Franchising - The Way to Go in China?
- The JLJ Group
This article discusses how franchising can be a cost effective means of introducing your retail operation to the China market or expanding your operation from its current China base. Some of the greater challenges that franchisors face in China include finding a reliable partner, adapting to the tastes of the local market and protecting against violations of Intellectual Property.
Franchising, despite its relative obscurity in the early 90s, has spread like wildfire in recent years. The JLJ Group shares some findings from their recent market research on the franchising industry in China.
With some 200,000 franchised retail stores representing over 2,600 brands, China is now the largest franchise market in the world. Led by the early success of both foreign and domestic brands such as Nike and LiNing, franchising in China has been growing at an astonishing rate of 35-40 percent over the past few years. Franchising became popular in China in the mid to late 90s, as businesses across all sectors, including F&B, fashion, education, fitness and real estate began using the model.
Drivers of Growth
A recent study conducted by The JLJ Group found that this rapid spread of franchise networks can be attributed to the growing middle class in China, the rising acceptance of the franchising concept among entrepreneurs, and improvement in China’s regulatory environment.
Many brands have been lured to China by the increasing disposable income of its growing middle class. This is one of the key drivers that motivated Subway and Papa John’s to expand quickly in China. Their goal was to fight for a share of the market with well-established early entrants such as KFC, McDonald’s, and Pizza Hut. Franchising was an attractive alternative.
By leveraging the financial resources of the franchisees, Subway swiftly filled East China and Sichuan with more than 60 outlets, while over 50 Papa John’s have appeared in East China over the past few years.
The entrepreneurial spirit of Chinese individuals and companies has helped sustain a constant supply of capital that franchisors can tap. KFC attracts 100 franchisee applicants every month, each ready with the ¥8 million in required capital.
The gradual evolution and improvement of China’s regulatory environment has also played an important role in advancing the franchise industry in China. China enacted its first franchise law in 1997, but the law did not specify any provisions for foreign companies. As a result, early franchisors were operating in legal grey areas. Following China’s accession into the WTO, new franchise regulations were promulgated in 2005 and 2007. These new regulations provided more flexibility and options for foreign brands, particularly in the area of cross-border franchising.
The thought of utilizing the franchisees’ deep pool of capital to penetrate the market faster, as well as using entrepreneurs themselves as motivated managers to run the business, has definitely enticed many brands to enter the Chinese market. At the start of 2007, 69 percent of the companies with existing chain stores in China had adopted the franchise model for business expansion. However, there are others who are hesitant. KFC and McDonald’s – which have both embraced the franchising model outside of China – each only have a few franchised outlets in China. Pizza Hut has none. The question is: Why are these major players so cautious about franchising in China?
Finding reliable partners
There is no lack of Chinese entrepreneurs willing to invest in a franchised store, but few are competent to manage it. Many local franchisees do not have a good understanding of the franchising concept, and lack modern management experience. For example, a popular Inner Mongolian restaurant chain, Xiao Fei Yang, is closing franchised stores that do not meet its quality standards. Wide-Tera, an international player with around 70 fitness gyms in China, has also reclaimed many of the franchised stores. Both brands, painstakingly established over the years, were damaged by the franchisees’ poor product knowledge, inferior equipment or ingredient purchases, and subpar service quality.
Providing long-term guidance and training has thus become a critical focus of many franchisors. Burger King – which has plans to set up as many as 1,000 outlets in China by 2015 – requires all of its franchisees to undergo six-months of training. KFC provides a 20-week training course to bring its franchisees up to speed.
Because of the myriad challenges, many chain stores prefer to expand through direct ownership or Joint Ventures (JVs) with local partners. At the same time, the fast-growing market offers potential to yield higher returns through the direct ownership of stores. Among companies that do franchise, 60 percent chose to establish master franchisee agreements with reputable companies for different regions. Proven companies are better equipped with management experience, and are less likely to sacrifice brand image and quality for short-term gains. Most Papa John’s outlets in Shanghai are run by a master franchise – Shanghai RCS Group Co. Ltd and RCS’s sub-franchisees.
