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by Dr Ilan Alon

Restaurant franchisors are eyeing developing countries. China is among the first considered for a number of reasons. These include size, 1.3 billion people, with a 230 million middle class consumers in 2005, the world's highest economic growth rate in 2005 (about 9%), WTO membership, and recent franchise and contract laws. Shanghai is an excellent entry point because the government has targeted Shanghai as a new economic center to shift emphasis from Hong Kong. In addition, the per capita income in Shanghai, over $6,500 (adjusted to purchasing power), is the highest in mainland China. Shanghai offers numerous economic incentives, an increasingly westernized population, and a large numbers of tourists and expatriates.

There is reason for caution, however. While legal reforms have taken place, laws still seem archaic and sporadically enforced. And there remains insufficient protection for copyright, trademark and intellectual property. Add the language barrier, the cultural distance between the West and China, and the fact that many Western brands are unknown in China, and it's clear that Shanghai is a challenging opportunity to be considered carefully.

Franchising is a niche strategy that works; trading expertise and a proven business format for local knowledge, connections, and contacts. Successful franchising rests on the ability to transplant strategy that was successful in the home country. In Shanghai, the fundamentals of successful restaurant franchising are the same; consumers want flavorful food, delivered quickly and efficiently in a clean, pleasant environment at an affordable price. One recent survey of people in Shanghai conducted by the author revealed that consumers rated taste, service, atmosphere, price and brand name in declining order of importance when selecting a restaurant.

Given the cultural, social, political and infrastructure differences in Shanghai, complete standardization is unlikely. The key is to assess what adaptation will be necessary.

Product - The product includes the novelty, service, atmospherics, and overall experience that the restaurant provides. Traditional domestic restaurants are not direct competitors. Franchisors may be more successful by emphasizing the westernness of their products, making standardization viable. Of course, minor modifications will be required to adapt to local tastes. For example, Starbucks in Shanghai offers a sausage Danish while McDonald's serves seafood soup.

Promotion - Adaptation will depend largely on the product strategy. Standardized products make a standardized message possible, while different products mean different messages. Pizza Hut, for example, localized its business by decorating with large red "Double Happiness" signs, decorative firecrackers, traditional poetic couplets and the traditional Chinese character Fu (fortune); changing the design of the red roof to a Chinese feather Calligraphy brush willed with red; offering a customized "Xinyi" (goodwill) pizza from the Chinese new year to the Lantern Festival.

Pricing - First-time visitors to Shanghai are amazed at the low prices of locally-made goods. International franchisors need not use local restaurant prices for reference. As long as the product is of high quality, and presents a new concept of consumption, a higher price will signal quality and credibility. But remember that average income is substantially lower than in the West. Effective strategy might include portioning some products in sizes that can be purchased at very low price points. Both McDonald's and KFC ran 1 Yuan (about 12 cents) ice cream specials to entice customers into the store.

Distribution - Three location strategies seem viable.

  • Downtown - The commercial and cultural center, it boasts the greatest variety of restaurants. But high rents have restricted growth. Only 2,100 of over 29,000 restaurants are located in Xuhui and Jing-an, the busiest sections and the center of the downtown area. Foreign restaurants are concentrated in Huaihai Lu, Maoming, Nan Lu and Henshan Lu; streets of the French Quarters in old Shanghai.
  • Special Economic Zones - Pudong, a financial center and the site of many multinational corporations and government offices, has 2,700 restaurants. Substantial residential construction is also underway. Hongqiao, west of Shanghai boasts over 1,300 restaurants and is a favorite of expatriates and foreign investors.
  • Upscale Residential - About 2 million people have moved to suburban residential areas, made possible by numerous infrastructure projects that have increased the commutability of city workers.

Target Markets - Three segments represent attractive targets for international restaurant franchisors.

  • Foreigners and Expatriates - Short and long-term expatriates, visitors and tourists have relatively high income, and a willingness to pay a premium for familiar food with consistent quality. Continued foreign investment will result in a growing expatriate population as well as an increase in tourism.
  • Business People and Young Professionals - Includes educated professionals 25-50. They are likely to be the most receptive to new ideas, value the foreign dining experience, and possess sufficient discretionary income.
  • Young Emperors - Preschool through college-age children. There are an estimated 1.25 million one-child families in Shanghai. Young Emperors command the attention of the extended family and have a substantial influence on family buying decisions. A foreign restaurant that attracts these children will attract their parents and extended family as well.

Restaurant franchisors that miss the opportunity to enter China now will face intense competition from early entrants. It will be difficult for restaurant franchisors entering now to beat the scale and profitability of the already entrenched McDonald's and KFC. Nonetheless, the market is vast and great potential exists in many niche.

Despite the potential, doing business in China is difficult. The language and culture are remarkably distinct. Franchisors should seek local partners who can help them navigate the local business environment. A partner in the same industry with channels of distribution, industrial connections, and guanxi (personal connections) can greatly facilitate the success of the franchisor.

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Ilan Alon, Ph.D.
Associate Professor of International Business
Director of Global Consulting Projects

Rollins College
Crummer Graduate School of Business
1000 Holt Ave - 2722
Winter Park, Florida 32789
United States of America

Phone: (407) 646-1512
Fax: (407) 646-1550


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