Franchising Industry in Shanghai

By Alex Wang

Overview

The franchising business is slowly growing in Shanghai. There were 4,460 chain stores and franchise stores in Shanghai in the year 2000, including 1,750 supermarkets, 41 hypermarkets, 1,109 convenience stores, 365 fastfood outlets and 1,200 others. The total sales of the 4,460 chain stores and franchise stores exceeded 40 billion RMB (US$ 5 billion) in the year 2000. And it accounted for 23.9 percent of total retail sales in Shanghai. At present, the franchise business covers a wide range of 30 or more business categories. These include supermarkets, convenience stores, fast food outlets, restaurants, coffee shops, fashion retailers, home electronic appliance stores, pharmacies, bookstores, eyewear stores, auto servicing centers, interior renovation firms, hotels, real estate agencies, laundry services, auto leasing services, gas stations, photo shops, video rental stores, beauty salons, travel agencies, education centers, printing services, commercial cleaning services and others.

Despite legal uncertainties in the China market, there are already a number of American franchisors in the Shanghai market. Among these are fast food outlets, including KFC, McDonald's, Subway, T.G.I. Friday, Hard Rock Cafe, Tony Roma's, Pizza Hut, Haggen Dazs, Carvel Ice Cream, Starbucks, TCBY, and Mr. Donut. Other well-known American franchisors include Century 21, Kodak, Athlete's Foot, Ramada, English First, and Wall Street. Walmart and Coffee Beanery are coming soon.

Obstacles to establishing and operating a franchise business in Shanghai.

The franchising industry in China is still in its developing stage and there are some obstacles for foreign franchisers seeking to establish or operate
their business. Among them are two major obstacles: the lack of international or foreign franchising laws and regulations, and the absence of the franchising
business concept.

For foreign franchisers interested in entering the China market, the absence of laws and regulations is the largest obstacle. Currently, most local franchisers in China are regulated by the China Chainstore & Franchise Association (CCFA). The mission of the CCFA is to set up standards for CCFA's members and to practice self-regulation within the association. CCFA is a semi-official organization which was established in 1998 under the Internal Trade Bureau. On January 26, 2000, a set of domestic regulations was passed. However, these regulations only pertain to local Chinese franchisers and are not therefore relevant to foreign franchisers. Last year, the CCFA submitted their ''commercial franchising regulations'' to the State Council. The Chinese Board of Commerce and Trade is still making changes and discussing the regulations, which will ultimately be passed as laws. These laws should clarify the responsibilities of the franchiser and the franchisee, including disclosure rules for the franchiser, the basic structure of a franchising contract, and the scope of government authority and legal responsibilities. It is hoped that the laws will protect the rights of local franchiser and franchisee as well as foreign franchisers and franchisees, solve disagreements in the franchising process, and raise the level of understanding of laws governing the franchising industry.

Despite the barriers, however, the enormous potential for profits from the franchising industry should be enough to entice foreign franchisers to explore the Shanghai market. Well-known foreign franchisers have still managed to operate profitable businesses in Shanghai. Uncertainty about the franchising market has meant that these foreign franchisers have had to find an alternative way of doing business in China. Alternatives include the establishment of joint ventures or wholly owned outlets in China. For xample, both traditional franchisers such as McDonald's and Kentucky Fried Chicken (KFC) have a very entrenched and strong presence in the Shanghai market through their network of either joint ventures or wholly owned fast food outlets. Although Tricon now has 500 KFC outlets in over 90 Chinese cities, only five percent of Chinese KFC stores are under franchises, and they are all located in medium-sized cities in the interior of the country. Due to legal obstacles, foreign franchisers have been hesitant to franchise their business in China, opting instead to retain control through joint ventures and full ownership.

Since franchising has only recently become a familiar name in China, it takes time to introduce the franchise business concept to Chinese entrepreneurs.

American franchisers should keep in mind that many problems are plaguing the industry. In general, the lack of management expertise is low among franchisees, and they have limited access to credit. The value of brandname recognition, and the importance of industry know-how and discipline, are not well recognized in China. The existing laws on franchising are not sufficiently comprehensive to protect the intellectual property rights of franchisers. It is wise to choose big Chinese cities such as Beijing, Shanghai, and Guangzhou as a starting point. The population in these cities is well-educated and is particularly receptive to foreign goods and services.

Overview of potential market for U.S. franchisers

Statistics on China's demography and growth suggest an optimistic picture for the development of the franchising industry in China. High incomes and real consumer purchasing power have grown markedly in major cities like Shanghai, Beijing, Guangzhou and Chengdu. Within this population of urban consumers, households with significant amounts of disposable income are increasing in number. In 1990, households with disposable incomes exceeding 22,500 RMB (US$2,700) accounted for only 3.9 percent of the total. This number rose to 30.4 percent by the year 2000 and is expected to exceed 56.8 percent by 2010. An increase in wealth leads to a corresponding growth in consumption, particularly in expenditures for recreation, education and food.

A survey taken by the CCFA at the Franchising Expo 2000 show in China revealed the top ten franchising industries as shown in the table below:

Top Ten Popular Franchising Industries

Industry Corporation Representatives Individuals
(Percentage of Attendants) (Percentage of Attendants)
Chinese Cuisine 47.40% 54.20%
Convenient Stores 31.60% 45.80%
Supermarkets 26.30% 23.70%
Fashion Retailing 26.30% 45.80%
Laundry Services 26.30% 40.70%
Tea Stores 26.30% 18.60%
Bookstores 26.30% 39.00%
Color Photo Printing 21.10% 22.00%
E-Commerce 15.80% 25.40%
Western Cuisine 5.30% 55.90%

Amount of Potential Investment

Investment Corporation Representatives Individuals
(Percentage of Attendants) (Percentage of
Attendants)
Under 10,000 RMB 7.10% 5.70%
10,000 - 25,000RMB 12.20% 14.80%
25,000 - 50,000RMB 17.30% 19.80%
50,000- 100,000RMB 19.40% 26.30%
100,000- 499,999RMB 20.40% 24.20%
500,000RMB and Above 8.20% 6.70%

WTO impact

Before its accession to the WTO, China prohibited foreign companies from engaging in true franchising business. With China's entry into the WTO in December 2001, these prohibitions are now to be phased out over three years.