost price to sales price, there is VAT applicability. At the same time, franchisors are liable to pay service tax on franchise service given to the franchisee. To avoid a dual tax liability, franchisors prefer to give product outright basis with advance billing rather than on consignment basis and also prefer to call their partners dealers instead of franchisees to avoid the service tax accrual. The final burden of the service tax is passed on to the franchisee, as the franchisor is unable to forgo his share of franchise fees, which dampen the entrepreneurship of the small businesses.
While, the taxes are nonetheless critical, however in a franchise operation the implication of these taxes are not justified and commonly led to situation where franchisors particularly, retail franchisors are shying to term themselves as franchisors and have diluted the business practices which are fundamental to the success of franchising format. Thus, the business practices that emerged further, complicates the franchisee-franchisor relationship, and also make the legal framework more tedious, in addition, the whole magnitude of the franchising industry is often misinterpreted.
Agreeing to the point Akhil Chaturvedi, Director, Provogue (India) Limited says, "For the franchise industry to thrive successfully, it would require the abolition of service tax currently levied on transportation, rent and commission."
Badrinath, Director, Accretive Business Consulting, said that the dual taxation status needs to be resolved. This has not only added to the cost of operations, but also has put the sector at cross roads. Further, not only retail, but also other sectors like software are facing a negative impact for the same.
Both franchisors as well franchisees across sectors believe that franchise services should not be liable to service tax. There is a strong opposition from the franchisees as the franchise system in India is yet to reach a mature stage and hence the tax policy must facilitate the format to become more competitive. Sharing his views Kundan Kashyap, an Archies Franchisee based in Ranchi says, "Service tax should be abolished as the franchisees pay full VAT and hence dual taxation should be avoided. Government should understand the franchise concept is unique in the way that the most of the resources involved are invested by the franchisee." Sharing the same view, Chander, Franchisee of Catmoss based in Sarojani Nagar New Delhi says, "Service taxes causes unnecessary burden on the franchise service formats and cause operational hurdles."
Service tax on rentals should be avoided
Real estate has become one of the most important aspects of franchise preposition or for that matter a retail success. The rental lease cost could be a significant contributor to the franchisee's running cost. With service tax plus education cess at 10.30 per cent, every tenant will now pay service tax equivalent to six weeks of rent. The industry seeks abolition of service tax on the rental leases. Badrinath, suggests, "The applicability of service tax on rentals should be clarified." With the verdict of Delhi High Court in case of home retail already being challenged by the Central Government, it would be good if the Supreme Court could hear the case and provide the ruling at the earliest. In the retail sector, rentals being one of major expenditures, a 10.30 per cent of rent therefore is significant from both, cash flow as well as margin perspective` This would be a relief for a margin centric business like retail. Lack of structured industry specific measures prevent the business to avail industry appropriate benefits. Shubhranshu Pani, MD, Retail Services, Jones Lang Lasalle Meghraj recommended that pertaining service tax on the rentals should be clarified and freed from existing ambiguity. Over the last few years, there has been an increasing tendency to indiscriminately levy tax on contracts rather than tax on services. Ninad Kapre, also believes that there should be a simple tax structure which is implemented in a fair and transparent manner.
Introduction of a flawless GST
Eliminating the current system of dual taxation, application of a uniform GST, will have its own implications. Since GST is not just VAT plus service tax but an improvement over the previous VAT and disjointed service tax, the tax incidence will come down in case of goods. Tax experts are of the view that this budget is crucial for implementation of a comprehensive as well as flawless implementation of GST nation-wide to enable the economy to become more competitive. The GST implementation should be robust to involve the extended industries. Jalan explains, "In case of services, the incidence, and coverage of tax may rise resulting in higher prices. In this context, for the franchise industry, service franchising may be less lucrative. Supply chain efficiencies will further support this phenomenon. For goods, the existing rate is more than 20 per cent, but for services, the existing rate is 10.3 per cent since GST is expected to be in the range of 12-16 per cent, the prices may rise in the services segment due to the rising tax burden."
This being the last budget to be presented before the proposed implementation of GST, this is also the last instrument for the Government to step ahead to align itself with GST implementation. Among others, the Government should use this budget to align the rates of taxes towards the proposed GST rates. Further, it should indicate the roadmap for the publishing of draft laws and constitutional changes required thereto', Badrinath adds. Baba Chandok, Cartridge World Franchise voices the same and says, "The industry is hopeful that implementation of GST will be breather for the retail."
Introduction of composite scheme for threshold exemption
Currently, the tax structure is certainly not conducive for a robust franchise environment. As a SME, the franchisee must be able to derive maximum benefit so that the same could be passed on to the end users. "Tax structure needs to be much more integrated with a long term approach."
Speaking on the issue of a structured taxation policy for franchising Arun Khetan explains, "For example, in education franchising, the individual service provider is not exempt from the Service Tax Registration and payment if he/she is a franchisee where the turnover of the franchisor is above the exemption limit (currently Rs 10 lakh). It is but natural that the franchisor's turnover for the entire year would exceed this and as a consequence, all the franchisees, even if their individual turnover does not reach the exemption threshold have to get registration with service tax department, collect the service tax from students and deposit the same to the Government. While, such rationale is fine for consumer goods, but seems highly dual and confused policy for education and indirectly leads in suppressing the growth of education at some point in the value chain.
Thus, a composite scheme for small business is the need of the industry to reduce the cost of compliance and hence encourage entrepreneurship. A composite scheme involving a threshold exemption of Rs 50 lakh is proposed by the industry.
Abolition of CST
Badrinath adds, "In terms of the initial agenda of the Central Government, CST was to be zero rated effective 1-4-07, but still continues at two per cent. It would be good for the Government to reduce the CST to one per cent and ultimately move towards a complete abolition with the introduction of GST according to the expectation of the industry. This would contribute in reducing the effective cost of inter-state purchase of goods and also in keeping the inflation at current levels, if not reduce."
Withdrawal of stimulus
Badrinath adds, "While there are much deliberations happening around the withdrawal of the stimulus granted in form of reduction in central excise and service tax rates, in the previous budget and thereafter, this does not appear to be the right time to withdraw the same. It is worthwhile to note that with the support of the Government, the businesses have demonstrated their strength to survive the recession and shown a positive trend as a year-on-year performance. While the performance from 2009 to 2010 is positive and growing, the overall growth from 2008 to 2010 does not appear impressive since the year 2009 was a slump. Hence, the stimulus should ideally be continued and help the industry completely recover from the recession. It could be withdrawn as part of the GST implementation. With the implementation of GST, the cost of tax in the supply chain is envisaged to be reduced, therefore, the cumulative impact of withdrawal of stimulus (added costs) and reduction in supply chain tax cost (benefit) is believed to be mitigated by the businesses. Withdrawal of stimulus could result in high service cost and goods and thereby, impact the growth of retail business. Further, with the inflation rate continuously rising, it does not again appear to be the right time for withdrawal of stimulus."
