China: Franchising Industry Access Dynamic and Emerging Markets

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CHINA: Franchising Industry Commercial Service – The JLJ Group US Access Dynamic and Emerging Markets
China Franchising Industry Page 1 of 23

The JLJ Group September 2007 INTRODUCTION
The objective of this report is to provide an overview of the Chinese franchise market1 with focus on four sectors: food & beverage, apparel, education, and fitness, beyond the already established cities of Shanghai, Beijing, and Guangzhou.

EXECUTIVE SUMMARY
Market overview. There are an estimated 2,600 brands with some 200,000 franchised retail stores in over 80 sectors. Franchising has also experienced significant growth in the last few years due to rising disposable incomes and an increasing number of Chinese entrepreneurs willing to adopt franchising models. Regulatory environment. China’s first franchise law was enacted in 1997, but there were several uncertainties and “grey” areas, particularly for foreign franchisors. More regulations were issued in 2005 and in March 2007, which further clarified the law; for example cross-border franchising2, which was previously in a grey area, is now permitted. This opens up opportunities for mid-sized US franchisors that do not necessarily want to or have the resources to set up a legal presence in China. Key sectors. The franchising model has been used to different degrees in the four sectors analyzed in this report. The F&B sector was one of the first to use franchising in China, but majority of franchisors are domestic; many international F&B brands have few franchised stores in China. In the apparel sector, franchising is mainly used to expand in Tier 2 or Tier 3 cities, while stores in Tier 1 markets are usually kept as direct-owned outlets. There is a large presence of foreign companies in both the education and fitness sectors. In education, the use of franchising is limited by regulations. In the fitness sector, franchising is still a common strategy for expansion, although several large gym chains are moving away from it and using Joint Ventures or direct-owned stores instead. Key emerging markets. Key Tier 2 emerging markets for franchisors are still concentrated on the East Coast, e.g. Qingdao and Nanjing. Inland Tier 2 cities – such as Xian and Chongqing – offer potential in the longer term since disposable incomes there are still relatively low. It is generally difficult to find good potential partners in Tier 2 cities, and many strong hospitality groups are large domestic or Hong Kong companies with a national presence. Key opportunities and challenges. There are good opportunities in all four sectors for US franchisors, especially for mid-market or high-end brands. However, there are several key challenges to adopting the franchising model, including the difficulty of finding good partners or franchisees, lack of control over store quality, need for localization, etc. Companies need to be prepared to invest a significant amount of time, commitment, and resources to manage China operations. Market access. Foreign franchisors can enter via either cross-border franchising or establishing a local legal entity (WOFE/JV3). If the local legal entity is to be a franchisor, it must operate two direct-owned stores for at least one year, before it can have franchisees. However, more time is still needed to observe how the new franchising law is implemented. Although a higher capital investment is needed to set up a direct presence in China, it offers the foreign company greater monitoring/control over Chinese franchisees.

1

Franchising refers to the practice where the franchisor grants the franchisee the right to use a developed concept (including trademarks and brand names, production, service and marketing methods and the entire business operation model) for a fee. Franchisees supply the capital and staff. Where the foreign franchisor signs a franchise contract with a master franchisee in China, without establishing a legal presence in China 3 Wholly-owned Foreign Enterprise or...
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