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Breaking into China

Can a second wave of U.S. franchises scale the great wall of ‘opportunities’?


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A new day is dawning in China, as mid-size franchises follow iconic brands into an ancient country that is impatiently trying to meld the new with the old.

The shell of the tortoise is a thing of beauty in the Chinese culture—it symbolizes longevity, power and tenacity. While slow and steady wins the race (at least against a hare in American folklore), the speed of a tortoise may not seem so beautiful to American franchisors who want to build mass quickly. But it is the way business gets done in China. 

Pathway into China

The pathway into China is not an
easy one, but for franchisors who do
their homework and learn the culture,
it can be lucrative. 

“China is not a market for beginners,” says Mark Siebert, CEO of iFranchise, a consultant who works with both international and U.S. clients. But no one can deny it is an important market. There are 1.3 billion people in the People’s Republic of China as of the last census in 2012, and the middle class, which is one of the factors that helps franchisors decide whether a market is viable, is becoming a buying force. Add to that a government policy strongly encouraging migration from farms to the cities—and the resulting urbanization—and even more demand for brands is created. Plus the Chinese like American brands. Around 4,000 shopping malls are on the horizon, and a network of fast trains linking the cities is creating another venue for retail stores—upscale rail stations.

Pick up any newspaper or scan the headlines online and you will find no fewer than one article on China daily. But unlike coverage on other countries franchise trade missions visited in 2013, the news is mostly business related, not violence caused by dissenting factions. 

In early December, National Public Radio reported that for the last reporting period China’s exports were up 13 percent, putting to rest some analysts’ predictions that its economy was faltering.

Luxury brands are especially in demand. We saw that firsthand during the Franchise Times, International Franchise Association and U.S. Commercial Service-sponsored franchise trade mission to four cities in China last November. Delegates stayed at the China World hotel in Beijing, connected to the spacious China World mall. The shopping center was filled with brands the likes of Prada, Armani and Gucci, and yet two of the dining choices were Fatburger and Schlotzsky’s. While Americans would rarely choose to dine in a fast-casual hamburger chain while surrounded by shopping bags filled with Jimmy Choo shoes or diamond necklaces and bracelets from Tiffany & Co., in China American brands, even some fast-casual and quick-service restaurant brands, are seen as status symbols.

Status is important, but excess isn’t the norm. Andrew Gately, the U.S. Commercial Service officer who led the trade mission, studied in China in 1996. He said his Chinese roommate was in awe of his backpackers’ pack. “You’re carrying more on your back than I own,” Gately remembers him saying.

In his book, “What Chinese Want,” Tom Doctoroff, the guiding force behind the China office of J. Walter Thomas ad agency, says the middle class is striving for status, and these people want the real thing, not a knock-off. Which is ironic since one of the downsides of doing business in China is the problem of protecting your intellectual property. We heard stories of “coming soon” signs touting a foreign brand, only to have the name spelled slightly different so consumers will be tricked into thinking it’s the real brand. Even Apple and Disney have had problems protecting their brands there.

While luxury items lounge on the shelves of the legit stores—tariffs up the price for these goods as much as 40 percent more than they can be purchased in the U.S. and Europe—the multi-storied Silk Market in Beijing sells knock-offs of those same brands. The quality, as well as the price, goes up the higher the floor you’re shopping on, someone told us.

Doctoroff’s perspective after studying the Chinese market for decades is the Chinese love stability and conformity, hate chaos (which would make for good franchisees). But while they love American brands, the Chinese no longer think we hold all the answers, the book’s forward says, especially after the Western financial crisis in 2008, when China’s economy continued to grow. We faltered, they did not. 

Chinese in their 20s and 30s have only seen economic growth. But, according to Time magazine, “among young people in their 20s, those with a college degree were four times as likely to be unemployed as those with only an elementary school education.” That could be a selling point for the need to open franchised units.

While KFC and McDonald’s have been in China for years—McDonald’s “just” arrived in 1990—a second wave of smaller franchises has started to flow into the market. 

At one time, the Chinese market was KFC’s saving grace, when its domestic units were having trouble keeping traction. One of the reasons American food brands do well in Asia is the consumers’ perception that U.S. quality is superior to their own. They trust the American brands’ food will be safe because of Americans’ high standards.