Conclusion:
The future of Indian retail markets seek organised and innovative business formats to ensure scalability which healthy franchise practices can facilitate. Hence, the policymakers must bring about industry centric reforms to unlock the potential of the SME.
With the union budget 2010-11, the franchise industry's budget expectations would facilitate the necessary reforms and enable the sector to take the next big leap. Franchising has been a significant organiser as well as facilitator of small and medium businesses across industry verticals, thus galvanising the evolution of organised markets. Replication of structured business practices through franchising has contributed significantly in bringing a large number of business units under the tax net. However, policy makers are yet to deliver a conducive eco-system for the growth of the franchise community, which incidentally includes a new breed of Indian entrepreneurs. An intricate framework of legal policies supported by transparent tax policies as well as robust funding institutions is sought by the industry.
Franchising paves way to entrepreneurship
The magnitude as well as the future potential that Indian domestic consumption exhibit makes it an attractive destination for investments. However, statistical trends give a wider perspective of the potential of the Indian market. Yet the investments, both domestic as well as international have had always taken a conservative pace. Presently, liberalisation and market openings have facilitated the business dynamics to become more conducive for entrepreneurial activity. There has been a positive entrepreneurial activity in the business environment which is extremely important as the economic studies have repeatedly proven that innovation as well as entrepreneurship can propel the fiscal machinery of the nation.
India has presented a curious case as entrepreneurial activity here always had its own implication. It has been observed that 90 per cent of start -ups fail in the first year of their inception. There are many reasons for it. Firstly, the Indian market is testing waters in terms of readiness for newer business concepts and formats. Moreover, mature business systems are yet to be developed in terms of redesigning the whole process of starting a business which ideally should be a seamless process. Unfortunately, in India the burden of regulatory procedures as well as processes makes it strenuous for the entrepreneurs as well as innovators. As a result, most of the entrepreneurial activity is reduced to low involvement as well as low risk models. Franchising as an entrepreneurial route is extremely interesting and successful. The acceptability of franchising has been quite prolific amongst Indian business minds. According to the figure, 90 per cent of the franchising ventures have a huge probability of success. This attracts many investors to invest in proven business models and concepts which involve less risk as well. This however is just the tip of the iceberg, although, there is a lot more to franchising than the apparent. Also, franchising in the Indian market becomes much more intricate rather than just being a low capital expansion mode.
Industry status to franchising
India is an attractive market for franchising. The expanded market size seeks deeper as well as broader market penetration. However, the demographic variables make this expansion a risky proposition, especially in a capital constrained market like India. India, as any developing country seeks investment, technology as well as business know-how from the developed countries. Foreign investments have repeatedly done wonders in turning the market game around as it tends to make markets more competitive for IT, retail, manufacturing or service sectors.
The franchise industry in India is currently an anonymous contributor to the country's economy, which is not favourable for a sustainable growth. As Arun.Khetan, Managing Director, The New Age Knowledge Solutions (NAKS) explains, "The status will not only have a detrimental impact on further proliferation of franchising but will also deprive excellent local brands the opportunities to come up with products/services that are of relatively superior value proposition compared to many foreign brands, which are much new to the Indian turf, in terms of knowledge of local preferences and delivery mechanism, but score out heavily in terms of resource deployment and hence are able to reap away most of the benefit." He further adds , "The need of the hour is that the Indian franchising be formally recognised as an industry, which would propel the action plan and processes of the industry and set the ball rolling, that would have a cascading effect on all the interfaces that are related to it either directly or indirectly."
The policy makers must recognise the fact that this is a format segment that cuts across all the industries and that its presence in the Indian backdrop is real. Granting legitimacy would not only put an end to the shadow war but also make the world wake up to the fact that Indian policy makers are serious about the franchising business. This would have mammoth implications in terms of perception that overseas market carry about Indian franchisors and franchising products / services and bestow credibility (which, due to lack of Government sanctity currently rests mostly on private players who have forayed abroad on their own grit, merit and strength).
Remove dual taxation policy on the franchise systems
Under Notification No. 7/2003 dated 20.06.2003, service tax is payable on the gross amount charged by the franchisor from the franchisee in relation to franchise. However, the definition of franchise services flawlessly comprehends the scope of the business activity. The implementation triggers a lot of impact on the operationalisation of the format. Today, Indian franchisor is subjected to dual taxation of service tax and sales tax. Product franchising is a mode of product distribution. Therefore, from cost price to sales price, there is VAT applicability. At the same time, franchisors are liable to pay service tax on franchise service given to the franchisee. To avoid a dual tax liability, franchisors prefer to give product outright basis with advance billing rather than on consignment basis and also prefer to call their partners dealers instead of franchisees to avoid the service tax accrual. The final burden of the service tax is passed on to the franchisee, as the franchisor is unable to forgo his share of franchise fees, which dampen the entrepreneurship of the small businesses.
While, the taxes are nonetheless critical, however in a franchise operation the implication of these taxes are not justified and commonly led to situation where franchisors particularly, retail franchisors are shying to term themselves as franchisors and have diluted the business practices which are fundamental to the success of franchising format. Thus, the business practices that emerged further, complicates the franchisee-franchisor relationship, and also make the legal framework more tedious, in addition, the whole magnitude of the franchising industry is often misinterpreted.
Agreeing to the point Akhil Chaturvedi, Director, Provogue (India) Limited says, "For the franchise industry to thrive successfully, it would require the abolition of service tax currently levied on transportation, rent and commission."
Badrinath, Director, Accretive Business Consulting, said that the dual taxation status needs to be resolved. This has not only added to the cost of operations, but also has put the sector at cross roads. Further, not only retail, but also other sectors like software are facing a negative impact for the same.
Both franchisors as well franchisees across sectors believe that franchise services should not be liable to service tax. There is a strong opposition from the franchisees as the franchise system in India is yet to reach a mature stage and hence the tax policy must facilitate the format to become more competitive. Sharing his views Kundan Kashyap, an Archies Franchisee based in Ranchi says, "Service tax should be abolished as the franchisees pay full VAT and hence dual taxation should be avoided. Government should understand the franchise concept is unique in the way that the most of the resources involved are invested by the franchisee." Sharing the same view, Chander, Franchisee of Catmoss based in Sarojani Nagar New Delhi says, "Service taxes causes unnecessary burden on the franchise service formats and cause operational hurdles."
