Jurisdiction - Indonesia
Reports and Analysis
Indonesia – New Franchise Regulation And Its Implications For The Retail Sector.

10 November, 2012

 

 

Even for a first time visitor to modern day Jakarta, it is hard not to notice the widespread presence of modern retail outlets (both local and international), ranging from food and beverage outlets to convenience stores, existing in close proximity to traditional shops (toko) and the ubiquitous traditional street vendors (warungs). This blend of old and new constitutes the changing face of the Indonesian retail sector and is a reflection of the growing interest shown by both local and foreign investors investing heavily in this sector, in the hope of tapping the rising disposable income of Indonesia’s increasingly large consumer class. Indeed, the fast growing urban middle class associates its aspirations with modern retail and so there is a strong demand for such shopping outlets, in addition to the traditional outlets relied upon by lower income groups. It is in the context of this tension that the new Ministry of Trade Regulation on Franchise Implementation introduced on 24 
August 2012 (“New Franchise Implementation Regulation”) and the Ministry of Trade Regulation on Modern Stores Franchise introduced on 29 October 2012 (“New Modern Stores Franchise Regulation”) have recently sparked a lively debate among local and foreign investors in this sector, and also the wider public. Features of that debate and the resulting regulations, which are of particular interest relate to (1) whether stores can legitimately be licensed as restaurants or cafeterias as opposed to mini markets with different foreign investment restrictions applying, (2) the limit on the number of “company owned outlets” for franchisors / franchisees, (3) the requirement to have at least 80% of products sold be produced in Indonesia, and (4) the role of small and medium sized enterprises (“SMEs”) in the franchise system. Note that these regulations do not apply to large scale modern retail stores or non-franchise modern retail outlets. The common thread running through the debate, and the resulting regulations, is the growing impact that “modern trade” has on “traditional trade” in the Indonesian retail sector and the Government’s wish to promote SME articipation in this sector. The political reality of the next general elections in 2014 also influences the debate.
 
1. Why introduce the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation?
 
  • The New Franchise Implementation Regulation (together with the New Modern Stores Franchise Regulation) replace a preexisting 2008 Ministry of Trade regulation regulating franchise businesses in Indonesia, and the new regulations are introduced to address a number of perceived shortcomings and loopholes in the current operation of franchise businesses in Indonesia, including the following:
  • (a) Although the franchise business format (including the presence of foreign franchised brands) has been in existence in Indonesia for decades, in reality it is often the case that the foreign franchisor will appoint only one local master franchisee (who is, in turn, in certain instances restricted from appointing other local sub-franchisees). In practice, the participation of local SMEs in the franchise business sector has been relatively limited.
  • (b) Meanwhile, local Indonesian franchisors often own and operate their own outlets (the so-called “company owned outlets”) more than they grant licences to multiple SMEs ranchisees, in part (it is said) due to the difficulties of finding suitable partners for propagation of the brand, especially in more remote regions of Indonesia. 
  • (c) It is also alleged that certain foreign franchisors are encroaching on certain prohibited areas of the retail sector (e.g. mini markets) under Indonesia’s foreign investment laws, in particular operating mixed-format stores which double as both informal cafeteria / restaurants and mini markets. It is argued by some that these mixed-format stores – although popular among young Indonesians as any casual observer would attest to on any given Jakarta evening – are in breach of their operating licences issued by the relevant government ministry.
 
2. What are the key provisions of the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation?
 
  • The key provisions of the New Franchise Implementation Regulation are as follows:
 
  • a) Franchisor is prohibited from appointing a franchisee which is controlled by the franchisor, whether directly or indirectly (Article 7). 
  • b) If a franchise agreement is unilaterally terminated by the franchisor prior to its expiry date, the franchisor is prohibited from appointing a new franchisee for the same geographical area, prior to achieving a settlement on the dispute or until there is a final and binding court decision in relation to a disputed termination (Article 8). No time limit is provided as to how long the resolution of the dispute may take. 
  • c) Franchisor and franchisee must use raw materials and equipment, and sell products, such that at least 80% of such goods and/or services are locally produced (Article 19). Subject to the recommendation of an “evaluation team”, the Minister of Trade may grant exemption to this requirement. It is currently unclear how this will be applied in practice (e.g. for foreign fashion brands).
  • d) Franchisor must cooperate with local SMEs as franchisees or suppliers of goods and/or services, insofar as such SMEs can satisfy the requirements determined by the franchisor (Article 20). 
  • e) Franchisor and franchisee may only operate a business which is within the scope of its operational licence (Article 21). In certain circumstances, the franchisor and franchisee may sell goods supporting the main business activities (“barang-barang pendukung usaha utama”) (e.g. selling groceries in a cafeteria), upto a maximum of 10% of the total type of goods sold. This requirement will be monitored by “monitoring team” formed by the Director General of Domestic Trade.
 
  • The key provisions of the New Modern Stores Franchise Regulation are as follows:
 
