Indonesia introduces mandatory local supply requirements

Background

Indonesia's recent economic growth and the increasing wealth and size of the local market has seen a growing demand for foreign brands and a corresponding increase in international businesses entering the market through franchising.

Franchising in Indonesia has been regulated since 1997. Franchisors must register with the local authorities, including submitting a pre-contractual disclosure document, before signing a franchise agreement with a franchisee.

The Indonesian Government has recently issued a new regulation referred to as "Regulation 53", which came into force at the end of August 2012.  The main purpose of Regulation 53 is to increase the participation of local SMEs in franchise supply chains.

Key Requirements - The 80% Rule

Regulation 53 amends aspects of the registration and pre-contractual formalities but it is the "domestic product" requirement which is the main cause for concern for international franchisors, particularly to franchisors whose commercial models rely on a high level of imported products, equipment and materials. International retailers will need to look very carefully at this issue.

Regulation 53 imposes a requirement on the franchise business to use "local components for at least eighty per cent (80%) of the raw materials, business equipment and merchandise used in the franchise", (the "80% Rule").

In certain cases the Ministry of Trade ("MOT") may grant exemptions to the 80% Rule.  However, it is not yet clear on what grounds a franchisor may apply for an exemption.  The MOT needs to enact implementing legislation, which, it is hoped, will clarify this issue but some commentators believe it could take the best part of two (2) years before this happens.  The implementing legislation will establish an "Assessment Team", which will be tasked with enforcing Regulation 53.

What are the options for Franchisors?

• Get Your Franchise Application or Renewal Submitted Before Regulation 53 Takes Effect: It is likely that current applications or renewals will not be judged against Regulation 53 until such time as the enabling legislation is passed, although it is expected that the MOT will review applications and renewals made post August 2012 and apply the Regulation 53 retrospectively, so this option is not fail safe.
• Full Compliance: Franchisors may consider adapting their supply models now to ensure that local suppliers are involved wherever possible. This may include identifying appropriate local suppliers for equipment, fixtures and fittings, materials and possibly even the retailed products and merchandise. However, this course of action may be commercially unviable and/or possibly premature, as the MOT may soften its stance before passing the enabling legislation.
• The "Licence Agreement" Route: some local observers suggest that franchisors can avoid the franchise regulations by opting to enter into a "licence agreement" or "distribution agreement".  However, if the underlying relationship has all or most of the hallmarks of a franchise relationship, this option may not be legally compliant.  The main risk of this approach is that the MOT could impose fines and/or revoke the franchisee's operating licence leading to the closure of stores and considerable brand damage.
• Wait and See: Some commentators suggest it may take up to two (2) years before the enabling legislation is passed and the new Assessment Team is established, by which time there may have been development in terms of grace periods, postponements or even revocations of some of the requirements of Regulation 53.  Franchisors not already operating in Indonesia may therefore decide to put entry on hold until the regulatory framework is better understood. However, the longer they wait, the more they risk losing out to competitors in this growing economy.

Conclusion

Franchisors that are either looking to expand into Indonesia or are due to renew an existing franchise licence need to be aware of the franchise regulations and how they will impact upon their business.

The MOT's position towards foreign franchisors is not clear and the new regulations raise more questions than answers. It can only be hoped that the authorities strike an appropriate balance between, on the one hand, creating an environment which encourages foreign investment through franchising and, on the other hand, ensuring local businesses can participate in those supply chains as much as reasonably possible.

For more information on franchising in Indonesia, please speak to your usual contact at Fieldfisher or to Graeme Payne or Gordon Drakes.