Service tax on rentals should be avoided
Real estate has become one of the most important aspects of franchise preposition or for that matter a retail success. The rental lease cost could be a significant contributor to the franchisee's running cost. With service tax plus education cess at 10.30 per cent, every tenant will now pay service tax equivalent to six weeks of rent. The industry seeks abolition of service tax on the rental leases. Badrinath, suggests, "The applicability of service tax on rentals should be clarified." With the verdict of Delhi High Court in case of home retail already being challenged by the Central Government, it would be good if the Supreme Court could hear the case and provide the ruling at the earliest. In the retail sector, rentals being one of major expenditures, a 10.30 per cent of rent therefore is significant from both, cash flow as well as margin perspective` This would be a relief for a margin centric business like retail. Lack of structured industry specific measures prevent the business to avail industry appropriate benefits. Shubhranshu Pani, MD, Retail Services, Jones Lang Lasalle Meghraj recommended that pertaining service tax on the rentals should be clarified and freed from existing ambiguity. Over the last few years, there has been an increasing tendency to indiscriminately levy tax on contracts rather than tax on services. Ninad Kapre, also believes that there should be a simple tax structure which is implemented in a fair and transparent manner.
Introduction of a flawless GST
Eliminating the current system of dual taxation, application of a uniform GST, will have its own implications. Since GST is not just VAT plus service tax but an improvement over the previous VAT and disjointed service tax, the tax incidence will come down in case of goods. Tax experts are of the view that this budget is crucial for implementation of a comprehensive as well as flawless implementation of GST nation-wide to enable the economy to become more competitive. The GST implementation should be robust to involve the extended industries. Jalan explains, "In case of services, the incidence, and coverage of tax may rise resulting in higher prices. In this context, for the franchise industry, service franchising may be less lucrative. Supply chain efficiencies will further support this phenomenon. For goods, the existing rate is more than 20 per cent, but for services, the existing rate is 10.3 per cent since GST is expected to be in the range of 12-16 per cent, the prices may rise in the services segment due to the rising tax burden."
This being the last budget to be presented before the proposed implementation of GST, this is also the last instrument for the Government to step ahead to align itself with GST implementation. Among others, the Government should use this budget to align the rates of taxes towards the proposed GST rates. Further, it should indicate the roadmap for the publishing of draft laws and constitutional changes required thereto', Badrinath adds. Baba Chandok, Franchisee, Cartridge World voices the same and says, "The industry is hopeful that implementation of GST will be breather for the retail."
Introduction of composite scheme for threshold exemption
Currently, the tax structure is certainly not conducive for a robust franchise environment. As a SME, the franchisee must be able to derive maximum benefit so that the same could be passed on to the end users. "Tax structure needs to be much more integrated with a long term approach."
Speaking on the issue of a structured taxation policy for franchising Arun Khetan explains, "For example, in education franchising, the individual service provider is not exempt from the Service Tax Registration and payment if he/she is a franchisee where the turnover of the franchisor is above the exemption limit (currently Rs 10 lakh). It is but natural that the franchisor's turnover for the entire year would exceed this and as a consequence, all the franchisees, even if their individual turnover does not reach the exemption threshold have to get registration with service tax department, collect the service tax from students and deposit the same to the Government. While, such rationale is fine for consumer goods, but seems highly dual and confused policy for education and indirectly leads in suppressing the growth of education at some point in the value chain.
Thus, a composite scheme for small business is the need of the industry to reduce the cost of compliance and hence encourage entrepreneurship. A composite scheme involving a threshold exemption of Rs 50 lakh is proposed by the industry.
Improved legal and regulatory framework
While India has no specific legislation regulating franchise arrangements, there are a number of laws that affect the franchisor-franchisee relationship. Intellectual property, taxation, labor, competition, property, and exchange control regulations all influence franchising. Lack of appropriate format for franchising agreements can have far fetching impact on the Industry. Dey agrees it is seen several times that due to absence of any franchising laws or any Government guidelines in India, franchisors tend to follow formats which are approved or followed in other countries. Also, it is seen that most of the times the franchisees do not have much bargaining/negotiating capacity in front of the giant franchisors. In view of the circumstance, it may be advisable if the Government frames certain guidelines taking care of the needs and concerns of both the franchisors and franchisees.
Adding further, she said that it is important to have mandatory disclosure requirements. This will ensure transparency. Countries with specific franchising legislations or guidelines make it mandatory for parties to a franchise agreement to disclose certain factual information pertaining to their businesses. A franchisor should be required by law, to make certain disclosures to the prospective franchisee, via details regarding pending litigation and bankruptcy history, financial position, etc. In India, in the absence of any such Government guideline, a prospective franchisee is rendered helpless as the franchisor is under no statutory obligations to make disclosures.
Facilitate an industry centric credit infrastructure
New-age small and medium businesses in India are seeing a transition from manufacturing to the service industry. There are 35 million SMB units in India of which retail sector constitutes 18 million units and service sector has 9.5 million units respectively covering almost 75 per cent of the SME sector. Franchising has been responsible for bringing structural growth and modernising the formats in both the service and retail-based small businesses. However, the mechanism for financing the franchise formats has not evolved, as the banks don't render industry specific funding options due to lack of knowledge. In order to bring an orderly growth in these sectors, it is important that the government makes a special budgetary allocation to franchising businesses in its SME finance allocated to the financial institutions. As new unit franchisees, growth in 2010 is expected to be 40 per cent. Credit is a major hurdle in the growth of franchising obtaining capital to finance single or multi-unit operations has been relatively difficult for franchisee entrepreneurs. No more than five per cent of the entire franchise financing requirement in India is met by financial institutions. Industry believes that as the risk involved in a franchise business model is optimised to a large extent, banks must offer an easy interest rate.
A sound mechanism of franchising funding is hence very essential as non-availability of third party guarantee often proves to be a hurdle to obtain required funds. Internationally, particularly in United States, U.S. Small Business Administration (SBA) financing has played a significant role in helping new or small operators secure the necessary capital to start or acquire franchise units. The SBA and its sponsored loan programs are one of the best sources of capital to open a start-up franchise unit or purchase an existing resale unit for small-business franchise operators that would otherwise experience difficulties in qualifying for conventional financing or loans. Ninad Kapre, Managing Director & CEO of Aptech Ltd recommends that a lot more effort is required to institutionalise the funding infrastructure.
Khetan agrees, "The current ambiguity in the Government's policy guidelines with respect to the franchising industry has left the franchisor and the franchisees at the mercy of the bankers /financial institutions that use their discretion to interpret and regulate the funding propositions from the franchising industry and are quite passive in their response towards franchising as a business model. This is a sad state and would be addressed immediately once the Government confers franchising with industry status."
Abolition of CST
Badrinath adds, "In terms of the initial agenda of the Central Government, CST was to be zero rated effective 1-4-07, but still continues at two per cent. It would be good for the Government to reduce the CST to one per cent and ultimately move towards a complete abolition with the introduction of GST according to the expectation of the industry. This would contribute in reducing the effective cost of inter-state purchase of goods and also in keeping the inflation at current levels, if not reduce."