  • a) These provisions are applicable to certain “modern stores”, over and above the New Franchise mplementation Regulation which is of general application.
  • b) Franchisor and franchisee of modern stores are limited to having 150  “company owned outlets” (“gerai milik sendiri”), which are owned and managed by the franchisor or franchisee themselves (Article 3). The term “modern stores” in this context means a store which has a self-service system, selling a variety of goods by retail, which may be in the form of mini market, supermarket, department store, hypermarket or whole sale cash and carry outlets (“grosir yang berbentuk perkulakan”).
  • c) In the event, the franchisor and franchisee of modern stores already own 150 outlets and further outlets are being opened, such additional outlets must be franchised to local SMEs, so long as such SMEs satisfy the conditions specified by the franchisor (Articles 4(1) and 6). The percentage of the total number of outlets which are franchised to local SMEs must be at least 40% of the total number of further outlets opened (Article 4(2)). Although the drafting in the regulation is not entirely clear, this suggests that once the 150 “company owned outlets” limit is reached, for every 10 new stores opened, 4 must be franchised to third party local SMEs. This requirement applies to “modern stores” (as defined) which are (i) (for mini markets) equal to or less than 400 m2; (ii) (for supermarket) equal to or less than 1,200 m2; and (iii) (for department store) equal to or less than 2,000 m2.
  • d) The requirement set out in paragraph (b) above is exempted if:
    • (i) the franchisor / franchisee which already own 150 outlets have not made a profit as evidenced by financial statements which have been audited by a Public Accountant determined by the Minister of Trade; or 
    • (ii) based on the evaluation of the “evaluation team”, a franchisor which is looking to open outlets in the regions, is unable to find a local business enterprise which can be the franchisee.
  • e) At least 80% of the products sold by franchisor and franchisee of modern stores must be produced in Indonesia (Article 7). Subject to the recommendation of the “evaluation team”, the Minister of Trade may grant exemption to this requirement.
  • f) The New Modern Stores Franchise Regulation has retrospective effect, subject to a transitional period. Article 12 provides that franchisor and franchisee of modern stores must comply with the requirement limiting the number of “company owned stores” as set out in Articles 3 and 4, within 5 years of 29 October 2012, and such compliance must be undertaken by giving up at least 20%, each year, of the total outlets which has to be franchised by the franchisor or franchisee.
 
3. Observations
 
  • It is probably overstating the case to say that the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation are specifically intended to be anti-foreign investment (although there is some, particularly foreign, press commentary to this effect), not least because these new regulations (particularly, the limit imposed for “company owned outlets”) have drawn criticism from both local and foreign franchisors. A key objection from both local and foreign franchisors is that (it is said) it remains difficult to find suitable SME franchisees particularly in the more remote regions of Indonesia. Hence, prior to the introduction of the New Modern Stores Franchise Regulation, the concern expressed by various sector participants was to the effect that the introduction of a limit on “company owned outlets” will have a detrimental effect on the ability of the relevant businesses to expand further, especially in the more remote regions of Indonesia. It appears that the exemptions included in the New Modern Stores Franchise Regulation (i.e. the limit on “company owned stores” does not apply where the franchisor / franchisor is still loss-making or where suitable local SME franchisees cannot be found) are designed to assuage this concern. However, the fact that the New Modern Stores Franchise Regulation has retrospective effect and contains relinquishment obligations to meet the “company owned stores” limit for franchisors / franchisees who have exceeded the limit, will surely be met with disappointment by those affected. We expect that in practice structures will be developed by local franchisors / franchisees to work around this requirement by use of various methods to control SMEs partner businesses.
  • The rule focusing on the scope of operational licenses appears intended to address concerns about mixed format stores being used. Mixed-format stores which double as both informal cafeterias / restaurants and mini markets, whereby it is alleged, in reality they are mini markets dressed up as cafeterias / restaurants are felt to have stretched the scope of their operational licenses. The burgeoning mini market sector, with various foreign names included in franchises, appears to have prompted a tightening up in this area.
  • The strong pro-SME tenor of certain key provisions of both the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation is, however, nmistakable. This is, for example, exemplified by the new rule prohibiting a franchisor from appointing a franchisee which is controlled by the franchisor whether directly or indirectly,  the rule prohibiting a franchisor from appointing a new franchisee in a situation where the franchisor has unilaterally terminated the franchise agreement and the dispute with the old franchisee remains unresolved (without imposing any time limit), and of course the rule requiring further new outlets, beyond the “company owned outlet” limit, to be franchised to local SMEs. The current balance of different interests, in both the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation, is a reflection of the complex mix of policy drivers which inform the regulation of the retail sector in Indonesia. At its heart, the key issues are the growing impact that “modern trade” has on “traditional trade” in the Indonesian retail sector and the Government’s wish to promote SME participation in this sector. The political demands of the upcoming general elections in 2014 should also not be underestimated.
  • In addition, the “local content” provisions in the New Franchise Implementation Regulation and the New Modern Stores Franchise Regulation (e.g. the requirement to sell at least 80% local products, and the requirement that the franchisor obtains supplies from local SMEs insofar as such local SMEs can satisfy the requirements determined by the franchisor), exemplify a broader trend as the government seeks to increase the local participation in the entire value chain.
  • In terms of scope of impact of the new rules, it is important to recognise that the New Modern Stores Franchise Regulation, and the “company owned outlets” limit introduced by that regulation, is only applicable to “modern stores” (as defined) whichare (i) (for mini markets) equal to or less than 400 m2; (ii) (for supermarket) equal to or less than 1,200 m2; and (iii) (for department store) equal to or less than 2,000 m2. It does not apply to restaurant franchises or other forms of large retail outlets, although the Director General of Domestic trade (of the MOT) has recently indicated in the press that the MOT is currently looking at introducing further regulations to deal with franchised restaurants – it is unclear, at this stage, what the scope of this further regulation may be. There are also recent broader calls from various quarters, including the Indonesian Commission for Supervision of Business Competition, for a more generalized law governing various aspects of the retail sector (rather than adopting the current piecemeal approach), but currently it does not seem likely that such a general law will be introduced in the very near future.
   
  

For further information, please contact:

 
David Dawborn, Partner, Herbert Smith Freehills
david.dawborn@hsf.com
 
Brian Scott, Partner, Herbert Smith Freehills
brian.scott@hsf.com

  

Iril Hiswara, Partner, Hiswara Bunjamin & Tandjung
iril.hiswara@hbtlaw.com
 
Vik Tang, Hiswara Bunjamin & Tandjung
vik.tang@hbtlaw.com
 

 

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