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With some 200,000 franchised retail stores representingover 2,600 brands, China is now the largest franchise
market in the world. Led by the early success ofboth foreign and domestic brands such as Nike
and LiNing, franchising has been growing at an astonishing rateof 35-40 percent over the past few years. Especially in the mid
to late 90s, businesses across all sectors, including F&B, fashion,education, fitness and real estate have set up franchised chain stores
across China.
Drivers of growth
A recent study conducted by The JLJ Group found that this rapid
spread of franchise networks can be attributed to the growingmiddle class in China, the rising acceptance of the franchising
concept among entrepreneurs, as well as the overall improvementin Chinas regulatory environment.
Many brands have been lured to China by the increasingdisposable income of its growing middle class. This is one of the
key drivers that motivated Subway and Papa Johns to expandquickly in China. Their goal was to fight for a share of the
market with other well established early entrants such as KFC,
McDonalds and Pizza Hut and franchising seemed a viable
option. By leveraging the financial resources of the franchisees,Subway swiftly filled East China and Sichuan with more than 60
outlets, while over 50 Papa Johns have appeared in East Chinaover the past few years.
While demand is spurred by the growing middle class, theentrepreneurial spirit of Chinese individuals and companies has
helped sustain a constant supply of capital that both foreign anddomestic franchisors can tap into. KFC attracts 100 franchisee
applicants every month, each ready with the 8 million in capitalrequired to open a KFC outlet.The gradual evolution and improvement of Chinas regulatory
environment has also played an important role in advancingthe franchise industry. While China enacted its first franchise
law in 1997, the law did not specify any provisions for foreigncompanies and many early franchisors were operating in legal
grey areas. Following Chinas accession into the WTO, newfranchise regulations were promulgated in 2005 and 2007,
offering much more flexibility and options for foreign brands,particularly in the area of cross-border franchising.
The thought of utilizing the franchisees deep pool of capitalto penetrate the market faster, as well as using entrepreneurs
themselves as motivated managers to run the business, has
definitely enticed many brands. At the start of 2007, 69 percent
[ franchising in China ]
Franchising the Way to
Go in China?Franchising, despite its relative obscurity in the early 90s, has spread like wildfire in recent years. The JLJGroup shares some findings from their recent market research on Chinas franchising industry.
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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
McDonalds who have both embraced the franchising model
outside China have only a few franchised outlets in China.Pizza Hut has none. So why are these major players so cautious
about taking the franchising plunge?
Finding reliable partners
Though there is no lack of Chinese entrepreneurs willing to investin a franchised store, but few are competent to manage one.
Many local franchisees do not have a good understanding of thefranchising concept and lack modern management experience.
For example, a popular Inner-Mongolian hotpot chain, Xiao FeiYang, is closing franchised stores that do not meet its quality
standards. Wide-Tera, an international player with around 70fitness gyms in China, has also reclaimed many of its franchised
gyms. Both brands, painstakingly established over the years, weredamaged by the franchisees poor product knowledge, inferiorequipment or ingredient purchases and lousy service quality.
Providing long-term guidance and training has thus become acritical focus of many franchisors. Burger King which has plans
to set up as many as 1,000 outlets in China by 2015 requiresall their franchisees to undergo six months of training, while KFC
provides a 20-week training course to bring their franchisees upto speed.
There are so many challenges to overcome that many chainstores prefer to expand through direct ownership stores or JVs
with local partners in China. At the same time, the fast-growingmarket offers potential to yield higher returns through the direct
ownership of stores. Among those that do franchise, 60 percentchose to establish master franchisee agreements with reputable
companies for different regions. Such organizations are betterequipped with management experience and are less likely to
sacrifice brand image and quality for short-term gains. MostPapa Johns outlets in Shanghai are run by a master franchise
Shanghai RCS Group Co. Ltd and RCSs sub-franchisees.
Adapting to fit local tastes
International franchisors should also consciously assess the vast
differences between China and other countries. Even withinChina, regional tastes and practical needs may vary considerably.
While Sichuan food is very spicy, Southeastern food tends tobe bland. Though consistency is an important facet of the
franchising concept, innovative product modifications to fit localdemands have a strong bearing on the success of franchise chains.
KFC local offerings such as spicy chicken burgers and mushroomchicken congee have become key attractions for Chinese
consumers. Burger King ran a pilot restaurant in an undisclosedlocation to analyze local tastes prior to its official entry and has
now developed a loyal following among local teens, white collarsand expatriates.
Taste preferences apart, China is also very fragmented interms of spending power. Average income levels in cities such asChongqing, Qingdao and Xian are substantially lower than those
in Beijing and Shanghai. This implies that franchisors may need tostrategize effectively the launch of products in smaller volumes or
at reduced prices. For instance, McDonalds and KFC have beenvery successful with using their 1 ice creams to attract crowds
into their restaurants.
Last but not least, purchase priorities differ across regions in
China. Take Nanjing for example. One may imagine that with
their higher disposable income as compared to cities such asQingdao, Chongqing and Xian, the Nanjing population shouldcorrelate to higher dining expenses. In reality, the Nanjing
population spends less dining out compared to the other threecities. Instead, they prefer to spend income on 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 widespreadviolation of Intellectual Property (IP). While regulations are in
place, enforcement is weak. The responsibility to track downviolations often falls on the IP owner. Quan Ju De is one that
has fallen prey to cheap copycats exploiting their logo to attractcustomers. Xiao Fei Yang also witnessed many imitators operating
under its brand some of which are ex-franchisees fired for failingto meet standards.
Though registering trademarks may not guarantee thefranchisors recourse stemming from IP violations, failure to do somay lead to dreadful consequences. As China grants trademarks
on a first-to-register basis, there have been cases of individualsmaliciously registering anothers trademark and subsequently
demanding payment for the use of it. It is therefore imperative forcompanies to register all trademarks, brand names (both English
and Chinese), domain names and patents before entering themarket.
OperatinginChina
The new franchise regulations passed 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 they can start to franchise. Currently, theyjust need to own two successful stores anywhere in the world.
Despite welcoming cross-border franchising policies, manyfranchisors still prefer to establish legal presence in China so as to
maintain control and supervision over their 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 franchisorshave explored the option of expanding in Tier 2 cities. Ten cities,
including key ones such as Shenzhen, Tianjin, Nanjing, Qingdao,Nanjing, Shenzhen, Xian, and Chongqing have been analyzed
in JLJs study. In some of these cities, the population is alreadyfamiliar with foreign brands but not spoilt 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 as well as the desire toyield higher profits from the booming market have steered some
foreign brands to opt for direct-run stores and partnerships insteadof franchising. In all cases, significant amounts of time, effort, andresources are necessary to sustain the franchise network. Foreign
companies should research the market thoroughly and seekprofessional advice where necessary to facilitate the planning of a
successful China expansion strategy.
The JLJ Group is a one-stop service provider assisting foreigncompanies to enter and grow in China. For more information,
please visit www.jljgroup.com or email [email protected].
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