Withdrawal of stimulus
Badrinath adds, "While there are much deliberations happening around the withdrawal of the stimulus granted in form of reduction in central excise and service tax rates, in the previous budget and thereafter, this does not appear to be the right time to withdraw the same. It is worthwhile to note that with the support of the Government, the businesses have demonstrated their strength to survive the recession and shown a positive trend as a year-on-year performance. While the performance from 2009 to 2010 is positive and growing, the overall growth from 2008 to 2010 does not appear impressive since the year 2009 was a slump. Hence, the stimulus should ideally be continued and help the industry completely recover from the recession. It could be withdrawn as part of the GST implementation. With the implementation of GST, the cost of tax in the supply chain is envisaged to be reduced, therefore, the cumulative impact of withdrawal of stimulus (added costs) and reduction in supply chain tax cost (benefit) is believed to be mitigated by the businesses. Withdrawal of stimulus could result in high service cost and goods and thereby, impact the growth of retail business. Further, with the inflation rate continuously rising, it does not again appear to be the right time for withdrawal of stimulus."
Pave way to FDI reforms
Historically, Indian policy makers had been skeptical about Foreign Direct Investment or FDI. A limit of 51 per cent on foreign investment in retail has brought in a lot of innovation in the market. International investors have always come up with India-centric policies. The importance of the franchising process is reflected in the retail and industries where nearly every retailer (in malls) and every major restaurant are franchisees of international as well as major national chains. Internationally, franchising is very well accepted and is entrenched deeply within USA, Western Europe, South Africa, SouthEast Asia.
Ratan Jalan, Founder and Principal Consultant, Medium Healthcare Consulting Pvt. Ltd recommends, "The expected foreign investment reform in the forthcoming budget is likely to encourage international players to enter the Indian market. Hence, it would be pertinent for the Government to ease borrowing for players interested to open outlets for these international players." Currently, there are also restrictions on the number of shares a foreign company or person can hold in an Indian company if the joint venture option is considered. There are restrictions on payment of royalties if it is a technical collaboration agreement between the foreign master franchisor and Indian master franchisee. In the forthcoming budget, the Government would need to address some of these issues also in addition to the foreign investment reforms. Sonali Dey, Fox & Mandal shares, "Assuming that the current sectoral limit remains unchanged, FDI up to 51 per cent, may be brought under the automatic route. In addition, the prevailing ambiguity over FIIs should be clarified."
Conclusion:
The future of Indian retail markets seek organised and innovative business formats to ensure scalability which healthy franchise practices can facilitate. Hence, the policymakers must bring about industry centric reforms to unlock the potential of the SME.
The magnitude as well as the future potential that Indian domestic consumption exhibit makes it an attractive destination for investments. However, statistical trends give a wider perspective of the potential of the Indian market. Yet the investments, both domestic as well as international have had always taken a conservative pace. Presently, liberalisation and market openings have facilitated the business dynamics to become more conducive for entrepreneurial activity. There has been a positive entrepreneurial activity in the business environment which is extremely important as the economic studies have repeatedly proven that innovation as well as entrepreneurship can propel the fiscal machinery of the nation.
India has presented a curious case as entrepreneurial activity here always had its own implication. It has been observed that 90 per cent of start ups fail in the first year of their inception. There are many reasons for it. Firstly, the Indian market is testing waters in terms of readiness for newer business concepts and formats. Moreover, mature business systems are yet to be developed in terms of redesigning the whole process of starting a business which ideally should be a seamless process. Unfortunately, in India the burden of regulatory procedures as well as processes makes it strenuous for the entrepreneurs as well as innovators. As a result, most of the entrepreneurial activity is reduced to low involvement as well as low risk models. Franchising as an entrepreneurial route is extremely interesting and successful. The acceptability of franchising has been quite prolific amongst Indian business minds. According to the figure, 90 per cent of the franchising ventures have a huge probability of success. This attracts many investors to invest in proven business models and concepts which involve less risk as well. This however is just the tip of the iceberg, although, there is a lot more to franchising than the apparent. Also, franchising in the Indian market becomes much more intricate rather than just being a low capital expansion mode.
Industry status to franchising
India is an attractive market for franchising. The expanded market size seeks deeper as well as broader market penetration. However, the demographic variables make this expansion a risky proposition, especially in a capital constrained market like India. India, as any developing country seeks investment, technology as well as business know-how from the developed countries. Foreign investments have repeatedly done wonders in turning the market game around as it tends to make markets more competitive for IT, retail, manufacturing or service sectors.
The franchise industry in India is currently an anonymous contributor to the country's economy, which is not favourable for a sustainable growth. As Arun Khetan, Managing Director, The New Age Knowledge Solutions (NAKS) explains, "The status will not only have a detrimental impact on further proliferation of franchising but will also deprive excellent local brands the opportunities to come up with products/services that are of relatively superior value proposition compared to many foreign brands, which are much new to the Indian turf, in terms of knowledge of local preferences and delivery mechanism, but score out heavily in terms of resource deployment and hence are able to reap away most of the benefit." He further adds , "The need of the hour is that the Indian franchising be formally recognised as an industry, which would propel the action plan and processes of the industry and set the ball rolling, that would have a cascading effect on all the interfaces that are related to it either directly or indirectly."
The policy makers must recognise the fact that this is a format segment that cuts across all the industries and that its presence in the Indian backdrop is real. Granting legitimacy would not only put an end to the shadow war but also make the world wake up to the fact that Indian policy makers are serious about the franchising business. This would have mammoth implications in terms of perception that overseas market carry about Indian franchisors and franchising products / services and bestow credibility (which, due to lack of Government sanctity currently rests mostly on private players who have forayed abroad on their own grit, merit and strength).
Pave way to FDI reforms
Historically, Indian policy makers had been skeptical about Foreign Direct Investment or FDI. A limit of 51 per cent on foreign investment in retail has brought in a lot of innovation in the market. International investors have always come up with India-centric policies. The importance of the franchising process is reflected in the retail and industries where nearly every retailer (in malls) and every major restaurant are franchisees of international as well as major national chains. Internationally, franchising is very well accepted and is entrenched deeply within USA, Western Europe, South Africa, SouthEast Asia.
Ratan Jalan, Founder and Principal Consultant, Medium Healthcare Consulting Pvt. Ltd recommends, "The expected foreign investment reform in the forthcoming budget is likely to encourage international players to enter the Indian market. Hence, it would be pertinent for the Government to ease borrowing for players interested to open outlets for these international players." Currently, there are also restrictions on the number of shares a foreign company or person can hold in an Indian company if the joint venture option is considered. There are restrictions on payment of royalties if it is a technical collaboration agreement between the foreign master franchisor and Indian master franchisee. In the forthcoming budget, the Government would need to address some of these issues also in addition to the foreign investment reforms. Sonali Dey, Fox & Mandal shares, "Assuming that the current sectoral limit remains unchanged, FDI up to 51 per cent, may be brought under the automatic route. In addition, the prevailing ambiguity over FIIs should be clarified."
