Franchising Insight Chinese Market Offers Franchise Challenges

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Ride through Beijing and there's a good chance you'll see KFC's Colonel Sanders' smiling face. But though the country may seem franchise friendly, in China looks can be deceiving.

The late Colonel Sanders is China's most recognized commercial icon. So popular that when managers of a KFC restaurant in Guiyang, in southwestern China, replaced the old-fashioned glasses on his plastic statue with the kind worn by retired president Jiang Zemin, the event made the front pages of the China Daily newspaper. This country of 1.3 billion people has over 1,000 KFCs, plus 560 McDonald's, 110 Pizza Huts and 70 Starbucks. The country's largest retail chain--9,200 KEX photo express franchises in 700 cities--belongs to Eastman Kodak, of Rochester, N.Y. China is so important to McDonald's that the fast-food company recently hired Chinese basketball star Yao Ming of the Houston Rockets as an official spokesperson and signed a contract to sponsor the 2008 Summer Olympics in Beijing.

Dramatic Progress

Franchising began in the late 1980s, but China's acceptance into the World Trade Organization in 2001; its hosting of the Summer Olympics; and its astonishing gross domestic product growth of 9% a year have led to a dramatic increase in the pace. According to the U.S.-China Consulting Group in Beijing, China now has about 1,500 franchise companies--local and foreign concepts--with 70,000 franchisees. In 2003, sales from franchised stores increased 44% from the previous year, but franchising still makes up only 2% of all retail sales. It's no wonder the consultancy reports that another 300 North American franchise companies "have their eye on China."

Chinese entrepreneurs are looking right back. Bill Janeri, vice president of Global Sources Exhibitions, organizer of the annual Franchising China Conference and Exhibition, says China's new prosperity has created a middle class that should hit 200 million people by 2009. Besides spending more money on themselves and their children, these university-educated professionals are looking for ways to stake their claim in this growing market. Of the 20,300 people who attended last year's franchising exhibition, almost 75% said they'd like to become a franchisee. Even more potential investors are expected to attend the 2004 conferences, scheduled for Nov. 1 to 9 in Beijing, Guangzhou and Shanghai.

But matching prospective Chinese franchisees with Western concepts is not always easy, despite their mutual goals. For example, the Chinese government owns all the land and almost all the buildings, and government agencies determine who can lease space. Tony Foley, international director of Sign-A-Rama in West Palm Beach, Fla., says his company ran into trouble when trying to put a sign on their flagship store in Beijing. A government agency would grant approval one day; the next day, another would rescind it.

Franchising is also very new in China: the country passed its first franchise law, the "Regulation on Commercial Franchise Business" in 1997. According to the U.S.-China Consulting Group, additional laws should pass this year that will provide better protection for a franchiser's intellectual property. Ye-Sho Chen, a professor at Louisiana State University in Baton Rouge and an expert on franchising in China, warns that some Chinese have been known to sign up as franchise partners, only to steal a franchiser's trade secrets or recipes, then open a competing store under a different name.

Even franchisees that mean well can cause problems if they're undercapitalized or lack experience in running a business. "It's very difficult to find a good partner," says Dr. Chen, "and once you have one, they're not easy to get rid of." Thomas Dambrine, director of international development for Dairy Queen in Minneapolis, says his company has had one franchisee since 1991 who now operates 41 restaurants in Beijing. But Dairy Queen has spent over a year searching for prospective franchisees with food-service experience to expand into the country's provinces. "It's our biggest challenge," says Mr. Dambrine.

Dr. Chen says successful companies focus not on quick expansion, but on fitting their products or services into current Chinese habits; helping residents there manage the "change process" into the 21st century; or helping the government. Kodak, it seems, did all three. Although Kodak has no franchises in the U.S., it founded the KEX system in China as a partial solution to the government's unemployment problem. In the early 1990s, Kodak and government banks established a joint franchise loan program, enabling thousands of Chinese to open KEX stores. When the Chinese government moved its expansion focus to the western provinces, Kodak followed, moving its local office from Shanghai to Chongqing.

Today, KEX franchisees offer what Dr. Chen calls "a poor man's Internet," enabling a customer to take a photo with a digital camera in one KEX kiosk and send it to another KEX shop elsewhere in China for a nominal fee. Kodak benefits on the low-tech end--each store opening includes a giveaway of traditional cameras, ensuring a continuing market for Kodak film.

Jim Bryant, Subway's development agent in China, opened that country's first Subway Sandwich Shop in Beijing in 1995 with a state-owned company as a partner, then started franchising two years later. Subway's 27 Chinese franchises, he says, haven't changed the chain's basic sandwich menu, but do offer local condiments.

Those 1,000 KFC outlets offer the chain's U.S. menu items, plus 'Duck Soup' and the 'Old Beijing Twister,' a wrap modeled on the way Peking Duck is served, but with fried chicken inside. But what KFC has not offered until very recently is franchising. Colonel Sanders first appeared in China in 1987, but all stores were corporately owned and operated until 2001, when the company launched a franchising program. McDonald's has been in China since 1989, but sold its first franchise last August in Tianjin and hopes to add 80 more franchised locations this year.

Philip Zeidman, a partner with Piper Rudnick LLP, a law firm in Washington, and an international franchising expert, likes this cautious approach. "China is so important that no sizable franchise company can afford not to look at it, but no company can afford to leap into it. Franchisers should look to the long run, realizing that the long run in China is centuries."

But it's hard to go slow, says William Edwards, of international consulting company Edwards Global Services in Irvine, California, when China's new middle class is clamoring for better products and services. The young people you see in China's cities, dressed in Western clothes and talking into cellphones, want Western conveniences, like drive-through fast-food windows--KFC just opened the first in Beijing--and affordable lodging, like the 40 Days Inns that Cendant Corp.'s Singapore-based franchisee plans to open by 2008. Dairy Queen is targeting China's 15- to 30-year-olds with Treat Centers, franchises that sell only ice cream and fruit drinks, and last month, KFC opened its first Drink and Dessert outlet in Beijing.

Coffee Chains Compete

The demand for that new icon of Western culture--pricey coffee--is so great that Starbucks has opened 70 franchises since 1999 and its master franchisee in Beijing, the Meida Coffee Co., is opening a new store every month. But here the demand for Western products is bumping into Chinese habits. Like its other stores, China's Starbucks are smoke-free, but a high percentage of Chinese smoke. Canada's Blenz Coffee chain, with no such restrictions, opened six franchises in China last year, will have 50 cafes open by the end of 2004 and expects to overtake Starbucks in 2005.

Several resources provide insights into franchising in China. The China Chainstore and Franchise Association's Web siteprovides translations of franchise news stories. The U.S.-China Consulting Group's sitecontains news on government regulations. Information on trade missions is posted on the International Franchise Association's site, and from Global Sources.

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