China, Franchising and the 2008 Olympics: Is the Time Right?

A SHORT HISTORY
The current state of the franchising industry in China is phenomenal when one considers its history. Franchising was virtually non-existent in China in the early 1990s: China enacted its first franchise law in 1997. However, the 1997 law did not refer to foreign companies and it was questionable whether foreign franchises were permitted in China. At this time there was no public awareness of the franchising model. Jim Bryant, the entrepreneur behind bringing Subway to China, once stated that his early experiences in China involved him having to teach the franchising concept to a country that had never heard of it. He recalls that when he started, there was no Chinese word for “franchise.”¹

Since the 1990s the Chinese have been quick to recognize the usefulness of the franchised business model, particularly its ability to combine the benefits of small businesses with large brands, distribution and processes. However, the franchising model in China has not been attractive to those companies that predominantly use it in the West – the overwhelming majority of McDonalds and KFC restaurants in China are corporately owned (it was not until 2003 that McDonalds granted its first franchise). Legal insecurities and the immaturity of the market were the main reasons for the reluctance of these companies to use the franchise model. Also, because many industries, most importantly the retail industry, were not fully open to foreign investment, some foreign franchisees had to operate in a gray area of the law. However, other international chains like Subway, Century 21 and Athlete's Foot were more willing to use the franchise model. By the late 1990s-early 2000s Subway stores had sprung up all over China. This could be attributed to the cheaper cost of purchasing a Subway franchise in comparison to KFC or McDonalds.

In December 2004, China issued the Measures for the Regulation of Commercial Franchise (the “Measures”), which replaced the regulations issued in 1997 and also brought in new rules that applied to both foreign and domestic franchising activities in China. The main provision vis-à-vis foreign franchisors was that all foreign investors and domestic entities that wanted to conduct franchising activities in China were required to establish a legal entity in China, namely a foreign invested enterprise (FIE) or domestic company. Although China has finally allowed direct foreign participation in the franchise business sector by implementation of the Measures, there were still many deficiencies, in particular, the so-called “two plus one” requirement. This required franchisors to own and operate their brands' first two outlets profitably in China for one year, before franchising.