Improved legal and regulatory framework
While India has no specific legislation regulating franchise arrangements, there are a number of laws that affect the franchisor-franchisee relationship. Intellectual property, taxation, labor, competition, property, and exchange control regulations all influence franchising. Lack of appropriate format for franchising agreements can have far fetching impact on the Industry. Dey agrees it is seen several times that due to absence of any franchising laws or any Government guidelines in India, franchisors tend to follow formats which are approved or followed in other countries. Also, it is seen that most of the times the franchisees do not have much bargaining/negotiating capacity in front of the giant franchisors. In view of the circumstance, it may be advisable if the Government frames certain guidelines taking care of the needs and concerns of both the franchisors and franchisees.
Adding further, she said that it is important to have mandatory disclosure requirements. This will ensure transparency. Countries with specific franchising legislations or guidelines make it mandatory for parties to a franchise agreement to disclose certain factual information pertaining to their businesses. A franchisor should be required by law, to make certain disclosures to the prospective franchisee, via details regarding pending litigation and bankruptcy history, financial position, etc. In India, in the absence of any such Government guideline, a prospective franchisee is rendered helpless as the franchisor is under no statutory obligations to make disclosures.
Facilitate an industry centric credit infrastructure
New-age small and medium businesses in India are seeing a transition from manufacturing to the service industry. There are 35 million SMB units in India of which retail sector constitutes 18 million units and service sector has 9.5 million units respectively covering almost 75 per cent of the SME sector. Franchising has been responsible for bringing structural growth and modernising the formats in both the service and retail-based small businesses. However, the mechanism for financing the franchise formats has not evolved, as the banks don't render industry specific funding options due to lack of knowledge. In order to bring an orderly growth in these sectors, it is important that the government makes a special budgetary allocation to franchising businesses in its SME finance allocated to the financial institutions. As new unit franchisees, growth in 2010 is expected to be 40 per cent. Credit is a major hurdle in the growth of franchising obtaining capital to finance single or multi-unit operations has been relatively difficult for franchisee entrepreneurs. No more than five per cent of the entire franchise financing requirement in India is met by financial institutions. Industry believes that as the risk involved in a franchise business model is optimised to a large extent, banks must offer an easy interest rate.
A sound mechanism of franchising funding is hence very essential as non-availability of third party guarantee often proves to be a hurdle to obtain required funds. Internationally, particularly in United States, U.S. Small Business Administration (SBA) financing has played a significant role in helping new or small operators secure the necessary capital to start or acquire franchise units. The SBA and its sponsored loan programs are one of the best sources of capital to open a start-up franchise unit or purchase an existing resale unit for small-business franchise operators that would otherwise experience difficulties in qualifying for conventional financing or loans. Ninad Kapre, Managing Director & CEO of Aptech Ltd recommends that a lot more effort is required to institutionalise the funding infrastructure.
Khetan agrees, "The current ambiguity in the Government's policy guidelines with respect to the franchising industry has left the franchisor and the franchisees at the mercy of the bankers /financial institutions that use their discretion to interpret and regulate the funding propositions from the franchising industry and are quite passive in their response towards franchising as a business model. This is a sad state and would be addressed immediately once the Government confers franchising with industry status."
Remove dual taxation policy on the franchise systems
Under Notification No. 7/2003 dated 20.06.2003, service tax is payable on the gross amount charged by the franchisor from the franchisee in relation to franchise. However, the definition of franchise services flawlessly comprehends the scope of the business activity. The implementation triggers a lot of impact on the operationalisation of the format. Today, Indian franchisor is subjected to dual taxation of service tax and sales tax. Product franchising is a mode of product distribution. Therefore, from cost price to sales price, there is VAT applicability. At the same time, franchisors are liable to pay service tax on franchise service given to the franchisee. To avoid a dual tax liability, franchisors prefer to give product outright basis with advance billing rather than on consignment basis and also prefer to call their partners dealers instead of franchisees to avoid the service tax accrual. The final burden of the service tax is passed on to the franchisee, as the franchisor is unable to forgo his share of franchise fees, which dampen the entrepreneurship of the small businesses.
While, the taxes are nonetheless critical, however in a franchise operation the implication of these taxes are not justified and commonly led to situation where franchisors particularly, retail franchisors are shying to term themselves as franchisors and have diluted the business practices which are fundamental to the success of franchising format. Thus, the business practices that emerged further, complicates the franchisee-franchisor relationship, and also make the legal framework more tedious, in addition, the whole magnitude of the franchising industry is often misinterpreted.
Agreeing to the point Akhil Chaturvedi, Director, Provogue (India) Limited says, "For the franchise industry to thrive successfully, it would require the abolition of service tax currently levied on transportation, rent and commission."
Badrinath, Director, Accretive Business Consulting, said that the dual taxation status needs to be resolved. This has not only added to the cost of operations, but also has put the sector at cross roads. Further, not only retail, but also other sectors like software are facing a negative impact for the same.
Both franchisors as well franchisees across sectors believe that franchise services should not be liable to service tax. There is a strong opposition from the franchisees as the franchise system in India is yet to reach a mature stage and hence the tax policy must facilitate the format to become more competitive. Sharing his views Kundan Kashyap, an Archies Franchisee based in Ranchi says, "Service tax should be abolished as the franchisees pay full VAT and hence dual taxation should be avoided. Government should understand the franchise concept is unique in the way that the most of the resources involved are invested by the franchisee." Sharing the same view, Chander, Franchisee of Catmoss based in Sarojani Nagar New Delhi says, "Service taxes causes unnecessary burden on the franchise service formats and cause operational hurdles."
Service tax on rentals should be avoided
Real estate has become one of the most important aspects of franchise preposition or for that matter a retail success. The rental lease cost could be a significant contributor to the franchisee's running cost. With service tax plus education cess at 10.30 per cent, every tenant will now pay service tax equivalent to six weeks of rent. The industry seeks abolition of service tax on the rental leases. Badrinath, suggests, "The applicability of service tax on rentals should be clarified." With the verdict of Delhi High Court in case of home retail already being challenged by the Central Government, it would be good if the Supreme Court could hear the case and provide the ruling at the earliest. In the retail sector, rentals being one of major expenditures, a 10.30 per cent of rent therefore is significant from both, cash flow as well as margin perspective` This would be a relief for a margin centric business like retail. Lack of structured industry specific measures prevent the business to avail industry appropriate benefits. Shubhranshu Pani, MD, Retail Services, Jones Lang Lasalle Meghraj recommended that pertaining service tax on the rentals should be clarified and freed from existing ambiguity. Over the last few years, there has been an increasing tendency to indiscriminately levy tax on contracts rather than tax on services. Ninad Kapre, also believes that there should be a simple tax structure which is implemented in a fair and transparent manner.
