We have been actively involved in the China market for the past 10 years and our clients always ask about the business opportunities beyond Beijing and Shanghai.  Is there a market for their restaurant concepts in Tier 2 and 3 cities?  Our answer is always the same – depends on the concept and the development model!

First, a little background.

The restaurant industry has changed significantly the last 10 years in China.  Early entrants such as KFC, Pizza Hut, McDonald’s and Starbucks have reaped the benefits from first mover advantage, and have been able to build sizable businesses in Beijing and Shanghai as well as the other Tier 1 cities – Guangzhou and Shenzhen.  These businesses for the most part were built out as direct owned units or later acquired by the brand owner who then developed the concepts aggressively.  The only two successful Master Franchise cases I know of for foreign concepts – Yoshinoya (Japan) and DQ – have benefited from strong partner relationships in Beijing and Shanghai but their efforts in the other two Tier 1 cities have been spotty.

Developing a profitable business today in any Tier 1 city is very challenging given escalating tenancy costs, labor rates and food inflation.  Moreover, Chinese consumers are far more discriminating today than 10 years ago when air conditioning and a clean bathroom were enough to entice diners.

All the successful scalable restaurant models to date have been built with direct owned stores.  Franchising is very under-developed in China and there are serious trust issues as well.  There are many historical reasons why but I will save it for another posting.  There are very few successful franchise cases and they tend to be local concepts where the franchiser controls the entire supply chain and makes money from the sale of the critical ingredients which are necessary to run the operations and also difficult to source from other parties.

There are very few western restaurants in Tier 2 and 3 cities and the ones that exist are not very busy with the exception of the big four brands I mentioned earlier.  There are two reasons for this.  First, children have a big say in restaurant choice and they are highly influenced by TV advertising – no TV advertising then no brand recognition. Second, the Chinese family is very conservative and careful with their cash.  They do not frequent concepts they do not know or where they might find the menu unfamiliar.

Final point, the profitability of national chains is far better in Tier 2-4 cities than in Tier 1 for the reasons described above.   If this is the case, is it possible for new brands to enter the China market and go straight to Tier 2 & 3 cities and bypass Tier 1?

That is the subject of the next post!





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