China: UK franchisors are missing out

The rapid expansion of the Chinese economy has been a key feature of global economics for the past 10 years and the Beijing Olympics in 2008 demonstrated China's ascendant position as the new economic superpower with the fastest growing consumer market in the world.

The statistics are impressive:
• Total population 1.3 billion
• 18 million children born every year
• 193 cities with a population of over 1 million, including six cities with over 10 million people;
• The Chinese now run 61 million cars with a growing and increasingly affluent middle class numbering in excess of 120 million people
• There are 220 million internet users and three times that number of the population have mobile phones
• Retail sales for 2008 are estimated at £1 billion.

This impressive record of economic growth has included a steady introduction to the market of franchised businesses and the expansion through licensing of well-known consumer brands. Successful franchisors include KFC, McDonald's, Burger King, Haagen-Dazs, Domino's Pizza, Starbucks, TGI Fridays, Pizza Hut, Taco Bell, Subway, Esquires Coffee, Dunkin' Donuts, TCBY and Costa Coffee (among others) in the fast food sector which has been the spearhead of franchising growth in China. However, as the market has become more sophisticated service industries too are now beginning to make their mark-- such as Mr Handyman, Sir Speedy, Gymboree, Berlitz and Chem-Dry.

The alternative structures adopted by these franchises encompass direct franchising (KFC), joint ventures (McDonald's), area development agreements (Dunkin' Donuts) and master franchise agreements (Century 21). By early 2008 China had a total of 230,000 franchised outlets with an average of 82 outlets per system.

The types of business utilising franchised structures include fast food and beverage, convenience stores, education and training businesses, estate agents, vehicle repair, cosmetics retail and service businesses, home decoration, clothing and accessories, hotels and fitness centres.

As the list of named franchised businesses above indicates, it is the US brands that have led the introduction of franchising into China with Australia and New Zealand taking an active role in the process, ever conscious of their close proximity to this very substantial market. UK franchisors might be considered significant by their absence.

There appear a number of reasons why UK franchising companies have been less than keen to look to the Chinese market as one into which to expand. These have included:
• Concerns about the protection and enforcement of intellectual property rights
• Unfamiliarity with the language and culture
• The cost of establishing the two company owned outlets that it was (formerly, but no longer) necessary to operate in China for at least a year before franchising to third parties
• The perceived difficulties in identifying suitable local partners on the ground with whom to work
• Concerns about the cost and levels of ongoing resources required to support the master franchise owner/area developer

The rapidly developing sophistication of the market, the success of those franchises that have established themselves, China's accession to the World Trade Organisation (WTO) and the simplification of the registration and disclosure requirements with which franchisors must comply have all contributed to create a new environment which is very much easier and more inviting for UK franchisors and of which they ought now to take advantage.

While Hong Kong was returned to China in 1997 it retains a unique position within China, together with significant elements of its British based legal system and an affinity with the UK of which UK franchisors ought to take advantage. While the Hong Kong market itself may not be considered large enough to merit the grant of master franchise rights, for many franchisors it nevertheless provides a unique market within which to test, adapt and prepare a business system for franchising more widely in other parts of China.

Hong Kong has long attracted Chinese entrepreneurs, English is widely spoken and UK franchisors may well find it a great deal easier to utilise Hong Kong as a stepping stone towards the expansion of their brand through franchising in China generally rather than commencing franchising elsewhere in China.

Preliminary steps:

As with any international expansion it is vital that UK franchisors firstly undertake a realistic assessment of their suitability for international franchising. They need to be sure they have a sound and profitable core business operating in the UK and the ability and resources to provide cross border and trans-cultural support to a master franchise owner or area developer operating on the other side of the globe. They must also have the commitment to support international expansion on the ground and the ability to develop marketing and technical solutions to adapt the business system to the new (Chinese) market.

Protect IPR in China:

Even if not proposing to enter the Chinese market it would be prudent for any UK franchisor that has any realistic potential for expanding there in the future to immediately take steps to protect their intellectual property rights ('IPR') there. Typically these would include registration of trade marks and domain names and, where possible and applicable, the extension of patent rights. Whilst plagiarism is still possible (as it is in any jurisdiction) it would be prudent for a franchisor to take local advice on likely derivatives of its brand which unscrupulous Chinese entrepreneurs might seek to register, e.g. by simply translating the franchisor's brand into Chinese and registering the Chinese characters as the trade mark rather than the UK name.

In many respects expansion into China is no different from expansion into any other jurisdiction. The franchisor should:

• Protect its intellectual property rights.
• Secure appropriate professional advice and seek the necessary contacts in that jurisdiction with professionals who understand franchising and have experience of working with international brands in China.
• Maintain a willingness to fund and undertake the necessary market research to establish demand for the goods and/or services to be provided and to identify necessary adaptations to the system to meet local market requirements.

Legal requirements for franchising in China:

In addition to ownership of the business system suitable for replication through franchising, the UK franchisor seriously considering entering the Chinese market needs to:

• Ensure its intellectual property rights are properly protected.
• Have the capacity to provide operational guidance and technical support and training for its franchise partners.
• Have at least two company owned outlets operating for more than one year but (importantly) these outlets no longer have to be located in China.
• Comply with the Chinese disclosure and registration rules.

The requirements for disclosure in China are not dissimilar to those for Australia and New Zealand, the US or France. They include the disclosure by the franchisor to all franchise owners of all information that a franchise owner would reasonably expect to be given, both with regard to the extent of the franchise offering and financial and commercial information in respect of the franchisor itself. Franchisors need advisors that can guide them through the disclosure compliance procedure and deal with registration of the franchisor's offering which is required within 15 days after the execution of the first franchise agreement.

Designer brands are king:

Like consumer markets elsewhere in the world young Chinese consumers are extremely brand focused and keen to acquire branded products and services bearing brands that are recognised and well-known to them. With a growing number of people now having sizeable disposable incomes to spend on such goods and services, franchisors are, through franchised outlets, in a unique position to provide what Chinese consumers want to buy.

The need for local partners:

Unless the franchisor has extremely deep pockets it could be well advised to build a relationship with a local business partner who will ultimately take responsibility for the development of the franchised network in China or designated parts of China.

They will need to identify with their local business partner whether the ingredients, or raw materials for products, can be easily sourced and supplied in China at the necessary price and of the requisite quality. They should also research the costs of labour and premises availability and expense.

A large and diverse market:

It should be appreciated that China is not one homogeneous market and that the tastes, culture and business habits of its consumers are different from region to region. Whilst currently less than one tenth of the total population represents the potential market for a franchisor's goods and services the enormous size of the population nevertheless provides a huge market. Despite that fact the strength of local competition should not be under-estimated and indeed should be carefully researched. Adaptation is essential if a western franchisor's business system is to succeed in the Chinese market.

Taking the right advice:

For UK franchisors there are small group of lawyers and consultants with the necessary experience of international franchise transactions and, most importantly, personal contacts in the Hong Kong and Chinese markets who can significantly assist the process. Their local contacts will also be able to provide up to date advice and assistance on the ground and identify suitable local business partners (individuals and corporations) interested in acquiring master licences, area development rights or taking up a joint venture interest in western franchise systems. UK franchisors which have established brands and franchise networks together with the resources and finance to expand internationally should now seriously consider the Chinese market as one which, with the right structure and involving Chinese partners, can reap them significant dividends.

They do however need to be prepared to think big, to make the initial investment in time and money and maintain the enthusiasm and commitment to see the project through to its conclusion.