As they push hard to attract investment from abroad, Middle East governments are widely expected to relax the constraints on foreign ownership of local companies (see feature, page 36). But in the retail sector, it is far from certain that such liberalisation will provoke a transformation of the prevailing franchise business model, which has delivered spectacular growth over the past 10 years.

The challenges that international groups would encounter in owning and managing local shops and malls could act as a powerful deterrent to direct investment, whereas existing arrangements are proving richly rewarding.

At the heart of today’s success is the crucial role played in Gulf economies by the indigenous, multi-sector, family business empires. Because these are local, with connections and trading lines spread across a range of sectors, they can bring to bear a level of knowledge, and range of activities and contacts, that the largest foreign groups would struggle to match.

Local knowledge

Consequently, the European companies that have been at the centre of the recent growth in Middle East retailing have built strong partnerships with major Gulf names. French supermarket giant Carrefour works with UAE-based Majid al-Futtaim, while UK department store chain Debenhams has built up its regional presence through a franchise arrangement with Kuwaiti group Alshaya.

Since starting out in Bahrain in 1997, the partnership of Debenhams and Alshaya has developed 17 stores, covering Jordan and every GCC market except Oman, where an opening is planned in the next three years.

Alshaya supplies the capital to finance each operation, while Debenhams supplies know-how, products and staff training, and is remunerated through a franchise fee.

However, the traffic in expertise is not one way. Alshaya brings to the venture its vast range of local contacts, its negotiating muscle as a major private sector business in the Gulf, a long understanding of local administrations and legal systems, and extensive connections among property developers in the GCC states. Indeed, Alshaya is Debenhams’ biggest franchise partner worldwide. By the beginning of 2008, the group had built up a portfolio of 40 stores in its international franchise network.

Francis McAuley, international director of Debenhams, says he does not believe liberal-isation of the rules of business ownership in GCC states would induce many foreign retailers to set up from scratch on their own in the region. “Most UK retailers and European retailers that I speak to regularly will want a franchise partner, and there is a plethora of good franchise partners,” he says. “The companies that are there have got all the skills to take out the risks.”

The nature of modern retail development in the Gulf countries is reinforcing the trend towards franchising. Increasingly, shops are developed in large covered malls, which offer a wide range of outlets and products, as well as coffee shops and entertainment facilities, under a single covered roof and accessible by car. In a business environment where retail growth increasingly takes place through such large mall projects, partnerships between major foreign groups and local franchise allies are particularly appropriate.

When a property developer is planning a big scheme, it wants to be assured that from the outset it will have a large department store or supermarket as an anchor for the scheme, complemented by a range of branded smaller shops, to give local consumers an interesting and varied shopping experience from the start.

Specialist brands

Alshaya can deliver this because, alongside its franchise ties with major multi-line retailers such as Carrefour and Debenhams, it holds franchises for a string of other specialist brands that it can bring to a project, such as H&M, Topshop, Next and Claire’s Accessories. “They can take huge blocks of space,” says one retail specialist.

The franchise arrangement also allows the international partner to mitigate the cost of expansion. After all, department stores or supermarkets are significant business commitments. To set up a typical Debenhams international franchise store costs about £2m ($3.9m) in shop-fitting and stocking costs.

McAuley expects about 10 new Debenhams stores to open in the region over the next three or four years. One of the big draws for the group is the strength of Gulf demand for new design. A distinct feature of Debenhams is its investment in own-brand designs, produced for the group by top names such as Julien Macdonald, John Rocha and Jasper Conran. These designer ranges have great appeal for Arabian consumers.

Not only can Debenhams find a ready Arabian market for its products, but it also reaps the benefits of lower costs. Average shop-fitting costs for its international franchise stores are £45 a square foot - about half the cost in the UK.

But none of this would be possible without the local knowledge of its franchise partner. “We are very happy with our franchisee,” says McAuley. “It would take years for us to get to the level of expertise they have accumulated.”

Key fact

$3.9m: Typical cost of fitting out a Debenhams store in the Middle East