Introduction of a flawless GST
Eliminating the current system of dual taxation, application of a uniform GST, will have its own implications. Since GST is not just VAT plus service tax but an improvement over the previous VAT and disjointed service tax, the tax incidence will come down in case of goods. Tax experts are of the view that this budget is crucial for implementation of a comprehensive as well as flawless implementation of GST nation-wide to enable the economy to become more competitive. The GST implementation should be robust to involve the extended industries. Jalan explains, "In case of services, the incidence, and coverage of tax may rise resulting in higher prices. In this context, for the franchise industry, service franchising may be less lucrative. Supply chain efficiencies will further support this phenomenon. For goods, the existing rate is more than 20 per cent, but for services, the existing rate is 10.3 per cent since GST is expected to be in the range of 12-16 per cent, the prices may rise in the services segment due to the rising tax burden."
This being the last budget to be presented before the proposed implementation of GST, this is also the last instrument for the Government to step ahead to align itself with GST implementation. Among others, the Government should use this budget to align the rates of taxes towards the proposed GST rates. Further, it should indicate the roadmap for the publishing of draft laws and constitutional changes required thereto', Badrinath adds. Baba Chandok, Cartridge World Franchise voices the same and says, "The industry is hopeful that implementation of GST will be breather for the retail."
Introduction of composite scheme for threshold exemption
Currently, the tax structure is certainly not conducive for a robust franchise environment. As a SME, the franchisee must be able to derive maximum benefit so that the same could be passed on to the end users. "Tax structure needs to be much more integrated with a long term approach."
Speaking on the issue of a structured taxation policy for franchising Arun Khetan explains, "For example, in education franchising, the individual service provider is not exempt from the Service Tax Registration and payment if he/she is a franchisee where the turnover of the franchisor is above the exemption limit (currently Rs 10 lakh). It is but natural that the franchisor's turnover for the entire year would exceed this and as a consequence, all the franchisees, even if their individual turnover does not reach the exemption threshold have to get registration with service tax department, collect the service tax from students and deposit the same to the Government. While, such rationale is fine for consumer goods, but seems highly dual and confused policy for education and indirectly leads in suppressing the growth of education at some point in the value chain.
Thus, a composite scheme for small business is the need of the industry to reduce the cost of compliance and hence encourage entrepreneurship. A composite scheme involving a threshold exemption of Rs 50 lakh is proposed by the industry.
Abolition of CST
Badrinath adds, "In terms of the initial agenda of the Central Government, CST was to be zero rated effective 1-4-07, but still continues at two per cent. It would be good for the Government to reduce the CST to one per cent and ultimately move towards a complete abolition with the introduction of GST according to the expectation of the industry. This would contribute in reducing the effective cost of inter-state purchase of goods and also in keeping the inflation at current levels, if not reduce."
Withdrawal of stimulus
Badrinath adds, "While there are much deliberations happening around the withdrawal of the stimulus granted in form of reduction in central excise and service tax rates, in the previous budget and thereafter, this does not appear to be the right time to withdraw the same. It is worthwhile to note that with the support of the Government, the businesses have demonstrated their strength to survive the recession and shown a positive trend as a year-on-year performance. While the performance from 2009 to 2010 is positive and growing, the overall growth from 2008 to 2010 does not appear impressive since the year 2009 was a slump. Hence, the stimulus should ideally be continued and help the industry completely recover from the recession. It could be withdrawn as part of the GST implementation. With the implementation of GST, the cost of tax in the supply chain is envisaged to be reduced, therefore, the cumulative impact of withdrawal of stimulus (added costs) and reduction in supply chain tax cost (benefit) is believed to be mitigated by the businesses. Withdrawal of stimulus could result in high service cost and goods and thereby, impact the growth of retail business. Further, with the inflation rate continuously rising, it does not again appear to be the right time for withdrawal of stimulus."
Conclusion:
The future of Indian retail markets seek organised and innovative business formats to ensure scalability which healthy franchise practices can facilitate. Hence, the policymakers must bring about industry centric reforms to unlock the potential of the SME.
With the union budget 2010-11, the franchise industry's budget expectations would facilitate the necessary reforms and enable the sector to take the next big leap. Franchising has been a significant organiser as well as facilitator of small and medium businesses across industry verticals, thus galvanising the evolution of organised markets. Replication of structured business practices through franchising has contributed significantly in bringing a large number of business units under the tax net. However, policy makers are yet to deliver a conducive eco-system for the growth of the franchise community, which incidentally includes a new breed of Indian entrepreneurs. An intricate framework of legal policies supported by transparent tax policies as well as robust funding institutions is sought by the industry.
Franchising paves way to entrepreneurship
The magnitude as well as the future potential that Indian domestic consumption exhibit makes it an attractive destination for investments. However, statistical trends give a wider perspective of the potential of the Indian market. Yet the investments, both domestic as well as international have had always taken a conservative pace. Presently, liberalisation and market openings have facilitated the business dynamics to become more conducive for entrepreneurial activity. There has been a positive entrepreneurial activity in the business environment which is extremely important as the economic studies have repeatedly proven that innovation as well as entrepreneurship can propel the fiscal machinery of the nation.
India has presented a curious case as entrepreneurial activity here always had its own implication. It has been observed that 90 per cent of start -ups fail in the first year of their inception. There are many reasons for it. Firstly, the Indian market is testing waters in terms of readiness for newer business concepts and formats. Moreover, mature business systems are yet to be developed in terms of redesigning the whole process of starting a business which ideally should be a seamless process. Unfortunately, in India the burden of regulatory procedures as well as processes makes it strenuous for the entrepreneurs as well as innovators. As a result, most of the entrepreneurial activity is reduced to low involvement as well as low risk models. Franchising as an entrepreneurial route is extremely interesting and successful. The acceptability of franchising has been quite prolific amongst Indian business minds. According to the figure, 90 per cent of the franchising ventures have a huge probability of success. This attracts many investors to invest in proven business models and concepts which involve less risk as well. This however is just the tip of the iceberg, although, there is a lot more to franchising than the apparent. Also, franchising in the Indian market becomes much more intricate rather than just being a low capital expansion mode.
Industry status to franchising
India is an attractive market for franchising. The expanded market size seeks deeper as well as broader market penetration. However, the demographic variables make this expansion a risky proposition, especially in a capital constrained market like India. India, as any developing country seeks investment, technology as well as business know-how from the developed countries. Foreign investments have repeatedly done wonders in turning the market game around as it tends to make markets more competitive for IT, retail, manufacturing or service sectors.