Barriers to entry

But with all the pluses, there are some pretty big obstacles for U.S. franchisors wanting to build stores in China: the language, both written and spoken; a vastly different culture; franchise regulations; a government that is making strides to be more business friendly, but is still a Communist governing body; an underdeveloped supply chain; plus infrastructure weaknesses and dangerous air pollution in the big cities. Perhaps the greatest challenge—or opportunity, as franchise people like to say—comes from the sheer vastness of the country. Americans sometimes naively think of China as one big country, but the language varies from region to region as does the weather, food preferences and culture. 

Calvin Wong

Calvin Wong

For instance, Sotheby’s International Realty’s Calvin Wong, who speaks Cantonese, not the Mandarin dialect of the areas the trade mission visited, ended up hiring a translator after the first session, to ensure the audience understood the nuances of his message, not just the overriding themes.

When one Chinese woman confused two men on the trade mission, she confessed, “You Americans think all Chinese look alike, but we think all Americans look alike.”

Families are selling their small piece of land and moving to the cities, but it comes at a price. Unlike in the U.S., where we can easily transfer from one state to another, in China, your residency remains with the area in which you were born, unless an exception is made. So if parents move to the city to find work, their children cannot be enrolled in the city’s schools because they’re not residents. This often means the children are left in the country to be raised by grandparents. Or, they attend private schools. In other words, Gately pointed out, the lowest wage earners pay for their children to attend private schools, while the wealthy residents’ children are attending school for free.

The one child rule that was in effect for 30 years, until altered last year, also affects urban families, since parents no long require a son to stay at home and work the farm. It also has impacted the current workforce, as well as the ability for children to take care of aging parents and grandparents. Government workers, a story on NBC.com reported, had to quit their job before they could pay a fine to have a second child. (Working for the government had lots of rules, we learned. One government executive, sitting next to us at a luncheon, said government workers get 15 days of vacation a year; however, they can only take it once a year and if they take more than a week, they’re seen as not being committed to the job.)

Lessons from Beijing

Franchising is a relatively immature concept in China, Belinda Tang, an attorney with the Beijing office of DLA Piper, told the group, but it is highly regulated. The delegation only spent one day in Beijing before moving on to the three second-tier cities where they would meet with prospective master franchisees, but a good portion of the education happened in one morning’s session.

Imitation may be the sincerest form of flattery in other industries, but in franchising, it is a legal headache.

Trademark registration can take up to two years to complete and licensing agreements can take between six months and a year, she said. A license cannot be granted until all the marks are fully registered and only then can a franchisor enjoy trademark protection.

Cross-border franchising is an option and can be implemented when: “The franchisor has met the ‘2-units-for-1-year qualification’ anywhere in the world; the franchisor has the capability to support the franchisees/franchise system onshore; and the franchisor has an experienced franchisee,” she said.

Tim Lai

Speaker Tim Lai

Tim Lai, a franchise consultant and founder of McDonald’s operations in China, and Xan Moody-Stuart, Subway’s master franchisee in north China, shared their experiences developing their respective brands.

McDonald’s came into the major Chinese cities first in 1990, and didn’t start franchising until 2004, Lai said. The company moved slowly because of the regulatory environment, which is now becoming more transparent, he said. Expect to adapt your menu to the local tastes, he advised; even McDonald’s added Chinese items to its burgers and fries. 

But don’t modify too much. Michael Woida, vice president of international for CKE, said later that when Carl’s Jr added rice to its menu in Shanghai, customers didn’t like it and told them they didn’t come to Carl’s for local food.

Developing in the major cities is most franchisors’ goal, but locations will be easier to find—and afford—in second-tier cities, those with 1 million to 8 million people, he added.

Training is important, he stressed, because “employee loyalty is not so high.”

Subway is making significant inroads into China, even though it had a lot of naysayers in the beginning. “As you travel around China, people will give you opinions on your brand,” Moody-Stuart said. Some feedback will be helpful, others will not. For instance, he pointed out, the chief comment he received was that people in China don’t eat sandwiches. Subway now has 100 stores in Beijing alone.

“You need to find a Chinese face,” said Moody-Stuart (who is Caucasian), meaning the person who is seen as the “face” of the company needs to be local. That shouldn’t be hard, he added, since the franchisees are the ones who should be front and center.

“The idea of coming here and finding a partner and going home won’t work here,” he cautioned.

“You have to stay longer than a year or the quality will go down,” Lai added.

While the norm is seeking partners with influence, Moody-Stuart said he shies away from people who are too well connected. “If you have a falling out, you’ll lose later,” he said. 

