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China has already become the
second-largest franchising market in the world
only behind the United States and the most promising
destination for those overseas franchise systems
aiming at the far eastern region. So far, it has
been more than ten years' history of franchising
in China and there have been more than 1,900 franchises
successfully developed locally. With the entry
of  China
to the World Trade Organization, more and more
foreign franchisors like Mcdonald's, KFC and 7-Eleven,
will be allowed to do franchising in the marketplace
of China with less and less restrictions in the
coming years.
To let you have a more objective view on the
development of franchising in China, we present
the following article written by Ms. Jayanthi
Iyengar for Retail Asia, for your kind reference.
Fighting shy of the franchise
route in China
By Jayanthi Iyengar
If a country already has 1,900 foreign and domestic
franchise companies, over 70,000 franchisees and
another 300 foreign companies waiting to enter
the market, then it has to be an attractive franchisor
destination, right? Not if the country is China,
which already has several global franchisors operating
on its soil. These include McDonald's, Kentucky
Fried Chicken (KFC), Dairy Queen, 7-Eleven, Pizza
Hut, Days Inn and Sign-A-Rama. KFC alone has over
1,000 outlets, while McDonald's has 560, Pizza
Hut 110 and Starbucks 70.
KFC's late Colonel Sanders may be a commercially
revered icon in China, but McDonald's has upped
the ante in the intensifying competition by recently
hiring Chinese basketball star Yao Ming of the
Houston Rockets, USA, as its official spokesperson.
To further improve brand recall and steal a march
on its competitors, the hamburger chain also signed
a contract to sponsor the 2008 Summer Olympics
in Beijing.
Yet, major franchisors did not start up in China
via the franchise format but through joint ventures
(JVs) with local partners.
''Several companies with very high-profile franchising
operations internationally have entered the Chinese
market with a standard foreign-investment model.
This involves [forming] a limited-liability joint
venture with a strong domestic company, followed
by the opening of branches in [various] locations,''
says Fraser Mendel, known IPR (intellectual-property
rights) expert and Beijing-based senior associate,
corporate department, Morrison & Foerster.
KFC, which entered China in 1987 and became one
of its best-known foreign brands, is an example.
Although it is currently in almost 1,000 locations
(it opened over 200 outlets in 2002 and another
200 in 2003), the brand started franchising only
recently and with a limited scope.
McDonald's, which opened its first store in 1992
and now has over 560 outlets, also started looking
at franchising opportunities only last year.
Understandably, 2003's sales from franchised
stores increased 44% from 2002 but they still
accounted for only 2% of all retail sales.
Today, foreign franchisors entering China are
not limited to JVs. ''Since June 1 of this year,
foreign entities have been allowed to establish
fully-owned companies in the commercial and retailing
areas. JV is not a must for foreign franchisors
(except in special areas where there are still
prohibitions),'' says James Liu, chief partner
of FranChina, a leading consultancy in China focusing
on franchising issues. FranChina also operates
two leading franchising-related websites - the
www.franchising.cn and www.chainstore.cn.
Why then do foreign franchisors still shy away
from their core format in China? The answer lies
in the country's laws and related problems linked
to trademark piracy, underdeveloped infrastructure,
uncertainties relating to the enforcement of contracts
and the weak dispute-settlement mechanism.
Besides, the franchising concept is new to the
Chinese market. Although foreign franchisors like
KFC entered the country nearly 20 years ago, cross-border
franchising has not been explicitly provided for
under Chinese law. Hence, cross-border franchising
is often perceived to be illegal, although there
is nothing barring it.
To explain the situation, Phil Zeidman, international
franchise and distribution expert, and senior
partner at Piper Rudnick LLP, cites the Chinese
government's first effort to address franchising
through a regulation adopted in 1997.
Being administered by the China Chainstore and
Franchise Association, a quasi-governmental organisation,
and adopted by a ministry without jurisdiction
over foreign trade and investment, the ''Measures
on the Management of Commercial Franchise Operations''
regulation was little more than a form of agency
ruling that did not cover cross-border franchising.
''A new and more comprehensive regulation is expected
before the end of the year,'' says Zeidman.
The franchise business model's success in many
other countries has been ascribed by Mendel to
those countries' stable and predictable legal
frameworks. This stability not only reduces business
costs but also creates a system that assures franchisors
of their rights against franchisees, and which
values and protects IPR such as trademarks, copyrights,
know-how as trade secrets and patents - all key
elements of franchising.
China's modern legal system is less than 20 years
old. Committed to transforming the country into
a modern economy, the Chinese government has undertaken
a monumental task to create a legal system to
support that economy. The result is a new legal
infrastructure of laws, enforcement mechanisms
and dispute-resolution process that has been undergoing
a seemingly endless changes since the economy
first opened to foreign investment.
