The unique challenges and opportunities of franchising in China

Depending on who you ask, China’s middle class now numbers at least 470 million people (more than the entire population of the United States) and it is growing rapidly. These newly prosperous people enjoy considerable disposable income, and they can be characterized, at least in part, by a fondness for Western products – especially fast food and luxury brands.

Add in China’s still-robust GDP growth, its world-leading aggregate purchasing power parity, its rapid urbanization, and its current transition to a consumer- driven economy, and the result might look like the Garden of Eden. But there is a snake lurking in the garden. Doing business in China isn’t easy for a number of reasons, and domestic competition is rising.

“When in Rome…”: Adaptation to Local Markets Within China

Ever heard of Red Bean Bubble Tea? How about Crayfish Pizza? You’re not likely to find those on the menu at McDonald’s or Pizza Hut, respectively, in the United States, but you may run into them in China. Likewise, you may have trouble purchasing a milkshake at a Chinese McDonald’s. As a franchisor, particularly in the restaurant business, you cannot be too much of a purist about your product.

Although you will need to keep the company’s core products (yes, you can still get a Big Mac in China), you will need to vary your products to meet local tastes, and you may also have to vary certain business practices. If you don’t, you can guarantee that a domestic franchisor will – to your great competitive disadvantage. Remember that even with a flexible mindset, you are going to have a hard timekeeping up with local brands that understand China’s cultural and operational norms batter than you do.

Brand Management and Protection

China is renowned for its lack of respect for intellectual property. Although this concern maybe exaggerated in some quarters, there is much more than a grain of truth to it. Although China’s formal intellectual property regime closely resembles that of Western countries (because China is a signatory to many of the same international IP treaties), you will need to watch for the following peculiarities:

• There is no such thing as a common law trademark in China. Except for internationally famous brands, you must register your trademark in China to receive protection. Because China operates on a first-to-filesystem, trademark squatting is commonplace, however, the first-to-file system has changed in recent years. Although It's hard to explain, the tendency is that the protection for trademark is raising and so is the complexity of legal actions. From the perspective of remedies, despite the amount of damages is raising, the slight increase of compensation still cannot weigh the low cost of rush registrations. On the other hand, various policy documents from 2021 have emphasized on combating the trademark squatting at the initial stages, which means decline to the rush registration at the first place. Thus, with a local agent keeping eyes on your brand-related register, you can take precautions with in more dimensions.
• You are likely to run into local bias in the courts outside of Shanghai and Beijing (a skilled Chinese IP lawyer, however, can help you take advantage of “forum shopping” opportunities).
• Even if you win an IP infringement lawsuit, damage awards are often too low to deter other companies from committing the same offense or even to deter the same company from continuing its IP infringement during an IP lawsuit against it.

MOFCOM (Ministry of Commerce) Registration

Franchising in China requires a lot of paperwork – both before and after the required registration with the Ministry of Commerce (MOFCOM) – which must take place within 15 days of signing the first franchise contract. Many overseas franchisors have complained of the difficulty in dealing with MOFCOM due to MOFCOM’s way of looking at evidence and documentation. Some of the peculiarities to watch out for include:

• An inherent distrust of experts: In China, “evidence” largely means government-issued documentation. Expert witnesses and sworn statements by experts, although sometimes used, do not carry the same weight as they do in the West. Distrust is particularly prevalent if the witness is being compensated in any amount at all, as MOFCOM will assume a conflict of interest.
• The use of notary publics: In the US and much of the West, a notary public attests to the identity of a person signing a sworn statement, not to the content of the statement itself. In China, however, notaries are widely used to attest to the accuracy of the content of the statement; in a sense, Chinese notaries are government-licenced rent-a-witnesses.

As such, Chinese authorities are used to demanding the type of evidence that a domestic party could easily procure using a notary public, but which might be extremely difficult for a Western party to secure from outside of China.

• A “guilty until proven innocent” mentality: This mentality is not limited to criminal law. The point is that, when you have something to prove, any statement you submit will be presumed false unless proven otherwise by evidence acceptable to MOFCOM (see above).

Western Franchises in China: How They’re Doing

Franchising in China is good business, at least for the top international brands. According to the China Chain Store & Franchise Association (CCFA), in 2015, the sales from the top 100 players exceeded RMB 434.5 billion (US$62.9 billion). Although, by 2017, that figure had declined to RMB 330 billion (US$47.8 billion).

The long-term outlook seems rosy because total consumption in China is projected to increase by more than 10 percent per year.

KFC, for example, has franchised over 6,000 outlets in China, making it the single most successful franchise in China, including some formidable domestic competition. McDonalds is not far behind, with plans to nearly double the number of Chinese franchises between 2017 and 2022. Even Hooters and Disney have established a presence in China.

Going forward, the greatest challenges for franchising in China do not include the size of its market or the rate of growth in its markets, both of which are immensely encouraging. Instead, the primary challenges are:

• Increasingly robust domestic competition, often indirect competition with products offered by Western franchises.
• Burgeoning consumer sophistication among Chinese consumers, along with a growing preference for local products.
• An unstable business climate (the US-China trade war, for example) and the uncertainty such a climate inevitably produces.

Although the future is impossible to predict with certainty, business risks can be calculated and appropriately managed. The ultimate reality, however, is that China is simply too big a market to ignore and it is likely to remain so for the foreseeable future.

Further reading:

Alliott Global Alliance joins International Franchise Expo in New York

The FTC’s Noncompete Ban: When it becomes effective and what it means

About IPO Pang Shenjun Law Firm:

IPO Pang Shenjun Law Firm is Alliott Global Alliance’s representative law firm in Shanghai Province, China and has a strong reputation for its outstanding service delivery of helping many companies across a wide spectrum of industries to establish and grow their operations. Established in the early 1990s, the firm now has associates throughout China and affiliate partners in almost 100 countries. Read more.