AMERICAN FRANCHISING COMPETITIVENESS IN CHINA

Ilan AlonAssociate Professor of International Business

Crummer Graduate School of BusinessRollins College

1000 Holt Ave. - 2722Winter Park, FL 32789-4499

ialon@rollins.eduPhone (407) 646-1512

Fax (407) 646-1550

Mark ToncarAssociate Professor of Marketing

Williamson College of Business AdministrationYoungstown State University

Youngstown, OH 44555mftoncar@ysu.edu

Lu LeShanghai University for Science and Technology

American Franchising Competitiveness in China

Ilan Alon, Mark Toncar, and Lu Le --

ABSTRACT

Consumer tastes and preferences are converging around the world as a result of advances in communications and transportation technologies, the liberalization of world trade, the formation of regional trade agreements, and the increased mobility in labor and capital. With 1.2 billion people, China is the largest consumer market in the world containing about 20 percent of the world’s population. The purpose of this article is to investigate the environment for foreign restaurant franchising in the Shanghai market, the main economic pole for Mainland China with a population of about 15 million people. This article examines environmental opportunities and threats, the consumer characteristics, and the marketing strategies that may be employed by restaurant franchisors considering entry into China.

INTRODUCTION

Over the last two decades Asia has been the fastest growing region in the world. Within Asia, Mainland China has been the fastest growing country, with the highest growth rate of GDP

brought about mainly by domestic market demand. With the largest consumer market in the world and an accelerating economy, China is hailed as one of the most important consumer markets of the 21st century. By 2005 the country is projected to have more than 230 million middle-class consumers earning more than a $1,000 per year (Chan et al., 1997).

This paper investigates the potential for restaurant franchising in Shanghai, China. The Shanghai market is the focus because (1) the average income there is almost twice as high as the rest of China, (2) Shanghai is a major economic growth pole that contains key industries, (3) China has targeted Shanghai as a new economic center to shift emphasis away from Hong Kong, and (4) regional variations in China are great in terms of customs, habits and eating behavior and, thus, a regional focus is useful from a decision maker’s point of view. Shanghai is a likely point of entry for foreign franchisors seeking expansion into China because of the relatively auspicious economic and political environments there.

We first examine the environmental conditions that influence the feasibility of international franchising in China, and then narrow the lens and focus on the opportunities and threats for restaurant franchising in Shanghai. Following the environmental examination is a discussion of strategic approaches to marketing concerning modes of entry, adaptation and consumer analysis.

FRANCHISING ENVIRONMENT IN CHINA

Given the vast potential of China as a consumer and industrial market, it is no surprise that large numbers of foreign organizations are either operating in China or giving serious consideration to doing so. Once the decision has been made to commit resources to the Chinese market, the fundamental channel decision must be made regarding market entry strategy. This decision is influenced and constrained by a variety of host country variables. These include the channels that are legally allowed as well as the national priorities of the host country, in terms of both channel development and resource allocation. Other important considerations include the political stability and overall development of the host country legal system, the convertibility of currency, host country infrastructure, the cultural distance from the home country, the availability of managerial and skilled labor, and the degree and pace of economic development in the host country.

Franchising as understood in the United States did not legally exist in China until November, 1997 when the Regulations for Commercial Franchise Business were implemented by the Chinese government on a trial basis. Prior to these regulations, foreign franchisors, notably KFC and McDonalds, operated outside the franchise format (Nair 2001) by developing joint operations with the Chinese government. While the regulations do not expressly apply to foreign franchisors, they represent an important development that, along with the more recent Contract Law of 1999, substantially enhances the attractiveness of franchising in China (Han 2001). The Regulations allow for franchise activities to be conducted between individuals for the first time, allow both direct and individual franchise arrangements and set forth the rights and obligations of both the franchisor and franchisee. Overall, the 1997 Regulations appear to have created a business format very similar to U.S. franchising (English 2001).

China’s accession to the World Trade Organization further enhances the attractiveness for international franchisors. Currently, there is no clear mechanism in Chinese law for

obtaining the necessary approval for the conversion of the Chinese Renminbi to hard currency (Han 2001). However, WTO membership is expected to quickly lead to full currency convertibility, eliminating an important stumbling block to franchise investment in China.

