No self respecting purveyor of fast-moving consumer goods would dream of by-passing China, but today's more savvy merchants are re-assessing the way they sell goods.
Franchises appear to be undergoing a twilight period, as problems of poor control and conflicting partner aims are surfacing. Meanwhile, even companies that have gone the wholly-owned route have discovered they are not immune from the vagaries of a developing regulatory and economic environment.
Mr Marvin Whaley, former president of McDonald's China Development Corp., said establishing operations in China was "six times as difficult" as the start-up of a McDonald's in the West.
The need to monitor
Other retailers have similar tales to tell. Giordano, a Hong Kong-based clothes manufacturer and retailer, has long suffered poor relations with China. One of its less publicised problems was disobedient franchisees with their own ambitions who filled the shelves with cheap jeans and T-shirts alongside Giordano-branded goods, and adopting their own pricing policies.
Giordano learnt that vigilant monitoring was crucial, to the extent of having an almost permanent inspector snooping around the franchises and ensuring the brand name was not being tarnished. Other Hong Kong retailers following the franchise route across the border, such as Theme, have concluded that monitoring and tight control will be key policies.
According to Mr Emmett Thomas, president of the US-based consultancy Monitor Company in Hong Kong: "The problems of a joint venture partner are probably if anything exacerbated in franchises, because companies like McDonald's or Giordano are used to dealing with a certain type of franchisee.
"In the West this would be an entrepreneur who has a strong business sense, and in China you are probably dealing with the arm of a municipal government,or subsidiary of the People's Liberation Army ?and it's just a whole completely unpredictable world for them."
Nor do such partners confer the privileges such connections might be assumed to deliver. The McDonald's Beijing franchise is held by Beijing Enterprises, an arm of the city government which is listed on the Hong Kong stock exchange. Even so, the company was forced to surrender its flagship store in the centre of the capital when Hong Kong tycoon Li Ka-shing decided to re-develop the prime Oriental Plaza plot into a massive commercial complex.
McDonald's put up a two-year battle, arguing it had signed a 20-year lease which was still far from expiry ?but failed to hold onto its prime plot.
Building supplier factories
One of the tnajor difficulties facing the burger giant is the fluctuating legal environment, which is compounded by the shortage of professionals such as lawyers, accountants and marketeers.
The more complex regulatory frame-work has also played havoc with global promotions and marketing ploys. For example, the group wanted to include toys in childrens' McHappy Meals but it lacked a licence to sell toys in Shanghai.
The inadequate infrastructure further added to woes for McDonald's ?on average it costs twice as much to develop a store as in America.
However, other companies have turned this shortcoming to their ad-vantage. Top Green International, the Hong Kong company responsible for TCBY frozen yoghurt franchises in greater China and India, resolved to kill the problems of poor infrastructure and distribution by developing its own factories in Guangdong and Zhejiang provinces where the bulk of its 35 outlets are concentrated. Having its own factories has also helped ensure sourcing reliability and product quality, by reducing dependence on third parties.
TCBY's experience suggests that companies can work around problems and restructure conventional franchise arrangements. In the area of fast food, for example, the rewards appear too good to ignore, especially given rapidly-developing brand awareness. Xinhua, the official Chinese news agency, reported that nearly all pupils surveyed at three Beijing schools knew the McDonald's name ?and some visited their restaurants as of-ten as 10 times a month.
China's fast food industry is tipped to grow 20 to 30 per cent a year over the next decade ?or worth as much as US$8bn by the year 2000, with some 40 per cent accruing to Western fast food.
Such projections are a source of great hope for multinational fast food enter-prises. The doughnut chain Dunkin' Donuts, now part of Allied Domecq, has more than a dozen outlets in China; KFC, formerly Kentucky Fried Chicken, has vaulted the 100 mark and plans to swell to 500 by 2000; McDonald's, which has 17 restaurants in Beijing alone and 73 in China, is aiming for 300 by the turn of the century.
Select partners carefully
More and more of these companies are looking at wholly-owned arrangements. Another alternative, cited as one of the most successful structures by Monitor's Thomas, is direct marketing ?or franchising directly to individuals. Successful examples he cites are Amway and Mary Kay Cosmetics of the US, which effectively have individuals as distributors.
"These are technically franchises, but they by-pass the constipated state-owned enterprises and go straight to the entrepreneurs. They have had a huge amount of success in getting strong distribution into the marketplace," he says.
In doing so they have tackled one of China's biggest stumbling blocks: "All fast-moving consumer goods producers that have entered China, if they look back and say 'What would we have done differently?', the number one answer is 'in-vested more in distribution'."
Resolving the problems posed by China has led some companies to retract ?such as Cafe de Coral, a Hong Kong fast food chain which closed down a number of its China outlets. Mr Andrew Chan, analyst at China Everbright Securities in Hong Kong, attributes its failure to an unreadiness for Hong Kong fast food and Beijing's crackdown on prostitutes, which deprived the Shenzheneateries of some of their best customers.
But others are more likely to persevere with new tactics and structures. Their starting advice is to pick partners carefully, says Thomas: "The biggest root cause of all the symptoms is a misalignment of goals between the foreign franchisor and local franchisee."
Franchisees may be more interested in touting a prestigious brand name around friends and government officials, or being seen as a source of foreign currency ?or even, more prosaically, guaranteeing lifetime employment.
Potential scenarios should be ad-dressed at the outset ?capital investment, the division of spoils (or debts) in the event of the venture having to be dissolved, what each partner expects from the other and how much control will be exercised by the franchisor.
A declining trend
Another consultant warns franchisors against moving too swiftly. Western companies in a hurry to grow fast tend to say 'yes' to the first-corner and don't always take a systematic look at choices, she says. Moreover there is a compelling economic argument to enter China through a franchise, since it removes the need to make infrastructure investments.
Ultimately, franchising may reappear on the menu in a few years time when the environment becomes more stable, but for now it appears to be on the de-cline. "We would generally see franchising decreasing, until things change from an infrastructure perspective," concludes Thomas. ^
gic decisions, the right to carry out operations and management, and the entitlement to profit distributions. In particular, if the original holding of the foreign party was less than 50 per cent and the contract already contains terms for the protection of minority interests, after the foreign party takes control no material amendment may be made to those terms.
Generally, the Chinese party's remaining holding must not be lower than 25 per cent. A joint venture that satisfies the approval conditions and procedures for a wholly foreign-owned enterprise and complies with the other regulations on the direction of foreign investment can ignore this limit ?but only for the time being. ^
Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. Fore further details, contact Matthew Cosans through its office in Hong Kong, tel: (852) 2846 3400 or Beijing, tel: (86) 10 6410 6338.