Can franchising work in China?

by Spitalnik, Mark

In early 1999, several US investors put the finishing touches on agreements that would allow them to become the China area developer for a well-known international computerized sign and banner franchise. At that time, the franchise was operating successfully in more than 20 countries, and everyone involved believed that the China area developer would be assured of success merely by applying the franchise's proven operational template to the China market. I was hired shortly thereafter as general manager of the area developer with marching orders to begin franchise operations in Beijing and with the goal of opening franchises throughout the rest of China over the next two years.

The fundamental principle of the franchise is to provide all types of quality custom-made signs and banners in a comfortable and visible retail environment. Each franchise store is a ''one-stop'' sign shop that produces a wide range of vinyl and indoor digitally imaged signs in-house. Signs that cannot be produced in-house-such as channel letters and routed and neon signs-are contracted out to capable manufacturers and are then marked up by the franchise store for sale to its customers.

Ideally, 80 percent of a franchise store's total sign projects are the higher-margin vinyl and indoor digitally imaged items produced in-house. Each franchise generates business contacts not through mass advertising but rather through direct mail and telemarketing focused on smaller ''Mom and Pop'' neighborhood businesses. Salespeople and designers work with the customer throughout the design and manufacturing process, which for vinyl and digitally imaged signs takes one week at most.

In April 1999, I arrived in China intent on applying the central tenets of our franchise to the China market. Our first one-stop sign center opened in May 2000, and we subsequently attended various franchise shows hoping to sell individual franchises in Beijing, Guangzhou, and Shanghai. But by the summer of 2002, after spending more than three years trying to develop a franchise system in China, our business plan had dramatically changed its focus to manufacturing signs for export. Plans for franchising had been delayed indefinitely.

What was so different about the non-fast food franchise market in China that necessitated such a drastic change in direction? Why couldn't a franchise operational method that had worked around the world succeed in China? The answers to these questions and the issues they raise can help people considering non-fast food franchising opportunities in China determine whether their franchising concept can work in this unique market.

Is time money?

The one-stop retail sign concept originated in a desire to help consumers avoid the delays and aggravation associated with obtaining the various signs they need from several out-of-the-way industrial manufacturing locations. One-stop sign centers located in visible commercial areas enable sign consumers to buy any type of sign or banner in a comfortable retail shopping environment. These types of sign franchises became one of the most popular types of franchises soon after their introduction in the United States in the mid-1980s.

The additional overhead associated with opening a sign center in a visible commercial area with a comfortable retail shopping environment ultimately led to higher-than-market prices. In China, however, we learned that most sign consumers are unwilling to pay extra for convenience and comfort. If they can save a little money by eliminating a middleman and by spending more time purchasing signs from several different vendors, they will. The average sign consumer in China prefers the less expensive alternative, even if it is less convenient.

Is quality job number one?

In the United States and Europe, our sign franchise stores constantly try to provide their customers with higher-quality materials in their custom-made signs. The use of such materials usually adds to the life of the product, but can also significantly increase the price. Sign consumers in the United States and Europe are generally willing to pay for the value added by higher-quality materials.

In China, very inexpensive sign materials are available. As a result, the use of higher-quality, imported sign materials may cause exponential increases in price. When presented with different material alternatives for what they see as a fungible good, Chinese sign consumers will generally opt for the less-durable, lower-priced sign-reasoning that such a sign can be replaced frequently, at a total price far below that of a more durable, high-quality sign.

After learning about the typical Chinese sign consumer's attitude to time and quality, our franchise focused the sales efforts of our model store in Beijing on other foreign businesses, since their consumption patterns more closely resembled those of our customers in the United States and Europe. As a result, we reached sales volumes in line with other stores in the franchise system and began our individual franchise sales efforts in China.

Factors affecting franchise sales in China

Like any established franchise, we sought to sell a recognized brand name, a track record of successful franchisees around the world, a time-tested operational system and manual, and a support infrastructure second to none in the industry. Despite these attractions, we were unable to convince enough attendees of the various franchise shows in China to purchase individual franchises. As a result, we were unable to meet the threshold level of individual stores necessary to justify starting franchise operations in China.

The first problem we encountered in our attempt to sell individual franchises was the different understanding of the concept of franchising in China. In the United States, franchising is a familiar, well-established practice. Most franchise purchasers in the United States accept the premise that there is value in a franchise's name, experience, and support and are willing to pay a franchise fee and royalties to obtain the right to take advantage of a franchise system's offerings. Most US franchise consumers know that in the United States, owners of small businesses that are a part of franchise systems are more successful than independent small businesses.

To many potential Chinese franchise consumers, however, franchising is an abstract concept and they do not believe that the benefits set forth above warrant payment of a significant franchise fee and royalties. These consumers generally believe that the purchase price of a franchise should include machinery, technology, goods, or services that are unavailable through any other means. If the machinery, technology, goods, or services that the franchise offers are otherwise available, would-be Chinese franchisees will usually conclude that they are better off putting their money into starting their own independent small business.

This conclusion can be overcome in the right circumstances. First, if the franchise brand name is already famous in China, the potential consumer will see added value in paying a franchise fee and royalties. On the other hand, Chinese consumers will not usually pay franchise fees and royalties for world-famous brand names that are unknown in China.

Second, if the franchise already has a significant presence in China in the form of a large support staff, Chinese-speaking personnel, and Chinese-language operational materials, the franchise consumer will feel that the franchise system has a better chance of succeeding. Chinese franchise consumers generally do not consider large overseas franchise support systems to be very useful.

Finally, if the franchise has successful company-owned stores in China, the franchise consumer will be more willing to consider purchasing a franchise. Success outside of China is nice, but most potential franchise purchasers in China do not necessarily view such success as indicative of whether the franchise will succeed inside China. Successful company-owned stores may show that a particular franchise concept works in China and may be the best way to convince skeptics.

A hard sell-but not impossible

Our franchise, although well known throughout the world, was unknown to consumers when I arrived in China. Though our headquarters' support staff in the United States can meet the needs of franchise storeowners around the world, our in-country support staff at first consisted of me and one other person. Chinese franchise consumers viewed our company-owned store as successful in terms of sales to other Western-owned businesses but thought that we lacked appeal for more typical Chinese sign consumers.

As a result, we were unable to convince Chinese consumers attending franchise shows that they would receive significant value in return for their franchise fee and royalty payments. During the franchising sales process, we also became convinced that the structural differences between the sign industries in China and the United States supported a business model based on manufacturing signs for export rather than one based on the sale of individual sign franchises.

Our experience notwithstanding, I believe that a non-fast food franchise system can succeed in China given the right conditions for success. As mentioned above, these include popularity among Chinese consumers, the existence of successful company-owned stores catering to Chinese consumers, devotion of significant resources to developing the franchise brand name in China, and the provision of machinery, technology, goods, and services otherwise unavailable in this market to franchisees. If your franchise system can meet these conditions, it has a chance to succeed in China. If not, you should consider committing your time and money to other markets.