The franchise industry in India is currently an anonymous contributor to the country's economy, which is not favourable for a sustainable growth. As Arun.Khetan, Managing Director, The New Age Knowledge Solutions (NAKS) explains, "The status will not only have a detrimental impact on further proliferation of franchising but will also deprive excellent local brands the opportunities to come up with products/services that are of relatively superior value proposition compared to many foreign brands, which are much new to the Indian turf, in terms of knowledge of local preferences and delivery mechanism, but score out heavily in terms of resource deployment and hence are able to reap away most of the benefit." He further adds , "The need of the hour is that the Indian franchising be formally recognised as an industry, which would propel the action plan and processes of the industry and set the ball rolling, that would have a cascading effect on all the interfaces that are related to it either directly or indirectly."
The policy makers must recognise the fact that this is a format segment that cuts across all the industries and that its presence in the Indian backdrop is real. Granting legitimacy would not only put an end to the shadow war but also make the world wake up to the fact that Indian policy makers are serious about the franchising business. This would have mammoth implications in terms of perception that overseas market carry about Indian franchisors and franchising products / services and bestow credibility (which, due to lack of Government sanctity currently rests mostly on private players who have forayed abroad on their own grit, merit and strength).
Remove dual taxation policy on the franchise systems
Under Notification No. 7/2003 dated 20.06.2003, service tax is payable on the gross amount charged by the franchisor from the franchisee in relation to franchise. However, the definition of franchise services flawlessly comprehends the scope of the business activity. The implementation triggers a lot of impact on the operationalisation of the format. Today, Indian franchisor is subjected to dual taxation of service tax and sales tax. Product franchising is a mode of product distribution. Therefore, from cost price to sales price, there is VAT applicability. At the same time, franchisors are liable to pay service tax on franchise service given to the franchisee. To avoid a dual tax liability, franchisors prefer to give product outright basis with advance billing rather than on consignment basis and also prefer to call their partners dealers instead of franchisees to avoid the service tax accrual. The final burden of the service tax is passed on to the franchisee, as the franchisor is unable to forgo his share of franchise fees, which dampen the entrepreneurship of the small businesses.
While, the taxes are nonetheless critical, however in a franchise operation the implication of these taxes are not justified and commonly led to situation where franchisors particularly, retail franchisors are shying to term themselves as franchisors and have diluted the business practices which are fundamental to the success of franchising format. Thus, the business practices that emerged further, complicates the franchisee-franchisor relationship, and also make the legal framework more tedious, in addition, the whole magnitude of the franchising industry is often misinterpreted.
Agreeing to the point Akhil Chaturvedi, Director, Provogue (India) Limited says, "For the franchise industry to thrive successfully, it would require the abolition of service tax currently levied on transportation, rent and commission."
Badrinath, Director, Accretive Business Consulting, said that the dual taxation status needs to be resolved. This has not only added to the cost of operations, but also has put the sector at cross roads. Further, not only retail, but also other sectors like software are facing a negative impact for the same.
Both franchisors as well franchisees across sectors believe that franchise services should not be liable to service tax. There is a strong opposition from the franchisees as the franchise system in India is yet to reach a mature stage and hence the tax policy must facilitate the format to become more competitive. Sharing his views Kundan Kashyap, an Archies Franchisee based in Ranchi says, "Service tax should be abolished as the franchisees pay full VAT and hence dual taxation should be avoided. Government should understand the franchise concept is unique in the way that the most of the resources involved are invested by the franchisee." Sharing the same view, Chander, Franchisee of Catmoss based in Sarojani Nagar New Delhi says, "Service taxes causes unnecessary burden on the franchise service formats and cause operational hurdles."
Service tax on rentals should be avoided
Real estate has become one of the most important aspects of franchise preposition or for that matter a retail success. The rental lease cost could be a significant contributor to the franchisee's running cost. With service tax plus education cess at 10.30 per cent, every tenant will now pay service tax equivalent to six weeks of rent. The industry seeks abolition of service tax on the rental leases. Badrinath, suggests, "The applicability of service tax on rentals should be clarified." With the verdict of Delhi High Court in case of home retail already being challenged by the Central Government, it would be good if the Supreme Court could hear the case and provide the ruling at the earliest. In the retail sector, rentals being one of major expenditures, a 10.30 per cent of rent therefore is significant from both, cash flow as well as margin perspective` This would be a relief for a margin centric business like retail. Lack of structured industry specific measures prevent the business to avail industry appropriate benefits. Shubhranshu Pani, MD, Retail Services, Jones Lang Lasalle Meghraj recommended that pertaining service tax on the rentals should be clarified and freed from existing ambiguity. Over the last few years, there has been an increasing tendency to indiscriminately levy tax on contracts rather than tax on services. Ninad Kapre, also believes that there should be a simple tax structure which is implemented in a fair and transparent manner.
Introduction of a flawless GST
Eliminating the current system of dual taxation, application of a uniform GST, will have its own implications. Since GST is not just VAT plus service tax but an improvement over the previous VAT and disjointed service tax, the tax incidence will come down in case of goods. Tax experts are of the view that this budget is crucial for implementation of a comprehensive as well as flawless implementation of GST nation-wide to enable the economy to become more competitive. The GST implementation should be robust to involve the extended industries. Jalan explains, "In case of services, the incidence, and coverage of tax may rise resulting in higher prices. In this context, for the franchise industry, service franchising may be less lucrative. Supply chain efficiencies will further support this phenomenon. For goods, the existing rate is more than 20 per cent, but for services, the existing rate is 10.3 per cent since GST is expected to be in the range of 12-16 per cent, the prices may rise in the services segment due to the rising tax burden."
This being the last budget to be presented before the proposed implementation of GST, this is also the last instrument for the Government to step ahead to align itself with GST implementation. Among others, the Government should use this budget to align the rates of taxes towards the proposed GST rates. Further, it should indicate the roadmap for the publishing of draft laws and constitutional changes required thereto', Badrinath adds. Baba Chandok, Franchisee, Cartridge World voices the same and says, "The industry is hopeful that implementation of GST will be breather for the retail."
Introduction of composite scheme for threshold exemption
Currently, the tax structure is certainly not conducive for a robust franchise environment. As a SME, the franchisee must be able to derive maximum benefit so that the same could be passed on to the end users. "Tax structure needs to be much more integrated with a long term approach."
