Just read a really good article in the China Business Review by William Edwards, a global franchise consultant, entitled, The Pros and Cons of Franchising in China. As its title implies, the article is on franchising in China, but the part I liked most has universal applicability for those looking at doing a consumer business of just about any kind in China.

That part sets out the opportunities foreign franchises face in China, and the challenges, and I below list out those in the article and then make brief comments in italics.  

Edwards sets out the following opportunities:

  • China’s consumer class is expanding fast. Agreed.
  • Western brands are highly regarded. Agreed.
  • Western franchises bring new and modern business systems. Agreed.
  • Second- and third-tier cities are open to franchising. Agreed.

Edwards sees the following challenges for franchises doing business in China:

  • “Intellectual property protection is uneven. Weak intellectual property enforcement and an inadequate legal framework are key reasons early foreign brands opened as company-owned stores or JVs, instead of franchises, in China. Many US brands have seen local companies take their name and logo and open fake, unapproved outlets. For example, after a local coffee store chain violated Starbucks’s trademark by nearly duplicating its name and logo, Starbucks took the company to court and won the dispute in 2006.” I both vehemently agree and disagree. Intellectual property protection in China is uneven, but it is uneven no matter how you go into China and going in as a franchise is not necessarily worse than going in some other way. Edwards says that foreign brands opened in China as company-owned stores or JVs so as to protect their intellectual property, but that isn’t correct about joint ventures. Foreign brands typically went into China as joint ventures either because the laws at that time required that they go into China as joint ventures or because they believed that they needed the assistance of a Chinese partner and that forming a joint venture was how to secure that. Generally, forming a joint venture is one of the worst ways to protect IP because it so often involves a foreign company turning over its IP to the joint venture and so when the Chinese company takes over the joint venture (a not uncommon occurrence) the foreign company loses its IP. I note also that Starbucks IP fight was not with a franchisee; it was with a completely unrelated company, which gets me to my next point. Going into China does put IP at risk, but not going into China also puts IP at risk and beyond that it risks no profits in China. The key to protecting your IP in China is much more about protecting your IP in China than it is about the structure you use to go into China.  
  • Local managers lack strong management skills. Agreed, though getting better.  
  • “Finding and evaluating licensee candidates is tough. The most important part of franchising a brand is finding, evaluating, and signing a qualified company as the local, regional, or country franchisee. Due diligence resources to fully check on a local company are improving, but it is still difficult to find companies with the management skills, business track record, and capital to acquire and properly develop a US franchise business. To help find appropriate licensees, companies can check with various organizations, such as US Commercial Service offices in China, legal firms with US ties, consulting firms, or American Chamber of Commerce offices.”  Completely agree. Do your due diligence on your putative Chinese partner before you ink the contract.  
  • “China has many markets.  The sheer size of China, and its diversity of business and food culture, makes franchise development difficult. Companies that function well in one region seldom function as well elsewhere in China. Accordingly, franchisors rarely grant companies a country franchise for China.” Completely agree. In fact, this reminds me of advice our China lawyers always give regarding China distribution agreements: giving one distributer an exclusive for China does not usually make sense because it is the rare Chinese company that is truly strong throughout China.  
  • The regulatory environment is evolving.  Unclear and changing regulations have created uncertainty for foreign franchisers that wanted to enter China in the past. Sort of agree. Our China attorneys have had less problems with the clarity of China’s franchise regulations than with the fact that they are not terribly franchise-friendly.
  • “Franchises must adapt their products to new markets.  Some franchises face difficulties in China when they do not adapt—or are slow to adapt—to the needs and tastes of Chinese consumers.”  Agreed. 

What do you think?

  • Joel Silverstein

    I agree with Dan. Most of the big franchisers are restaurant chains with operations too complex for franchising in many emerging markets like China. They go into many emerging markets with a direct owned or JV model and sometImes convert to franchise relationships over time once the market is mature. Starbucks started with two Taiwan companies in Beijing and Shanghai respectively because they both had extensive chain restaurant experience and were trustworthy. YUM started with multiple JV’s due to foreign ownership restrictions at the time, with SOE’s and controlled the business. I am deeply involved in retailing and hospitality businesses in China and I do not recommend franchising in most cases. If the companies are not substantial enough to build some of their own stores and proven their model then I suggest they stay home.