The business cards being presented by prospects won’t always tell the whole story. Chinese businesspeople tend to have several cards for each of their companies or areas of business. “Ask  (prospects) three or four times to see if what they’re saying is true,” he suggested.

The local office of the U.S. Commercial Service can also do a background check for around $600. “We can show up at their door and ask questions,” said Josh Halpern of the Beijing office. “Show you have the full force of the U.S. government behind you.”

Getting social in China

Twitter and Facebook are banned in China and local versions are censored. And yet the “social network is active in China,” Moody-Stuart contends.

A local site that touts itself as the No. 1 commerce site in Shanghai with 11 million registered members countrywide is jinti.com. A second site, jinti.net, is set up for U.S. companies that want to introduce their brands to the Chinese market. It’s a combination of Craigslist, Facebook and Twitter, according to Daniel Bollinger, the U.S. account executive for the Chinese company. “Jinti” translates to “today’s topic,” and much of the content is also soft news, sports and celebrities.

Franchise mission delegation

Franchise mission delegation:  l to r,  Bill Edwards, Edwards Global Services; Scott Schubiger, Rita’s; IFA’s Scott Lehr;  Debbie Huang, Right at Home; Michael Woida, CKE; FT’s Nancy Weingartner; Hair Parra, Wing Zone; Calvin Wong, Sotheby’s; and Andrew Gately of the U.S. Commercial Service. Not pictured are Don Burleson of Jani-King and James Liu of EGS.

The dot-net version of the site is in Chinese, but allows U.S. companies to start a dialogue with Chinese consumers, who Bollinger claims want to be educated about a brand before being sold on it. How this worked for one of his clients, Dunkin’ Donuts, he said, is that the brand was first introduced as blog posts and articles, along with banner ads. Subscribers weighed in on their experiences visiting a Dunkin’ store on their travels to the U.S. or elsewhere, or waxed poetically on their favorite flavors.

But most important, Bollinger says, the site enjoys a good relationship with the Chinese government. No negative news about the government is posted, and the site thrives.

Education is important to the Chinese. There’s a saying, according to Bollinger: “The Chinese don’t save anything for their children’s education, because they spend everything they have on their children’s education.”

That desire for education also benefits franchises going to China, because the next wave of franchisees will be university students who fall in love with a service or the food in a restaurant they visit over and over again while studying in the U.S.

Heading to the second-tier

The format of this trade mission was different from previous ones. For one thing, we visited what is considered second-tier cities instead of first-tier. That may have had an impact in other countries such as India or Nigeria, where most of the middle class is not in the smaller cities. But in China, the population of second-tier cities is a significant market—1 million to 9 million people.

Eight companies—Fuddruckers, Rita’s Italian Ice, Wing Zone, Right at Home, Round Table Pizza, CKE, Sotheby’s and Jani-King—participated in the trade mission. William Edwards of Edward’s Global Services and James Liu, EWG’s partner in China, represented three of the brands. Debbie Huang, deputy general manager of the master for Right at Home in China, did the presentations, in Chinese, for the franchisor.

Speaking the language gave the presenters an advantage since the revised format called for live presentations to a large group instead of just one-on-one meetings with candidates. The native speakers had the entire 15 minutes to sell—or rather educate—the prospects, while franchise reps with interpreters had to say it once in English and then wait while their interpreter translated.

Being on stage, however, gave the franchisor the opportunity to play a video showing his brand’s personality. Sometimes no translation was needed. Such was the case of CKE’s video depicting people all over the world enjoying oversized, messy hamburgers, including a few seconds of scantily clothed supermodels from Carl Jr.’s U.S. commercials.

Sadly, Wing Zone’s interpreter couldn’t keep up with Hair Parra’s funny commentary during his video, so the audience missed most of Parra’s jokes, but did get to see him dance.

Even with the shut-down, the Commercial Service’s local offices were able to recruit a significant number of prospects in each of the three cities we visited, Chongqing, Nanjing and Dalian.

Finding harmony

Feng shui, the art of harmonizing surroundings with individuals, is taken seriously here. CKE’s Woida said he had worked with an Asian franchisee and quickly learned that the placement of water can make or break a business. “It’s bad luck, so you can’t have the cook top across from the dishwasher (fire and water),” he said. In addition, signs had to be positioned in the right direction and there are certain days that are unlucky, so grand openings will sometimes be delayed for weeks, waiting for the luckier day.

It’s just one more example of the cost of doing business in China.

There are dozens of reasons not to go to China, but there are 1.3 billion reasons a franchise should at least consider it. 

 

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