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Franchising Trends Chinese Entrepreneurs Eye Fast-Food Franchises

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Today, most fast-food establishments in China are company-owned or operated in joint ventures with local companies. But the number of franchises is expected to grow now that China is set to launch newly standardized franchising regulations.

While working on an M.B.A. at the University of Calgary in Canada, Meng Sun took a part-time job behind the counter at a McDonald's. "I thought it was a very good place to start as an aspiring entrepreneur," Ms. Sun says.

Then, last year, armed with about three million yuan ($360,000) in savings from previous work as a financial consultant, the Chinese national cashed in her degree and fry time to become the first McDonald's franchisee in China. Now she operates a bustling mall-based restaurant in Tianjin, a city of 10 million people about 70 miles southeast of Beijing.

Ms. Sun, 34 years old, is at the forefront of an emerging race between McDonald's Corp. and Yum Brands Inc., owner of KFC and other fast-food brands, to recruit and train the best of China's new entrepreneurial class. The goal is to tap their enthusiasm and capital to boost the number of McDonald's and KFC outlets in China, just as small-business owners propelled the U.S. fast-food restaurant boom decades ago.

Today, most McDonald's and KFCs in China are company-owned or operated in joint ventures with local companies. But the number of franchises is expected to grow now that China is set to impose newly standardized franchising regulations next month.

As part of its entry into the World Trade Organization, China will set a framework for everything from the recruitment and vetting of prospective entrepreneurs to the protection of brand and property rights. Previously, Western companies feared they could lose control of their trade secrets and brands by offering franchises in China, which offered them few legal protections. They also had to set up convoluted offshore entities to sell franchise rights. The new rules will change that and also make franchises more enticing to Chinese businesspeople.

"Before, people in China couldn't imagine being an entrepreneur. They only tried to build large state-owned companies," Ms. Sun says. "But now, it's getting better, as people see that even Bill Gates is an entrepreneur."

For Yum, McDonald's and other Western fast-food operators, China is one of the few large economies with lots of room to grow. China's restaurant industry is projected to reach $91 billion in sales this year, nearly double 2001's $50.5 billion, says the consulting firm Bain & Co. (The U.S. industry is expected to take in about $476 billion this year.) While the U.S. chains face competition from Asia-based chains operating in China, including Shanghai YongHe King Co., controlled by Jollibee Foods Corp. of the Philippines, they see a bright future in the country, where the fast-food industry is widely viewed as being in its infancy.

KFC, formerly called Kentucky Fried Chicken, has been in the forefront of exporting U.S. fast food abroad, particularly in Asia. Capitalizing on China's culinary affinity for chicken, KFC arrived there in 1987 and has since amassed 1,200 restaurants. McDonald's, which opened its first Chinese stores in the early 1990s, has only half as many as Yum does today. Both expanded slowly.

Under the new franchise rules, industry analysts expect Yum to build at least 300 KFC stores a year in the coming decade, and McDonald's expects to have as many as 1,000 stores nationwide by 2008. To help meet these goals each needs to recruit armies of franchisees, who must be relatively wealthy to pass muster under the two companies' strict vetting rules.

The companies trust the franchise model. About 60% of the roughly 17,000 McDonald's restaurants outside the U.S. are franchised, as are about two-thirds of Yum's 12,000-plus non-U.S. outlets. In large markets, franchised restaurants tend to be better-managed and more profitable. (Under a franchise, a business person owns the restaurant and shares part of the proceeds with the parent company, among other requirements.) And American fast-food companies hope to tap the expertise of native franchisees steeped in vastly distinct Chinese markets. That should help the fast-food companies spread out well beyond the giant urban regions of Beijing, Shanghai and Guangzhou and into the 105 cities that have more than one million residents.

McDonald's is trolling for talent at business conventions and has fielded about 500 applications from Chinese businesspeople in China and abroad since September. McDonald's says it expects to have about nine new franchisees ready to own stores in China by the end of this year.

Yum executives are hunting for entrepreneurs in China, Australia and the U.S., some with advanced degrees from elite American colleges, to own restaurants in China. Yum says it receives inquiries daily from would-be franchisees. The Louisville, Ky., company adds that it has sold about 55 franchised outlets so far in China, each for roughly eight million yuan, or more than double the franchise cost of a McDonald's outlet.

"Franchising today is a very small part of our total business. But we are planting the seeds for a bigger future," says Sam Su, president of Yum Restaurants China.

Yet in a country with an emerging economy and legions of poor people the American companies are proceeding cautiously. McDonald's says it plans to thoroughly investigate the finances of all franchisees, and prefers applicants with a history at a large, established company. Unlike in the U.S., McDonald's doesn't allow its Chinese franchisees to borrow money from banks. Similarly, KFC's Chinese franchisees must provide almost all of the startup capital from personal savings.

Executives from both companies scout and compete for prime locations, build their restaurants from the ground up, and then hire and train the initial staff--all before turning over a store to a franchisee. Both companies require would-be owners to spend at least a year working at virtually every post in a restaurant.

For McDonald's, some of the skills are taught at a Hong Kong branch of its Hamburger University, which opened in 2001 and is modeled after the original program at the company's Oak Brook, Ill., headquarters. It resembles a business school, with case studies and breakout sessions. During a session with seven assistant store managers, instructor Grace Lau played the role of a testy boss. She scolded the managers for doing a poor job of presenting solutions to customer-service and management problems at an imaginary McDonald's.

Hamburger University instructors try to teach prospective franchisees and managers to think for themselves and make employees cheerful--skills not traditionally emphasized in Chinese universities and corporations. Instructors teach the importance of communicating and listening to employees so that workers can devise their own solutions.

Winning a franchise plugs entrepreneurs into an American business model that orchestrates everything from how to purchase food and manage workers to how to chop onions and mop floors. "Many restaurants in China don't have to offer such good service," says Li Kunyu, a KFC franchisee in the southern Chinese city of Dongguan. "The way that we greet customers, the hygiene levels that we ask for--these are pioneering in China."

Copyright © 2005 Dow Jones & Company, Inc. All Rights Reserved

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