Spreading the franchise: Regulating and protecting the market

In line with the recent trend toward nationalism and protectionism, the Indonesian government issued new regulations for franchises in 2012. Like other efforts to defend the country’s economic interests, it is fairly balanced and pragmatic. The policy works to encourage more local participation and limit dominance by any single foreign country or firm by setting limits to expansion. In fact, the new regulations can be viewed as little more than an extension of existing principles.

Not surprisingly, foreign participants and their local partners see the new stipulations as onerous. Many believe that the rules will be impossible to follow, and some wonder whether they can even be enforced. Concerns have been raised regarding the clarity of the regulations, and observers have many questions that have been left unanswered. Overall, the sense is that franchising is good for the country – because it brings foreign expertise and technology and provides services that Indonesians both want and need – and that the government should be more flexible and open.

LONG HISTORY: Indonesia has a long history of regulating franchises. It began with Government Regulation 16/97, issued in June 1997, which outlined written contract agreements between the franchisor and the franchisee. Business activities, rights and obligations of both parties, termination and extension processes and franchisee support all had to be established and spelled out in a document. According to legal experts, 16/97 was issued to increase opportunities for Indonesians and aid in technology transfer.

A decade later, the Indonesian government passed a second regulation, 42/2007. This statute essentially extended and gave more substance to the previous franchise law, calling for more detailed declarations and documentation. Under the regulations, the franchiser had to demonstrate a proven track record and at least two years of profitability, meaning that it cannot utilise a special purpose vehicle to register, has to have had at least one successful franchisee and the company’s trademark must be registered in Indonesia. The law added more burdens on both parties, but has been generally accepted as reasonable.

RECENT RUNS: The new regulations came in two waves and introduced an entirely new set of requirements. The first, 53/M-DAG/PER/8/2012 Concerning the Organisation of Franchises, was issued on August 24, 2012. The law states that a franchisee cannot be related to the franchisor whether in a controlling or subordinate role, which effectively prevents sub-franchising to affiliates. The regulation also calls for the use of small- and medium-sized enterprises as franchisees, and says that the business pursued must based on the technical licence granted. If the licence says convenience store, 90% of it products must be related to that business. According to analysis by law firm Hadiputranto, Hadinoto & Partners, the Ministry of Trade has stipulated that this ratio applied to inventory, not sales.

The new regulation also says that franchises need to display a logo identifying themselves as a franchise, and that when an agreement is terminated, there must be a “clean break”. All matters must be settled satisfactorily between the two parties before a new franchisee can be assigned. However, most notably, the new regulations require a high ratio of local content. Accordingly, 80% of raw materials or inventory must be locally sourced in Indonesia, a breakdown of which must be included in the franchise registration application. Existing franchises will have to meet the 80% requirement when renewing their registration.

On October 30, 2012 another new law was added, 68/M-DAG/PER/10/2012 Concerning Franchises for Modern Business Stores. Under this regulation, company-owned stores are limited to a total of 150 outlets. The rest have to be franchised. If a company goes beyond the limit, it has to sell 20% of its stores per year. The intent is to prevent monopolisation and to allow for more participation by local partners.

REACTIONS: Legal observers and industry participants were almost universally dissatisfied by the new regulations. Global law firm DLA Piper said that the rules were misguided and would only serve to slow economic growth. The firm pointed out that the 80% rule is vague and would cause serious problems with existing agreements. It also said the clean break provision could be tricky, as it could allow a disgruntled franchisee to hold the franchisor hostage by not agreeing to the break terms. Overall, the legal advisors concluded that the uncertainty would make it difficult for foreign franchisors to commit to the market. Stocks of franchisees, such as 7-Eleven franchise holder Modern Putra, fell following announcement of the 150-store rule.

The ministry defends the regulations, saying that foreign companies have abused regulations and steps must be taken to protect the local market. The Ministry of Trade said that often foreign firms would grant only one licence and not allow sub-franchising, or they were using the franchise system as a way to be involved in small retailing, which is restricted. The hope is that the new rules will make the franchises more inclusive and result in the sale of more local goods.

INEFFECTIVE: An analysis by Indonesian law firm Makarim & Taira S argues that the current law is not even followed, and that the new law could end up just as ineffective given the lack of resources. Many market participants and observers say that reason will prevail, and that the regulations will be lightly enforced. Another analysis says that under the unclear stipulations, businesses not structured as franchises will be exempt, and that the Ministry of Trade will also grant exemptions based on the availability of local products. Luxury branded products, for example, may not be bound to the 80% rule. Some observers say that discussions are likely to lead to a set of comprises that will maintain what exists while making the law effective.

“While we understand that the main spirit behind this requirement is to avoid a monopoly and to support the development of local business players by involving them as franchisees,” Mirza Diran, a partner at PwC Indonesia, told OBG, “we also understand that there has been discussion between the existing players and the government to not apply the limitation retroactively in order to avoid negative impact on existing players.”

REASONABLE: It can be argued that what the government is doing is reasonable. The new rules to a great extent are aimed at addressing abuses that are occurring because the current rules are poorly written, poorly enforced and have too many loopholes. The laws themselves are indeed quite moderate. They do not involve nationalisation or expropriation. Rather, they simply seek to avoid excessive concentration, it could be argued, and allow more players to enjoy the growth. The rules are not geared to keep people out, but to make sure that locals are involved and have the opportunity to participate. “We want foreigners to come, but not to forget about the locals,” Fetty Kwartati, the corporate secretary and head of investor relations at local franchiser Mitra Adiperkasa, which operates Starbucks, Burger King and, Domino’s Pizza in Indonesia, told OBG.