China flagI have been re-thinking this question over the last six months given the flood of new overseas franchise chains trying to establish a beachhead in the China market. There are so many so-called franchise consultants now trying to promote the huge potential of the China market where riches await. Some are even establishing franchise websites similar to those in the USA, Japan or Europe that promote individual franchises to potential investors. But has the China market really changed during the past several years? Is Master Franchising really a viable market entry strategy in China today? My answer is still no but with some caveats.

First, the franchise market in China is highly underdeveloped and trust is a big issue. I have the opportunity to meet with many leading restaurant chains started by local entrepreneurs and the great majority of them are negative about the near term future of franchising as a growth model. These firms, with unit scale of 200-400 stores, operate direct owned models and some that have tried franchising have generally given up and bought back the rights to the stores. There does seem to be one model that works which is similar to the hotel management case whereby the franchisee invests in a store using his property, the franchiser operates the concept and they share the cash flow.

Second, overseas concepts in many cases need significant modifications to gain acceptance with Chinese consumers. The overseas franchiser thinks this is the job of the Master Franchisee but how many of them have the experience or wisdom to get this job of localization done right? Many overseas franchise concept owners are too arrogant and push back against these localization requests. A classic case involves Auntie Anne’s pretzels and is well documented in the new book, The China Twist, by Wen-Szu Lin. By importing key ingredients such as the flour, the local group in China was subject to opaque customs laws and higher commodity costs which drove the retail price of the pretzels beyond what consumers would pay. There is no reason a bakery expert from the parent company could not have spent time in China working with local flour milling companies to get the mixture right and if that was not possible then probably entering China was a mistake to begin with.

Finally, Chinese companies just do not see the value of paying a franchise fee and royalty for a brand unless it is in the very top tier, such as Starbucks, Pizza Hut, McDonald’s and KFC. But these brands were all built up over long periods of time at significant start-up cash losses. In addition, local companies want to see some skin in the game from the overseas brand owner which most are unwilling to consider. It is much harder to replicate these success stories today than 10-15 years ago given rising labor, real estate and commodity costs in addition to increased local competition.

So we go back to the question of whether a Master Franchising strategy can succeed in China today. Overall the answer is still no but there are some limited cases where it can succeed. (1) The brand owner can set up his own company in China, build some stores to prove the concept and then seek out regional partners to help develop the brand. There are many good regional retail and F& B partners available throughout the country but they want to be convinced of the model first. (2) Very high end retail or F&B can probably succeed with good local partners given that the scale can be managed. For example, it is possible to find a partner to develop a few upscale western steakhouses in China in a city. It is much harder to find a partner to develop 50 value steakhouses in a larger territory. (3) Finally, one is in a far better position if the concept is simple to operate and there is no preparation done at the store level. I am thinking here of the Hong Kong gold jewelry chains such as Luk Fook and Chow Tai Fook that just sell the merchandise to individual franchisees in return for cash and the right to use the brand name on the door. These concepts are very successful and profitable for both franchiser and franchisee.

So for all those overseas franchise concepts from the USA, Europe and the rest of the world trying to find a Master Franchise partner, what should they do? First, make sure they do their homework and confirm that there is really legitimate demand for the concept and the store level model is attractive after paying all the fees. Second, be prepared to spend countless hours and days interviewing potential partners and then bargaining over the terms and conditions. Third, don’t promise what you cannot deliver and better have a good answer when you are asked to invest in the venture together with the local partner. All this may be worth it in the end if your persevere enough but it will be a long hard road with many obstacles along the way.

4 Responses to “Is Master Franchising a Losers Game in China?”

  1. William Edwardssays:

    Thank you for this posting, Mr. Silverstein. Based on 31 years of doing business in China, I concur that China is not ready for classic master franchising. Granting individual franchises is very iffy in China and not something to recommend. Granting area licenses that require the licensee to build, own and operate all units is challenge enough.

    I had the opportunity to address this subject in “The Pros and Cons of Franchising in China” – China Business Review, July-September 2011.

    Your comments about consultants offering to find franchisees are also right on. US franchisors are being bombarded with offers to find franchisees by China based groups with little franchise experience.

    Attending one of the many China franchise expos tells one that there are a lot of Chinese who wish to buy a low cost franchise. Not likely that these are multi-unit franchisees for Western brands.

    Best regards.

    William Edwards

  2. Dan Harris/China Law Blogsays:

    Excellent post. Nice to see an honest assesment. This completely coincides with what we have seen with our clients. Franchising in China is just too difficult for all but a select few.

  3. ewhospitalitysays:

    Thanks Dan. Your comments are greatly appreciated.

  4. ewhospitalitysays:

    Thanks for your input.

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