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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 consulting@jljgroup.com.

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