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By Paul Hallett
and Micah Truman
Although only a proportionately tiny number of
foreign franchisors have tackled China to date,
we have enough data to begin to understand the
elements prerequisite for foreign franchise success
in the coming struggles for sector dominance in
the world's largest franchise market.
To put these elements in context, it is helpful
first to categorize foreign franchisors according
to their approach to China. Broadly speaking,
foreign franchisors entering China to date have
fallen into one of three categories:
Chinese Take-outs. Reactive rather than proactive,
these franchisors sell China Master Franchise
Rights to the first likely comer, and wait (often
in vain) for the royalties to flow...
Bulls in the China Shop. Excited by the 1.3 billion
consumer opportunity, these franchisors rush in
themselves with an aggressive territorial land
grab, often critically overestimating the relevance
of their home-market franchise systems...
Global Thinkers - Local Masters. These are the
Taoists of foreign franchisors, taking what is
strong from their own franchise systems, and adapting
to local ways. Their characteristically deliberate
and iterative movements give them key competitive
advantage.
In keeping with a franchise spirit that engenders
dissemination of know-how, Baker Tilly, via this
brief article, is pleased to share the 'Eight
Locals', key elements of strategy from global
franchisors who have successfully mastered the
local way...
I. Local Market. It is a mistake to consider
China as a single market - language, culture,
development and consumer taste will vary as much
between, say, Shanghai and Kunming as they would
between Chicago and Athens. The potential for
a foreign franchised product or service in any
of China's regional markets will depend upon timing,
local taste, local economy, and of course, local
competition...
II. Local Competition. Don't underestimate it!
The days are numbered, we hear, for flagrant appropriation
(such as the 1996 opening of TGI Saturdays, less
than 100 meters away from TGI Fridays' flagship
Beijing development...), but have been replaced
by an era in which a well-educated, well-financed
and well-connected local competition can respond
quickly to opportunity, iterating with better-localized
franchise models at a time when the foreign brand
has yet to achieve traction.
III. Local Structure. Corporate structure considerations
are key in China, where very few sectors have
yet to allow unhindered foreign investment, and
where structure, once chosen, will determine the
franchisor's flexibility for control, financing,
foreign exchange, import, licensing and - crucially
- repatriation of franchise fees. While difficult
to generalize, the foreign franchisor will typically
be advised to avoid an 'all eggs in one basket'
approach, for instance by supplementing national/regional
master franchise Sino-foreign equity joint ventures
with one or more separate WFOEs (wholly foreign-owned
enterprises) - the latter with scope to provide
training and marketing advice to franchisees,
and license of technology and know-how to the
master franchise joint ventures.
IV. Local Finance. Many foreign franchisors underestimate
the investment necessary to establish their brand
in one or more of China's regional markets - very
few indeed consider China (or Asia, for that matter)
as a source of local finance to ensure sufficient
capitalization. And yet western venture capital
and private equity firms in the region favor models
that marry western know-how with local markets,
and - better still - genuinely local venture capital
can often come bundled with useful local connections
and strategic influence...
V. Local Product/Service. How well would consumers
take to a milkshake with cheeseburger and fries,
in a country where cows (as we know them) are
a recent foreign import, and rice and noodles
are the staples of choice? Very well, as it happened,
but local seasonal soups are also menu favorites
(at McDonald's and KFC outlets throughout China),
and indeed very few franchise products and services
have competed successfully here without first
being adapted to local taste.
VI. Local Supply. Sun Tzu wrote in his 'Art of
War': ''A zhong of grain from the local area is
equivalent to 20 zhong shipped from the home country
- a wise general is sure of obtaining provisions
from the land he attempts to conquer''. 2,200
years on, China's national policy for foreign
investment aims at maximizing benefit for the
local economy: savvy foreign franchisors have
learned to both support the local economy and
improve cost-efficiency (Kodak established joint
ventures for film manufacture, while Subway encourages
its franchisees to recommend local suppliers of
fresh produce).
VII. Local Partner(s). It's fair to say that,
even with all other strategic pieces in place,
success or failure for the foreign franchisor
in China can depend critically upon an initial
choice of national/regional master franchise partner(s).
Will the potential partner have sufficiently strong
government connections (e.g. to withstand an assault
from a competitor and its connections)? Is the
potential partner as financially stable as its
accounts show, or is it planning to rely on a
share of franchise royalties to finance its senior
management's lifestyles? Is there a business ally
of the potential partner in the wings, waiting
to benefit from the franchise know-how and establish
a rival franchise network? Careful advance due
diligence is advised...
VIII. Local Ties. In China, where the bond of
contract is still weak compared to personal and
network obligations, and where legal and accounting
systems give a local franchisee more scope for
creative observance of contractual responsibility,
the foreign franchisor can create strong ties
with local franchisees, by assisting the franchisee
to a greater extent than might otherwise be planned
in a 'standard franchise rollout'. Examples would
be provision of more hands-on training and advice
for franchisees, and (famously successful for
Kodak in China), agreement with local banks, whereby
approved franchisees pre-qualify for business
loans.
With these points of local strategy albeit briefly
introduced, this article will now close with a
quote from Zhu Ge Liang - a General renowned as
a military strategist in China's Eastern Han Dynasty
(AD20 - AD220). Almost 2,000 years before McDonald's
began their struggle with Malan Noodles et al
for market share in China, General Zhu noted:
''To operate, the armed forces need allies as
consultants and assistants to the leadership''
- in today's China, sound local advice and reliable
local support can give the foreign franchisor
sometimes decisive advantage in the battle for
franchise supremacy.¡¡
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