12 TH E B E AT / A P R I L 2 0 0 8 / W W W.S H A. B R I T C H A M .
O R G
[ 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 JLJ
Group shares some findings from their recent market research on China’s franchising industry.
W
ith 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 has been growing at an astonishing rate
of 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 growing
middle class in China, the rising acceptance of the franchising
concept among entrepreneurs, as well as the overall 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 other well established early entrants such as KFC,
McDonald’s and Pizza Hut – and franchising seemed a viable
Feature2.indd 12
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 John’s have appeared in East China
over the past few years.
While demand is spurred by the growing middle class, the
entrepreneurial spirit of Chinese individuals and companies has
helped sustain a constant supply of capital that both foreign and
domestic franchisors can tap into. KFC attracts 100 franchisee
applicants every month, each ready with the ¥8 million in capital
required to open a KFC outlet.
The gradual evolution and improvement of China’s regulatory
environment has also played an important role in advancing
the franchise industry. While China enacted its first franchise
law in 1997, the law did not specify any provisions for foreign
companies and many early franchisors were operating in legal
grey areas. Following China’s accession into the WTO, new
franchise 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 capital
to 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
3/27/08 12:26:34 PM
 THE BEAT / APRIL 2 0 0 8 / W W W.S H A. B R I T C H A M . O R G 13

Feature2.indd 13 3/27/08 12:26:39 PM

 14 TH E B E AT / A P R I L 2 0 0 8 / W W W.S H A. B R I T C H A M . O R G
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 – 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 invest
in a franchised store, but few are competent to manage one.
Many local franchisees do not have a good understanding of the
franchising concept and lack modern management experience.
For example, a popular Inner-Mongolian hotpot 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 its franchised
gyms. Both brands, painstakingly established over the years, were
damaged by the franchisees’ poor product knowledge, inferior
equipment or ingredient purchases and lousy 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 their franchisees to undergo six months of training, while KFC
provides a 20-week training course to bring their franchisees up
to speed.
There are so many challenges to overcome that many chain
stores prefer to expand through direct ownership stores or JVs
with local partners in China. At the same time, the fast-growing
market offers potential to yield higher returns through the direct
ownership of stores. Among those that do franchise, 60 percent
chose to establish master franchisee agreements with reputable
companies for different regions. Such organizations 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 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 apart, China is also 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
strategize effectively the launch of products in smaller volumes or
at reduced prices. For instance, McDonald’s and KFC have been
very successful with using their ¥1 ice creams to attract crowds
into their restaurants.
Last but not least, purchase priorities differ across regions in
Feature2.indd 14
China. Take Nanjing for example. One may imagine that with
their higher disposable income as compared to cities such as
Qingdao, Chongqing and Xi’an, the Nanjing population should
correlate to higher dining expenses. In reality, the Nanjing
population spends less dining out compared to the other three
cities. 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 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 that
has fallen prey to cheap copycats exploiting their 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
market.
Operating in China
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, they
just need to own two successful stores anywhere in the world.
Despite welcoming cross-border franchising policies, many
franchisors 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 franchisors
have explored the option of expanding in Tier 2 cities. Ten cities,
including key ones such as Shenzhen, Tianjin, Nanjing, Qingdao,
Nanjing, Shenzhen, Xi’an, and Chongqing have been analyzed
in JLJ’s study. In some of these cities, the population is already
familiar 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 to
yield higher profits from the booming market have steered some
foreign brands to opt for direct-run stores and partnerships instead
of franchising. 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 consulting@jljgroup.com.
3/27/08 12:26:40 PM