Establishing an Office According to a detailed survey sponsored by “Business Today” and undertaken by Gallup-MBA (India), the most important parameters in choosing a location in India are: (1) physical infrastructure; (2) state government support and flexibility; (3) cost and availability of power; and (4) the law & order situation. Other factors to take into account include labor availability and cost, labor relations and work culture, and proximity to resources and/or markets. In the area of labor law, an employer with more than 100 workers cannot fire them without permission from a government labor commissioner -- something usually impossible to obtain. Given the shortage of good commercial office space at reasonable prices in major Indian cities, business centers are a viable option for new companies wanting to establish a physical presence. Business centers are facilities that are ready to move in, wired for communications, and air-conditioned. Billing is normally done on a monthly basis. For long-term use, discounts are generally available. Many state governments are creating special Technology Parks for selected industry sectors like software, biotechnology, and automotive.
Type of Office
A foreign company or individual planning to set up business operations in India – but choosing not to establish a subsidiary or to form a joint venture with an Indian partner – can do so by establishing Liaison, Project, or Branch offices in India. Approval from the Reserve Bank of India (RBI) is required, and can be obtained by submitting form “FNC 1” which can be downloaded here. Such companies also have to register themselves with the Registrar of Companies (ROC) within 30 days of setting up a place of business in India.
Liaison or Representative Office
Many foreign companies initially establish a presence in India with a liaison or representative office that is not directly engaged in commercial transactions in India. The purpose of these offices is to oversee their networking efforts, promote awareness of products, and to explore further opportunities for business and investment. A liaison office is not allowed to undertake any commercial activity and cannot earn any revenue in India. As no revenue is generated, there are no tax implications to the office in India. Such offices are not allowed to charge any commission or receive other income from Indian customers for providing liaison services. All expenses are to be borne by remittances from the head office abroad. A foreign company establishing a liaison office cannot repatriate money out of India.
Branch Office
A branch office, like a liaison office, is not an incorporated company but an extension of the foreign company in India. A branch of a foreign company is limited to the following activities by the RBI: representing the parent company and acting as its buying/selling agent; conducting research for the parent company, carrying out import and export trading activities; promoting technical and financial collaborations between Indian and foreign companies, rendering professional or consulting services, rendering services in Information Technology and development of software in India, and rendering technical support to the products supplied by the parent/group companies. A branch office actually does business in India and is subject to tax in India. The branch office is allowed to repatriate the profits generated from the Indian operations to the parent company after payment of taxes. However, a branch office is not allowed to carry out manufacturing and processing activities directly although it can sub-contract such activities to an Indian manufacturer.
Project Office
Foreign companies sometimes set up a temporary project office to undertake projects in India awarded to the parent company. It is essentially a branch office set up for the limited purpose of executing a specific project. Approval for project offices is generally accorded for executing government-supported construction projects or where the projects are financed by Indian and international financial institutions and multilateral organizations. In exceptional cases, approval is also given for private projects. A project office is allowed to return surplus funds to the foreign country upon completion of the project. None of these entities are permitted to acquire real estate without prior RBI approval. However, they are allowed to lease property in India for a maximum period of 5 years.
Using an Agent or Distributor
Remember the scale of India and consider a Regional approach. Creating a local presence in India is strongly advised, but if your company isn’t ready to establish a branch office or a subsidiary, you can get this on-the-ground presence by appointing an agent, representative, or distributor. It’s important to remember that India is a huge and diverse country, with over 30 local languages. As such, it’s important strategically to consider taking a regional approach, and if your product has a wide market appeal, we advise finding regional representatives and distributors.
Defining the Terms
An agent will only procure business and will be paid through a commission. A representative normally works on a retention fee plus a commission on the sales generated. Also, a representative is similar to an indenting agent, where the foreign company deals directly with an Indian importer and then an agent consolidates all the imports, taking a commission from the foreign company. A distributor acts as an importer and typically purchases the product on his own account and stocks the products before selling it to the end user. Due to the risk of stocking the products, the distributor’s compensation is higher than that of an agent or a representative. Use Caution when Establishing this Critical Relationship The Indo-American relationship is strong, and Indian firms are eager to tie in with American products and services. The market is opening as required by India's WTO commitments, and as a result, U.S. exporters will find strong interest from potential representatives and distributors for a broad range of products. However, the enthusiasm of potential partners must be weighed against several factors before a relationship is considered. A thorough due diligence study is a must before establishing a relationship, no matter how positive initial meetings are. When evaluating a distributor or agent, the Indian firm’s business reputation, financial resources, willingness and ability to invest, marketing strength, regional coverage industry expertise, and credit worthiness should be considered. An ideal distributor will have an extremely good banking relationship to enable the extension of credit and also have the capacity to market a full range of products and services. It is important that the agent or distributor have modern infrastructure and facilities such as warehouses, service workshops, showrooms, and trained staff to meet and exceed the expected volume of business.