China’s priority with regard to foreign investment has been to seek technology-based investment. Next in terms of importance have been export-based industries. Retail development has been of much less concern. However, economic development in the country is breeding a new middle-class, clamoring for luxury items and things western. The increased disposable income of the burgeoning middle class has led to an increased demand for many of the products consumed by middle class consumer around the globe. This has led to greater acceptance of foreign retailers of all sorts, from restaurants to department stores.

The growth of the retail sector in China is also fueled to some extent by the worldwide increase in tourism and overall globalization of markets (Levitt 1983). Global consumers want familiar products wherever they travel. This, coupled with the increasing homogeneity of tastes and preferences makes western products far more attractive in China than in even the recent past.

International franchising can play a pivotal role in addressing some of the economic development needs of China. International franchising can act as a positive social and economic force. In recent years, massive unemployment in China has resulted from the shutdown of inefficient state-owned industries. These displaced workers represent a potential threat to the social order in China. International franchising can provide employment, training, and stimulate the further growth of the middle class in China.

Franchising is a western business format. As recently as 1994, the word “franchise” could not be directly translated in China (Wilke and Xau 1994). The closest translation was “multiple stores,” or “chain of stores.” Consequently, international franchisors were not sure whether or not franchising would be an appropriate business model in China from a cultural standpoint.

For franchising to succeed, they believed an entrepreneurial orientation and value system must exist among the franchisees in the host country. After 30 years of planned economy and another 20 years of transition from planned economy to the present market economy “with Chinese characteristics”, this spirit and orientation in China may be difficult to find. While this viewpoint may have been prevalent in the early 1990s, recent years have witnessed a growing enthusiasm for franchising. Following the first International China Franchise Exhibition held in Beijing in 1999, there have been four exhibitions, held almost simultaneously in Shanghai and Guangdong. The number of participants for the International China Franchise 2001 at the three cities totaled 14,363. A survey of the exhibition shows that three fourth of the participants planned a new investment within one year 1) Within 6 months: 39%2) Within one year: 35%3) Within two years: 15%4) No plan:11%

In summary, the macro-environmental conditions in China are favorable for international franchising. The political system is stable and increasingly welcomes foreign investment. The legal system is evolving quickly, providing the mechanisms necessary to encourage franchise growth. China’s membership in the WTO will lead to currency convertibility and further synchronization of Chinese economic policies with those of the developed world. In addition, the expanding body of potential franchisees and the large and growing middle class create broad opportunities for international franchising. Within this environment, however, potential franchisors must remain sensitive to the inconsistency of the franchise format with Chinese culture and recent history.

FRANCHISING IN SHANGHAI

This section will take a brief look at the general environmental opportunities and threats for restaurant franchising in Shanghai from economic, political, social and distributive perspectives.

Economic Environment

The favorable aspects of the economic environment in China, in general, and Shanghai, in specific, are:  Shanghai is the leading economic center of Mainland China with the highest average income in the country ($2,012 per year in 1999 compared with the national average income of $1,009) As incomes continue to increase, the opportunity cost of time will also rise, increasing the demand for time-saving services such as fast-food The admittance into the World Trade Organization will stimulate foreign direct investment, trade and travel, particularly in the economic and political centers, such as Shanghai, Beijing, and Hong Kong Competition from foreign franchise chains is still very low

On the other hand a number of economic factors limit the desirability of restaurant franchising in China:  People are reluctant to spend, even after the government’s attempt to stimulate consumption by successive reductions in interest rates Family incomes are not rising as fast as expectations and consumers are uncertain about the future The Asian crisis in 1997 has slowed the domestic economy, resulting in lower economic growth, high unemployment, deflation and weaker consumer confidence. The retail sector’s growth is sluggish as well The growth of domestic franchising represents a competitive threat to international franchising. The development of home-grown franchisors began in 1992 and is now estimated at over 200 franchisors with more than 3000 total outlets. The percentage of international and domestic brands that attract

potential investors are: 1. international: 24%; 2. domestic: 35%; 3. both: 41%. (www.franchise-cn.net)

Political/Legal Environment

Among the political factors favoring international franchising are:  There are economic incentives to invest both at the country level and the regional level, particularly in investments that produce jobs since the restructuring of state-owned enterprises produced considerable unemployment There are a number of free trade zones and bonded areas that are set up to lower the tax burden of certain investments The political/legal environment also holds certain risks for international franchisors:  Laws may seem archaic and sporadically enforced since political influence and political connections may supercede written laws Insufficient legal protection for copyright, trademark, and intellectual property Restrictive regulations on various types of investment and trade Difficulty in negotiating licenses and sites and establishing governmental networks (Chan et al., 1997).

