Directly operated stores and licensing agreements are like black and white among the options available to luxury brands when they are considering establishing mono-brand stores. Although licensing agreements are useful to separate the financial capability of a brand from its potential in terms of market penetration, the pros and cons of the two options should be carefully considered.

Especially where emerging brands are concerned, a policy to directly operate stores means that the brand must bear the burden of all the investments needed to set up the entire distribution network. Financial constraints must, however, be coupled with strategic considerations. Generally speaking, although licensees might have extensive expertise in the given market, they lack (by definition) direct experience with respect to the brand’s products, marketing strategies, heritage, etc. In other words, they cannot offer a 360° brand experience.

Licensees are independent entrepreneurs and a luxury brand – to protect its reputation and strengthen its market penetration – must take great care to ensure the franchisee complies with its guidelines. Some of the most common concerns for brand owners that do not directly take care of the operational management of a store that distributes its products mainly concern the opening of the store, the operation of the store itself, the purchase and re-sale of products, the advertising, the training of personnel and the sale of left over stock. Some of these disadvantages can be overcome by carefully negotiating the franchise arrangements. Rather than positioning the requirements under the brand’s guidelines as mere prohibitions, they should be coupled with actions that will naturally lead to the desired result.

In contrast, directly operated stores are generally able to better leverage the brand’s core message. For example, the merchandise mix is a careful balance of the latest style trends and carry-over products, the personnel have more training and can better explain the products’ characteristics (a key factor for luxury items). Furthermore, the brand has full control over inventory management and is therefore fully able to prevent closeout products (or, even worse, carry-over products) being sold through non-authorised channels and at premises other than those authorised (e.g., other stores owned by the same licensee or non-authorised distributors).

It is when a brand becomes more successful in a given market that it starts feeling that distribution through franchising is too tight (and less profitable) an arrangement. Consequently, some luxury brands have set up joint ventures with local partners (this happens in markets such as the Middle East and Africa, where having a local partner is often mandatory).

Joint ventures are certainly more expensive than franchising arrangements (although, by definition, less expensive than directly operated stores). But they do carry the advantage of the brand maintaining control over the management of the stores, the merchandising mix, pricing and discount policies, personnel training and after-sales support and inventory, while simultaneously benefiting from the partner’s local market knowledge.

Touching on the arrangement between the brand owner and the local partner, most commonly it is the joint venture entity that directly runs the business, by virtue of a franchise or a distribution agreement with the brand owner.

When a joint venture entity acts as franchisee, the brand, especially when it holds a majority shareholding or has control of the joint venture, is not only able to ensure that distribution complies with its own guidelines (as is the case for directly operated stores), but it is also able to hold title over the lease rights, the import permits, the employment agreements, the inventory and the like.

Control over a brand’s business through a joint venture entity in a given market moves the relationship with the local partner to shareholding level, which carries certain advantages in terms of enforceability of the negotiated shareholders’ agreements.

Most luxury brands have increased their market presence through franchising arrangements (we are closely monitoring the African market, and the trend seems to be confirmed there). And with Africa being the ‘place to watch’ as the last continent able to offer significant growth opportunities, the question is perhaps not so much whether to directly operate a store or license the brand, but whether a luxury brand can avoid the dispersal of its knowledge, heritage and soul through joint ventures rather than franchising arrangements. The joint venture option may be an attractive shade of grey.

Carlo Montagna is a partner and Francesca Secondari a managing associate at international law firm BonelliErede.