''As this system has quickly developed, the protection
of IPR has lagged behind. [Thus], until recently,
the fundamental legal environment in China has
not been reassuring for foreign franchisors,''
observes Mendel.
Moreover, market entry has been made more difficult
by the country's foreign-investment regulatory
regime restricting domestic franchisees' ability
to remit payments out of the country solely for
the provision of IPR. Further, a comprehensive
franchise law proposed by the government several
years ago has remained in draft form.
''[All] this has created additional uncertainty
for many foreign franchisors, which have been
reluctant to invest in China, where there is a
distinct possibility that the overall rules of
engagement will change when the draft franchise
law is promulgated,'' says Mendel.
Domestic competition:
The legal system aside, a foreign entrant also
has to contend with domestic competition. Several
local franchisors, including Beijing Quanjude
Roast Duck, Tianjin Goubuli Steamed Bun, Shanghai
Ronghua Fried Chicken and Lanzhou Jinding Beef
Noodles, are emulating foreign models.
Not only do these local operators have local
understanding and relations - important to doing
business in China - they also have local laws
working to their advantage. Existing regulations
that provide guidance for domestic franchise activities
are not applicable to foreign franchisors. ''This
gives domestic franchisors regulatory stability
while foreign franchisors are still waiting to
see what the new regulations governing their operations
will involve,'' says Mendel.
Why the China rush:
If things are so unattractive for franchisors,
how does one explain the China rush? ''How could
[foreign franchisors] not be interested?'' counters
Zeidman.
China's juggernaut economy has spawned a rapidly-growing
middle-class with ample disposable income and
a pent-up desire for faster, trendier and more
convenient lifestyles.
This booming trend is evidenced by retail sales
growing annually at an average of 10%, with retail
food and clothing sales growing at higher rates.
Although China's average disposable income is
low by developed countries' standards, the typical
franchisor is not trying to reach all its 1.3
billion consumers, nor finding it necessary to
do so, Zeidman maintains. ''The buying power of
this country is concentrated in urban centres
(there are more than 100 of them), each having
a population of more than one million,'' he says.
He notes that the advent of TV has raised the
level of Chinese buyers' awareness of the consumption
patterns of the West, and the cachet of modernity
has created a demand for the products and services
of mostly American, and some European, franchises.
''A growing number of indigenous franchise companies
are also tapping these new consumers,'' says Zeidman.
Adds Prof Chen Ye-Sho, associate director of
International Franchise Forum and professor of
management information systems at the EJ Ourso
College of Business Administration, Louisiana
State University, USA: ''Although there is room
for improving China's IPR law, the fact that China
has become the world's second-largest FDI recipient,
after the US, implies that prudent investors have
found the opportunities of making profits in the
country outweighing the fear of IPR infractions.''
Early entrants are waiting for the day China's
norms will be eased and aligned with those practised
internationally. The country's World Trade Organisation
(WTO) commitments for franchise operations include
removing restrictions on geographical location,
number, equity ratio and form of establishment
for foreign investment by December 2004.
Foreign franchisors can also expect IPR issues
to be resolved soon - as well as a more level
playing field. Although they recognise the limitations
of the standard JV model, many companies find
it ''the best way to protect their key assets
and build their brands in China while waiting
for the legal system to reach a state of development
that supports full-fledged franchising operations'',
says Mendel.
Precautions:
Some precautions remain essential in a market
where the norms are still evolving and the legal
framework is fluid. FranChina recommends its overseas
clients to consider four basic criteria when choosing
local partners and franchisees: Experience, funds,
public resources and credibility.
''Usually, we don't suggest a foreign franchise
system develop a franchising arrangement with
individuals directly in the beginning. Master
or area franchising is a more secure approach
for a new entrant to this market,'' says Liu of
FranChina.
Prof Chen also warns against market entry without
being aware of pre-existing laws. He identifies
''finding good partners, adaptation to local needs,
enforcing uniformity standards'' and dealing effectively
with copycats as some of the issues new entrants
will have to tackle.
The path ahead:
Experts are convinced that IPR will be a top
issue facing franchising in China. ''The fundamental
issue of how to structure a franchise relationship
remains,'' says Zeidman. ''Many franchisors have
cobbled together a set of various cross-border
licensing arrangements to deal with this problem.
Whether the Chinese government will recognise
and address this wasteful and convoluted process,
perhaps as part of the package of reforms adopted
in the accession to the WTO, remains to be seen.
Western franchise companies are cautiously optimistic,''
he says.
Liu foresees that the right mechanism for the
exit of incompetent franchisees will become more
important than merely knowing how to develop more
local franchisees.
''By the end of this year, a new franchising
regulation will replace the current one. We believe
that will be more complete in protecting the rights
of both franchisors and franchisees,'' he says.
Jayanthi Iyengar is a senior business journalist
from India who writes on a range of subjects for
several publications in Asia, Britain and the
United States. She may be contacted at jayanthiiyengar1@hotmail.com.
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