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Paradise Lost?

New rules take shine off Indonesia since trade mission


Published:

Philip F. Zeidman

When the franchise trade mission to Indonesia returned home last December, the reports from the participants as well as the sponsors (the International Franchise Association, the U.S. Commercial Service and Franchise Times) were uniformly positive, bordering on euphoria.

Here’s how this magazine reported on it: “The true value of a U.S. Commercial Service‑sponsored trip comes from the contacts with high-ranking officials in the countries visited and the invaluable information delivered by local industry experts.”

The IFA was pleased by “the consistently enthusiastic response” the trade mission encountered.

Indonesia has always had a more difficult regulatory regime than most other countries, with an extensive disclosure process, registration requirements, translation obligations and the like. But since 1997, when the law was enacted, most franchisors, with some grumbling, have learned to accommodate the regime and its eccentricities. Given the appeal of the market, that seemed to be a price worth paying.

Nothing in the trade mission experience upset this sense of complacency. Press coverage was favorable. Prospective franchisees were in ample supply. Meetings with government and trade groups were welcoming.

It was thus unsettling when rumors of changes in the regulatory pattern began trickling out of the country almost immediately. The rumors were not entirely consistent, but the persistent and pervasive theme was of a move to limit the freedom of a franchisor as to how it would enter the country.  

Some of the techniques for doing so seemed to be detached from reality: limit the number of company-owned outlets (a method used by relatively few foreign franchisors). The most chilling of the proposed steps, though, would be to bar area development, require master franchising and force the use of small Indonesian subfranchisees by greatly limiting the number of units operated by a single entity.  The apparent purpose: prevent “monopolies” and “open up” franchising to small local operators.

However well intentioned, the obvious flaw is the assumption that, in fact, there is a large pool of qualified operators of this nature. The preference of U.S. franchisors for larger, more experienced developers with demonstrable resources does not arise from any desire to suppress the growth of small business, but simply because experience has dictated their superior capacity to develop a territory and operate quality units.


 

Those were among the points the International Franchise Association made in a persuasive letter to the Indonesian government. Articles and presentations at International Franchise Association and International Bar Association functions followed.

Several months of uneasy silence ensued. The IFA letter had no response. A visit to the Indonesian Embassy was disconcerting; the reception was cordial, but characterized by almost total unawareness. Periodic press reports added nothing to what was known. The U.S. government representatives in Indonesia, while far more energetic and thoughtful than in many countries, were largely unable to penetrate the process. 

As of the deadline for this column, there remains no official action on that front. But the rumors continue unabated, with a level of detail that suggests almost certain action.  Among those details: There will be a package of regulations, others specifically covering retail and restaurants.

 At the beginning of September, the frame of reference shifted without notice. The government promulgated a totally different regulation.  It was unexpected, and it remains something of a mystery precisely who has agitated for its adoption.  

While previous iterations of the law oblige franchisors to prioritize the use of domestic goods and/or services, the new regulation took this kind of requirement to a level that almost no one could have predicted. Among many other features, it required franchisors and their franchisees to use domestically produced goods and/or services for at least 80 percent of their raw materials, business equipment and sales. 

This is draconian indeed; even India’s requirement is only 30 percent, and the proposed changes just announced in that country may lower it further. And there have been suggestions that the rule will be implemented in a way that emphasizes number of items rather than value. The effect of this requirement on the typical franchisor can hardly be overstated.  For many, it will be simply impossible to comply.  And there is at best ambiguity as to whether existing franchisors will find it applies to them retroactively (the latest word is a 5-year grace period).

The purpose of this regulation, and of the still-percolating original proposal, is to promote local businesses with the blunt instrument of government fiat. Both ignore the reality that it is likely to drive franchising out of the country, and with it the thousands of jobs franchising has the potential to create. 

While there have been protests by some business interests, and there is talk of an appeal from this legislative decision, nobody is counting on it or on its prospects for success. The consequences (taken together with the possibility that companies will need to submit extensive proprietary information to the government) are sufficiently serious that there is renewed speculation about franchisors’ efforts to change the structure of their relationships so as to remove them from the jurisdiction of this regulation, and of the Ministry that initiated it.

So, were the participants in the trade mission simply naive? Hardly. Among the group were some of the most experienced and savvy practitioners of the trade of international franchising. No, the likelier answer is that, with all the talk of globalization, the powers of protectionism and nationalism continue to survive and to flourish, without much thought given to the damage they may do to the country they purport to promote. The world may be flat, but there remain plenty of dark, dark caves. 

Philip F. Zeidman is a senior partner in the Washington, D.C. office of DLA Piper. He can be reached at Philip.Zeidman@dlapiper.com

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