Speaking on the issue of a structured taxation policy for franchising Arun Khetan explains, "For example, in education franchising, the individual service provider is not exempt from the Service Tax Registration and payment if he/she is a franchisee where the turnover of the franchisor is above the exemption limit (currently Rs 10 lakh). It is but natural that the franchisor's turnover for the entire year would exceed this and as a consequence, all the franchisees, even if their individual turnover does not reach the exemption threshold have to get registration with service tax department, collect the service tax from students and deposit the same to the Government. While, such rationale is fine for consumer goods, but seems highly dual and confused policy for education and indirectly leads in suppressing the growth of education at some point in the value chain.
Thus, a composite scheme for small business is the need of the industry to reduce the cost of compliance and hence encourage entrepreneurship. A composite scheme involving a threshold exemption of Rs 50 lakh is proposed by the industry.
Improved legal and regulatory framework
While India has no specific legislation regulating franchise arrangements, there are a number of laws that affect the franchisor-franchisee relationship. Intellectual property, taxation, labor, competition, property, and exchange control regulations all influence franchising. Lack of appropriate format for franchising agreements can have far fetching impact on the Industry. Dey agrees it is seen several times that due to absence of any franchising laws or any Government guidelines in India, franchisors tend to follow formats which are approved or followed in other countries. Also, it is seen that most of the times the franchisees do not have much bargaining/negotiating capacity in front of the giant franchisors. In view of the circumstance, it may be advisable if the Government frames certain guidelines taking care of the needs and concerns of both the franchisors and franchisees.
Adding further, she said that it is important to have mandatory disclosure requirements. This will ensure transparency. Countries with specific franchising legislations or guidelines make it mandatory for parties to a franchise agreement to disclose certain factual information pertaining to their businesses. A franchisor should be required by law, to make certain disclosures to the prospective franchisee, via details regarding pending litigation and bankruptcy history, financial position, etc. In India, in the absence of any such Government guideline, a prospective franchisee is rendered helpless as the franchisor is under no statutory obligations to make disclosures.
Facilitate an industry centric credit infrastructure
New-age small and medium businesses in India are seeing a transition from manufacturing to the service industry. There are 35 million SMB units in India of which retail sector constitutes 18 million units and service sector has 9.5 million units respectively covering almost 75 per cent of the SME sector. Franchising has been responsible for bringing structural growth and modernising the formats in both the service and retail-based small businesses. However, the mechanism for financing the franchise formats has not evolved, as the banks don't render industry specific funding options due to lack of knowledge. In order to bring an orderly growth in these sectors, it is important that the government makes a special budgetary allocation to franchising businesses in its SME finance allocated to the financial institutions. As new unit franchisees, growth in 2010 is expected to be 40 per cent. Credit is a major hurdle in the growth of franchising obtaining capital to finance single or multi-unit operations has been relatively difficult for franchisee entrepreneurs. No more than five per cent of the entire franchise financing requirement in India is met by financial institutions. Industry believes that as the risk involved in a franchise business model is optimised to a large extent, banks must offer an easy interest rate.
A sound mechanism of franchising funding is hence very essential as non-availability of third party guarantee often proves to be a hurdle to obtain required funds. Internationally, particularly in United States, U.S. Small Business Administration (SBA) financing has played a significant role in helping new or small operators secure the necessary capital to start or acquire franchise units. The SBA and its sponsored loan programs are one of the best sources of capital to open a start-up franchise unit or purchase an existing resale unit for small-business franchise operators that would otherwise experience difficulties in qualifying for conventional financing or loans. Ninad Kapre, Managing Director & CEO of Aptech Ltd recommends that a lot more effort is required to institutionalise the funding infrastructure.
Khetan agrees, "The current ambiguity in the Government's policy guidelines with respect to the franchising industry has left the franchisor and the franchisees at the mercy of the bankers /financial institutions that use their discretion to interpret and regulate the funding propositions from the franchising industry and are quite passive in their response towards franchising as a business model. This is a sad state and would be addressed immediately once the Government confers franchising with industry status."
Abolition of CST
Badrinath adds, "In terms of the initial agenda of the Central Government, CST was to be zero rated effective 1-4-07, but still continues at two per cent. It would be good for the Government to reduce the CST to one per cent and ultimately move towards a complete abolition with the introduction of GST according to the expectation of the industry. This would contribute in reducing the effective cost of inter-state purchase of goods and also in keeping the inflation at current levels, if not reduce."
Withdrawal of stimulus
Badrinath adds, "While there are much deliberations happening around the withdrawal of the stimulus granted in form of reduction in central excise and service tax rates, in the previous budget and thereafter, this does not appear to be the right time to withdraw the same. It is worthwhile to note that with the support of the Government, the businesses have demonstrated their strength to survive the recession and shown a positive trend as a year-on-year performance. While the performance from 2009 to 2010 is positive and growing, the overall growth from 2008 to 2010 does not appear impressive since the year 2009 was a slump. Hence, the stimulus should ideally be continued and help the industry completely recover from the recession. It could be withdrawn as part of the GST implementation. With the implementation of GST, the cost of tax in the supply chain is envisaged to be reduced, therefore, the cumulative impact of withdrawal of stimulus (added costs) and reduction in supply chain tax cost (benefit) is believed to be mitigated by the businesses. Withdrawal of stimulus could result in high service cost and goods and thereby, impact the growth of retail business. Further, with the inflation rate continuously rising, it does not again appear to be the right time for withdrawal of stimulus."
Pave way to FDI reforms
Historically, Indian policy makers had been skeptical about Foreign Direct Investment or FDI. A limit of 51 per cent on foreign investment in retail has brought in a lot of innovation in the market. International investors have always come up with India-centric policies. The importance of the franchising process is reflected in the retail and industries where nearly every retailer (in malls) and every major restaurant are franchisees of international as well as major national chains. Internationally, franchising is very well accepted and is entrenched deeply within USA, Western Europe, South Africa, SouthEast Asia.
Ratan Jalan, Founder and Principal Consultant, Medium Healthcare Consulting Pvt. Ltd recommends, "The expected foreign investment reform in the forthcoming budget is likely to encourage international players to enter the Indian market. Hence, it would be pertinent for the Government to ease borrowing for players interested to open outlets for these international players." Currently, there are also restrictions on the number of shares a foreign company or person can hold in an Indian company if the joint venture option is considered. There are restrictions on payment of royalties if it is a technical collaboration agreement between the foreign master franchisor and Indian master franchisee. In the forthcoming budget, the Government would need to address some of these issues also in addition to the foreign investment reforms. Sonali Dey, Fox & Mandal shares, "Assuming that the current sectoral limit remains unchanged, FDI up to 51 per cent, may be brought under the automatic route. In addition, the prevailing ambiguity over FIIs should be clarified."
Conclusion:
The future of Indian retail markets seek organised and innovative business formats to ensure scalability which healthy franchise practices can facilitate. Hence, the policymakers must bring about industry centric reforms to unlock the potential of the SME.
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