Growth Market
U.S. companies should be careful not to be influenced by the eagerness and persistence of a distributor or his representative. Sometimes Indian firms represent so many companies that they have little time or interest in developing new markets. The Indian firm may not have the vision to go beyond the existing list of contacts that they have nurtured over time. While in the short run, this can still provide very positive returns, as the market is more and more saturated with imported products, the real edge will be in the areas that are currently underdeveloped. Therefore it is critical to objectively measure the ability, willingness, and aggressiveness of the firm in developing new networks, contacts, and areas of business. By checking multiple professional references, a U.S. company can gain broad insight into an Indian counterpart.
Typical Pitfalls to Expect
U.S. companies should exercise pragmatic skepticism when the potential representative offers a long list of foreign clients. These lists may be outdated and the relationships may no longer exist. On the other hand, of all of these relationships do exist, the distributor or agent may not be able to fulfill all obligations and commitments to your product based on the time, financial, managerial, or logistical constraints of building the new relationship. The U.S. companies should confirm that the distributor or agent is able to represent the product along with the products of current clients.
U.S. companies should ensure that their distributor or agent is fully committed to promoting their product. Very often the distributors or the agents project a professional image backed by a qualified staff, widespread distribution network and a countrywide presence. The U.S. company should make sure that such representatives do not leave the distribution of their products or services to the network. Hence it is imperative that U.S. companies carefully consider all factors prior to making the final selection of a distributor or agent.
Other issues to Consider
A small distributor may be ideal for implementing a flexible distribution strategy. India being a vast nation of diverse states poses a logistical challenge to a distributor or an agent. A small distributor having presence within that region of India where the customers live may be more advantageous, as knowledge of the local market may be a competitive advantage. A small distributor with good product knowledge and marketing skills is often more desirable than a big distributor who leaves the marketing of the product to a section or department of their larger organization. U.S. companies should consider appointing multiple representatives for different products when this is possible.
Due Diligence
India is a new and rapidly growing economy, and as such, simple and traditional methods of validating the credentials of a potential partner are less reliable, and a thorough due diligence study is critical. Before signing a representative’s agreement, a credit check of the proposed partner is imperative. The U.S. firm should check with the distributor or agent’s bank to determine the potential partner’s financial health, reputation and credit worthiness, and seek additional details from accountants, lawyers, industrial associations, and other sources. For technical products, U.S. companies should also ensure the technical expertise of the distributor, the condition of the facilities, and the experience of the technical staff. Due care should be taken in finalizing the contract details and/or memorandum of understanding. To identify agents and distributors, U.S. companies can take advantage of the International Partner Search (IPS) and Gold Key Service (GKS) programs offered by the U.S. Commercial Service through its seven offices in India. To conduct a background check on local agents and distributors, U.S. companies can take advantage of the Commercial Service’s International Company Profile (ICP) service.
