Philip F. Zeidman
Years ago I found myself on a boat making its way down China’s famed Yangtze River, the longest in Asia. This was years before the Three Gorges Dam project, the largest water conservancy effort in the world, had raised the level of the Yangtze by several hundred feet—and at a time when the conditions of life in China were still so harsh we would occasionally see dead bodies floating alongside us.
Late one day we unexpectedly saw a settlement on the riverbank. Curious, we asked the captain for its name and population. He told us the name, and its size: 400,000 people. It did not appear on any map, perhaps considered too small to warrant inclusion.
That doesn’t seem as strange today as it did then. Consider: In the United States there are only nine cities with a population of 1 million or more. In China, 144. And this disparity will only grow. Continuing the largest rural-to-urban migration in history, it is estimated that in a little over a decade China will have more than 220 such cities.
The franchise trade mission to China, unfolding in early November, will see this phenomenon firsthand, through its visits to five selected cities. While most Americans of course know of Beijing (more than 20 million people) and Chongqing (10 million people, although they probably call it Chungking) and Nanjing (more than 8 million), it’s a fair bet that many fewer have heard of Qingdao (roughly the size of New York City) or Dalian (the size of Philadelphia, Phoenix, San Diego and Dallas combined). Quite apart from sheer size, these cities selected for the trade mission have appeal to franchisors ranging from unparalleled growth to strategic location for expansion to high per capita GDP.
But this is not a geography quiz. The emphasis on cities is not accidental. That’s where the opportunities lie—to reach the growing middle class, to reach young consumers, to achieve economies of scale. But as the franchisors will find, the very largest may not be the most attractive targets.
Because of skyrocketing rent and other costs in those megalopolises, second-tier cities and below may offer the most cost-effective opportunities, with populations familiar with U.S. brands but not already inured to their charms.
Indeed, a very recent survey showed 13 of the 20 most popular brands in China were from America (with two each from Germany and France and one from Italy, only one from Asia and none Chinese). Among the American brands: both KFC and McDonald’s. There is some tendency in lower-tier cities to be loyal to local brands, but not enough to cancel out the overriding preference for international brands, which offer quality, prestige and uniqueness and can command a 13 percent price premium.
And what of China itself? And what of its legal environment?
We’ve already touched on some of the trends that have drawn franchisors like a powerful magnet: hypergrowth, urbanization, growth of the young and of the middle class, attraction to Western products. Take these together with other riveting realities: the sheer size, 1.4 billion people; the largest movement out of poverty in the history of the world; the relative ease with which China weathered the recent economic setback; and the fact that, despite its growth, franchising still only accounts for 3 percent of China’s total retail sales.
The picture that emerges explains why, if it is not already, China will almost certainly be the largest franchise market in the world.
Cautionary features
But it would be a serious misjudgment to assume those uniformly appealing characteristics are all that our trade missioners will find. There are some other cautionary features that will appear on their ledgers.
For one, the extraordinary growth in the economy has begun to taper off, although the "lower" rate remains one for which most other countries can only pray.
For another, the construction boom, some observers believe, is on the verge of yet another bubble, which could burst with disastrous consequences.
The Chinese obsession with saving has recently begun to loosen its hold, but another economic setback could cause it to return with a vengeance.
There are already some worrying signs of backlash against some Western products (and YUM’s brush with avian flu and with rumors of unsafe products demonstrates how quickly that can erupt).
The demand for franchises is gratifying, but the relative paucity of qualified partners remains a concern.
The need to localize, to manage government relations adeptly, to deal with corruption and the lack of transparency—these are not unique to China, but they are an ever present reality.
Readers accustomed to these and other reports on franchising in China will note the single most dominant feature of those earlier columns and articles—the barriers posed by China’s franchise law—is conspicuous by its absence. That is not because it has disappeared; it remains an impediment to many franchisors, and unsettled questions abound, including the precise consequence of failure to comply, and the relative roles of the central and provincial authorities.
But the combination of effective persuasion by the International Franchise Association and the development of a more practical approach by Chinese authorities has led to today’s more tolerable landscape. A thoroughly well counseled franchisor can now view the Chinese franchise regulations the way it can view other legal regimes—as a time-consuming and costly necessary step, but one that can be managed.
One unfortunate byproduct of the positive developments is too many putative franchisors now dismiss the other legal problems of doing business in the country, chief among them the intellectual property laws and their enforcement and the requirements of the foreign exchange regulations. More than one franchisor, inadequately prepared and counseled, has found how quickly this golden market can turn to brass.
To be forewarned is to be forearmed. And that’s not just an old Chinese proverb.
Philip F. Zeidman is a senior partner in the Washington, D.C. office of DLA Piper. He can be reached at [email protected].