Adapting to fit local tastes
International franchisors should also consciously assess the vast differences between China and other countries. Even within China, regional tastes and practical needs may vary considerably.
While Sichuan food is very spicy, Southeastern food tends to be bland. Though consistency is an important facet of the franchising concept, innovative product modifications to fit local demands have a strong bearing on the success of franchise chains. KFC’s local offerings, such as spicy chicken burgers and mushroom chicken congee have become key attractions for Chinese consumers. Burger King ran a pilot restaurant in an undisclosed location to analyze local tastes prior to its official entry, and has now developed a loyal following among local teens, white collars and expatriates.
Taste preferences aside, China is very fragmented in terms of spending power. Average income levels in cities such as Chongqing, Qingdao and Xi’an are substantially lower than those in Beijing and Shanghai. This implies that franchisors may need to launch products in smaller volumes or at reduced prices in the less wealthy markets. For instance, McDonald’s and KFC have been very successful with using their ¥1 ice creams to attract crowds into their restaurants.
Complicating the analysis, purchasing priorities differ across regions in China. Because of its relatively high disposable income level, one could assume that Nanjing residents spend more money dining out than their counterparts in the less wealthy cities of Qingdao, Chongqing and Xi’an. In reality, the Nanjing residents spend less dining out – instead, they direct a relatively higher portion of their incomes to education.
Preventing the copycats
Another key challenge that slows the take-off of franchising, or for that matter any other foreign business in China, is the widespread violation of Intellectual Property (IP). While regulations are in place, enforcement is weak. The responsibility to track down violations often falls on the IP owner. Quan Ju De is one company that has fallen prey to cheap copycats exploiting its logo to attract customers. Xiao Fei Yang also witnessed many imitators operating under its brand – some of which are ex-franchisees fired for failing to meet standards.
Though registering trademarks may not guarantee the franchisors recourse stemming from IP violations, failure to do so may lead to dreadful consequences. As China grants trademarks on a “first-to-register” basis, there have been cases of individuals maliciously registering another’s trademark and subsequently demanding payment for the use of it. It is therefore imperative for companies to register all trademarks, brand names (both English and Chinese), domain names and patents before entering the Chinese market.
Operating in China
The new franchise regulations promulgated in 2007 effectively abolished many restrictions and grey areas. For the first time, foreign brands are not required to operate at least two stores within China before selling franchises. Currently, they just need to own two successful stores anywhere in the world. Despite welcoming cross-border franchising policies, many franchisors still prefer to establish a presence in China in order to supervise and control the franchisees.
Choice of cities for franchise expansion is as important as structuring an effective organization model. With Tier 1 cities becoming increasingly expensive and saturated, many franchisors have explored the option of expanding in Tier 2 cities. JLJ has analyzed ten cities in its study of franchising, including Shenzhen, Tianjin, Nanjing, Qingdao, Nanjing, Shenzhen, Xi’an, and Chongqing. In some of these cities, the population is already familiar with foreign brands, but not saturated with choices. These cities offer excellent opportunities for new franchise entrants.
Franchising in China currently accounts for only 3 percent of total retail sales, compared to 40 percent in the US. Undoubtedly, there is room for growth. However, several barriers, such as difficulty in finding reliable franchisees and the desire to yield higher profits from the booming market have steered some foreign brands to opt for direct ownership and partnerships instead. In all cases, significant amounts of time, effort, and resources are necessary to sustain the franchise network. Foreign companies should research the market thoroughly and seek professional advice where necessary to facilitate the planning of a successful China expansion strategy.
The JLJ Group is a one-stop service provider assisting foreign companies to enter and grow in China. For more information, please visit www.jljgroup.com or email This e-mail address is being protected from spambots. You need JavaScript enabled to view it .
