Here’s What You Need To Know To Start A Franchise In China

fast food in china

[credit provider=”Flickr Commons”]

McDonald’s, KFC, Burger King, and Papa John’s have already set up shop in China.Restaurant franchisors are moving into China for obvious reasons: 1.3 billion people, 230 million middle class consumers (as of 2005), the world’s highest economic growth rate in the last 20 years, WTO membership, and more favourable franchise and contract laws make it a place for brands to grow rapidly.  

Opportunities are not only in the restaurant sector. Growth prospects across service industries that typically use franchising (real estate, retailing, hotels, etc.) abound in China.  The middle class in China is projected to grow to 600 million in the next 10 years, and the Chinese economy is projected to become the largest in the world by 2050.

Franchising is a niche strategy, essentially a contractual relationship between a franchisee and a franchisor regarding trading rights and obligations.  The franchisee has the right to market the brand and/or process of a franchisor in return for a fee and ongoing royalties. In the case of business format franchising, the franchisor transfers both the know-how and the brand of the business, and often provides additional support.  As firms go global, they face differences in the operating environments, economics, politics and culture.  Successful international franchising rests on the ability to adapt strategy that worked at home to other areas of the world.

There is a dark side, however, to franchising in China.  Franchising regulations have changed multiple times, creating an unstable environment for franchising contracts. The new regulations require a franchisor to invest and own outlets, rather than franchise them before being able to sell franchise rights in the country, for example. 

The Chinese market is still not culturally used to playing by the franchising rules, and remains uncommitted to protecting intellectual property rights.  Franchising requires a high degree of trust, legal protection, and recourse.  To succeed in the Chinese market, the best strategy is to enter one of the major cities using company-owned stores.  In this way, the franchisor can gain familiarity with the cultural, economic and legal environments.  Gaining an understanding of the nuances of the local market can help a company assess the potential for franchising.  This is what most of the large multinational chains, such as McDonald’s, KFC and Yum have done.

More caution is in order. While legal reforms have taken place, the laws still seem archaic and sporadically enforced.  And there remains insufficient protection for copyright, trademark and intellectual property.  Add the language barrier, the cultural distance between the West and China, and the fact that many Western brands are unknown in China, and it’s clear that this is a challenging environment that requires careful consideration and planning.

Many global franchising companies franchise a very small percentage of their total outlets in China today; while others, such as Kodak, do this extensively, even though they don’t use franchising in their home market.  Kodak, for example, wanted to create channels of distribution for its film, and thus developed a quasi-franchising film-development retail model for Kodak Express in China, relying on the promise of franchisees to buy paper and equipment from Kodak.  Royalties as such were not charged.

For those interested in the China market, Shanghai is an excellent entry point because the government has nurtured Shanghai as a magnet for economic growth.  In addition, the per capita income in Shanghai is over $11,000 in purchasing power parity (Kwan, 2002), among the highest in mainland China.  Shanghai offers numerous economic incentives, an increasingly westernized population, and large numbers of tourists and expatriates.  Shanghai is truly one of China’s top mega-cities.

In Shanghai, the fundamentals of successful restaurant franchising are similar to those in the West: consumers want flavorful food, delivered quickly and efficiently, in a clean, pleasant environment, and at an affordable price.  One recent survey of Shanghai residents conducted by the author revealed that consumers rated taste, service, atmosphere, price and brand name in declining order of importance when selecting a restaurant.

Given the cultural, social, political and infrastructure differences in Shanghai, complete standardization is unlikely.  The key is to assess what adaptation will be necessary.

Product – The product includes the novelty, service, atmospherics, and overall experience that the restaurant provides.  Traditional domestic restaurants are not direct competitors. Franchisors may be more successful by emphasising the “Western-ness” of their products, making standardization viable.  Of course, minor modifications will be required to adapt to local tastes.  For example, Starbucks in Shanghai offers a sausage Danish while McDonald’s serves seafood soup.

Promotion – Adaptation will depend largely on the product strategy.  Standardized products make a standardized message possible, while differentiated products require tailored messages.  Pizza Hut, for example, localised its business by decorating with large red “Double Happiness” signs, decorative firecrackers, traditional poetic couplets and the traditional Chinese character Fu (fortune); changing the design of the red roof to a Chinese feather calligraphy brush painted in red; offering a customised “Xinyi” (goodwill) pizza from the Chinese New Year to the Lantern Festival.

Pricing – First-time visitors to Shanghai are amazed at the low prices of local goods.  International franchisors need not use local restaurant prices for reference.  As long as the product is of high quality, and presents a new concept of consumption, a higher price will signal quality and credibility.  But remember that average income is substantially lower than in the West.  Effective strategy might include portioning some products in sizes that can be purchased at very low price points.  Both McDonald’s and KFC ran one Yuan (about 12 cents) ice cream specials to entice customers into the store.

Distribution – Three location strategies seem viable:

  • Downtown – The commercial and cultural centre, it boasts the greatest variety of restaurants.  But high rents have restricted growth.  Only 2,100 of over 29,000 restaurants are located in Xuhui and Jing-an, the busiest sections and the centre of the downtown area.  Foreign restaurants are concentrated in Huaihai Lu, Maoming, Nan Lu and Henshan Lu — streets of the French Quarter in old Shanghai.
  • Special Economic Zones – Pudong, a financial centre and the site of many multinational corporations and government offices, has 2,700 restaurants. Substantial residential construction is also underway.  Hongqiao, west of Shanghai, boasts over 1,300 restaurants and is a favourite of expatriates and foreign investors.
  • Upscale Residential – About two million people have moved to suburban residential areas, made possible by numerous infrastructure projects that have increased the commutability of city workers.
  • Target Markets – Three segments represent attractive targets for international restaurant franchisors.
  • Foreigners and Expatriates – Short and long-term expatriates, visitors and tourists have relatively high incomes, and a willingness to pay a premium for familiar food with consistent quality.  Continued foreign investment will result in a growing expatriate population as well as an increase in tourism.
  • Business People and Young Professionals – Includes educated professionals in the 25-50 age group.  They are likely to be the most receptive to new ideas, value the foreign dining experience, and possess sufficient discretionary income.
  • Young Emperors – Preschool through college-age children.  There are an estimated 1.25 million one-child families in Shanghai.  Young Emperors command the attention of the extended family and have a substantial influence on family buying decisions.  A foreign restaurant that attracts these children will attract their parents and extended family as well.

Restaurant franchisors that miss the opportunity to enter China now will face intense competition from early entrants. It will be difficult for restaurant franchisors entering now to beat the scale and profitability of the already entrenched McDonald’s and KFC. Nonetheless, the market is vast and great potential exists in many niches.

Despite the potential, doing business in China is difficult. The language and culture are remarkably distinct.  Franchisors should seek local partners who can help them navigate the local business environment.  A partner in the same industry with channels of distribution, industrial connections, and guanxi (personal connections) can greatly facilitate the success of the franchisor.