Franchising
Franchising With an investment of $1.1 billion, and a sales turnover of $2.7 billion, India remains a “sizzling” market place for American Franchisers. Demand for U.S. brands remains strong in retailing, education & training, food & beverage, health & fitness, beauty salons & supplies, real estate & professional services, and clothing. Franchising is in its early stages of development in India. At present, franchising accounts for 3% of India’s total retail market and is increasingly becoming a popular business model. Today, India has around 40,000 franchisees, growing at a rate of 40% per annum. The annual turnover from franchising is approximately $2.7 billion and total investments made by franchisees are approximately $1.1 billion. Over 300,000 people are directly employed by franchised businesses with over 700 franchise systems operating in India. A large Indian market with an estimated 200 million middle-income groups, sustained GDP growth of over 9 per cent per year and huge growth of entrepreneurs since 1991, are all encouraging a franchising boom. India’s $330 billion retail sector is witnessing an evolution as traditional markets are beginning to make way for new models such as department stores, supermarkets, hypermarkets and specialty stores. Western-style malls have begun appearing in both large and second-tier cities, introducing the Indian consumer to a new shopping and entertainment experience. According to a study conducted by the management-consulting firm A.T. Kearney, India tops the list of the 30 most attractive emerging markets for investment opportunities by mass merchants and food retailers. Franchising retail outlets is emerging as a popular model for reaching the Indian consumer, and has grown in popularity. Though current investment regulations of the Indian government restrict foreign investment in the retail sector, many international companies have chosen the franchising route to grab a share of the enormous market that India offers. Following the economic liberalization of 1991, several foreign companies with strong brand names established a presence in India through franchising. In the hospitality and food service industries, this has been the preferred method for starting operations in India. Some international companies that operate through franchises include: Hertz, Avis and Budget car rental; Radisson, Best Western and Quality Inn hotels; Kentucky Fried Chicken, Domino’s Pizza, TGI Friday, Ruby Tuesday, Subway, and Baskin Robbins for food. Pizza Hut and Domino’s Pizza have opened many outlets under the franchise model. Similarly, Indian companies with strong brand recognition are also using the franchising route to expand business volume. Examples of such Indian companies are Archies for giftware, MRF for automotive tires, NIIT for computer training schools and Apollo Hospitals for healthcare. Challenges: Regional Approach to combat Indian diversity: Companies prefer to appoint master licensees on a zonal basis as India is a large geographical landmass with a diverse mix of population. Local Culture and Tastes: Understanding local culture and tastes and innovative strategies like “Indianization” of products is vital to a franchise success. For example, Indians are predominantly vegetarian. A classic example of successful ‘Indianization’ is the fast food sector. Several American companies such as McDonald’s, Pizza Hut and Domino’s have developed a special India menu to cater to the Indian palate. Expensive Real Estate: In the metro cities of India, retail space is extremely expensive and the quality is relatively poor. Antiquated rent control laws make finding a suitable and affordable location difficult.
Legal & Business Advise
A thorough understanding of the laws related to the business of franchising is crucial for the U.S. franchiser. In addition, hiring a good local tax consultant to provide guidance to avoid pitfalls is recommended. It is also vital to conduct a thorough financial and legal due diligence and preferably a feasibility study on a prospective franchisee.
Resistance on Fees & Cap on Royalty
U.S. franchisers should also be prepared to face stiff resistance from prospective Indian franchisees toward the franchisee fees/royalty payments, which are considered high. In most sectors the royalty payment is capped at 5%.
Lack of Legal Framework
It is also important to know that unlike in the U.S. and other western countries, India does not have any specific law on franchising. Franchising is covered within the broad definition of transfer of technology. Thus, the legal framework for new franchisers interested in setting up master franchises in India exists in terms of brand protection and rules regarding payment of franchise fees. Recent changes in Indian laws now permit lump sum and royalty payments made by Indian franchisees to their foreign counterparts for the use of foreign technology, such as manuals, systems, etc. Before this change came into effect, this was a major deterrent to U.S. franchisers considering India as a possible market for expansion. Currently, lump sum payments up to $2 million are permitted and royalties of 5% on domestic sales and 8% on exports can be paid to the foreign franchiser. In addition, foreign companies can now enter into consulting agreements and receive up to $1 million per project. Amounts in excess of this can also be received but only with the permission of the Indian government.
Direct Selling
Direct selling is one of the fastest growing industries in India. According to industry reports, the direct selling industry in India reported a total turnover of $689 million during the fiscal year 2005-06. If a proper regulatory mechanism is established, the industry has the potential to become an $888 million market in a year’s time and touch $1.8 billion by 2010. India has strong potential for direct selling because unemployment and underemployment is perennial. Multinational direct sellers have been quick to sense an opportunity in India’s post-liberalization economy. Currently, the direct selling industry employs more than 1.3 million people. There are about 750,000 active direct sales executives who buy or sell products at least once every two months. The total number of product offerings increased to 380 with 2,100 variants and product categories ranging from cosmetics to kitchenware, education, home care and natural products. In the absence of advertising in the direct selling industry, to increase penetration and facilitate direct access to their products, some direct selling companies have established lifestyle centers and kiosks at major retail stores. Promotions by direct selling companies are common. A lifestyle store is basically like a large store that carries the entire product range of the marketer but is not meant for retailing. Instead, it is a place for consumers to come and experience the brands and for distributors to conduct their business and impart training. To increase brand awareness, some direct selling companies set up temporary kiosks at leading retail stores to display and sell their products. These strategies have helped to enhance recruitment, create brand awareness and reach out to consumers who may not be aware how and where to buy the products from. According to industry estimates, there are roughly 20 direct selling companies in India with nation-wide coverage and approximately100 smaller companies with localized city specific presence.