Social Environment

The social environment has the potential to nurture restaurant franchising because:  The younger generation particularly in large cities such as Shanghai is increasingly seeking Western lifestyles and habits. This segment seeks “cool” and trendy U.S. products and services. Food consumption in Shanghai is relatively high at 41% of retail sales. Restaurant outings are common forms of

entertainment.  The social factors unfavorable to U.S. restaurant franchising in Shanghai are: There is a large cultural distance between the West and China Because the infusion of Western culture (e.g. movies, Internet sites, etc.) into China is controlled, many famous American brands are unknown. The language difference is another obstacle. For Western brand names to be effective they must be translated so as to be both culturally acceptable and easy to understand The city of Shanghai is aging with people over 64 constituting about 13% of the population compared with 8% for the rest of China. Older Chinese, being more tradition-bound, are a less attractive target market.

Distributive Environment

Several infrastructure projects – such as the new international airport in Pudong, Metro Line No. 2, and railroad and subway development – will increase the transportability of people and materials and decrease the cost of distribution (Ware et al., 1999). However, the distributive environment in China is still chaotic, consisting of fragmented retail channels and a proliferation of “mom-and-pop” stores, which account for 9 million businesses with an average sales volume of $20,000 per year (Chan et al., 1997). 

The Restaurant Industry

China’s retail market has shown robust growth in recent years: $170 billion in 1991, $250 billion in 1995, $350 billion in 1998; and is projected to grow to $930 billion by 2005 (Chan et al., 1997; Ware et al., 1999). It is currently the largest retail market in Asia outside Japan. Of the nine industries that are found to be the most attractive to investors, the restaurant industry is ranked first in the three important cities in China (see Table 1).

TABLE 1: POTENTIAL OF FRANCHISING IN CHINA

Beijing Guandong

Shanghai

Restaurant 72% 64% 63%Retailing 56% 61% 52%Domestic service and residence management 39% 31% 37%Commercial service 23% 25% 28%Gymnastics and beautification 23% 22% 21%Education 27% 21% 22%Day care 21% 17% 19%e-commerce, internet, multi-media 17% 18% 18%Automobile service 10% 10% 11%

(Source: http://www.franchisechina.com)

Spending on food products, such as branded products, higher-quality processed foods and fast-food restaurants, is expected to grow as discretionary spending rises. The top 100 cities are projected to spend $160 billion by 2005 (Chan et al., 1997). The growth in consumer spending and the retail environment has translated into stunning success for some international fast-food franchisors. KFC, for example, which opened in Beijing in 1987, now has 380 restaurants in 90 cities employing 25,500 residents. McDonalds, with well over 300 restaurants, has enjoyed similar growth and success.

Many other western restaurants have also been successful meeting the demands of the young generation who like to try new things, especially things representing Western culture and lifestyle. Many kinds of European and American foods, such as cheese and coffee, are relatively unfamiliar to the Chinese. However, in many product categories western marketers are the pioneers who acculturate some of the local population before gaining recognition and achieving success. The success of Pizza Hut and Starbucks are good illustrations.

At the same time, these western restaurants are trying to

assimilate themselves into mainstream Chinese culture. However, they are faced with the challenge that Eastern foods from Japan, Korea and Thailand are closer geographically and culturally and tend to enjoy more rapid acceptance. But the greater challenge may be that Chinese go to Chinese restaurants to eat while enjoying the pleasure of eating out with families and friends. In contrast, they often go to western restaurants to experience, looking for novelty and exoticism. They are likely to patronize local restaurants on a regular basis and visit western restaurants only occasionally. It is often the case that Chinese go to eat to the same Chinese restaurant over and over again while they try a different western restaurant each time they have the desire to experience western food.

Economic growth in Shanghai has increased the standard of living among its residents who are paying more attention to the quality of life and drawing increased satisfaction from the consumption of foreign goods and services. As can be seen in Table 2 below, output has increased in almost all industries from 1990 to 1998. The total consumer expenditures in general, and on food consumption and dining out per household specifically, more than tripled during this time period.  

TABLE 2: SHANGHAI ANNUAL URBAN EXPENDITURES (U.S. $)1990 1995 1997 1998

Total Consumer Expenditures 234 710 825 830Food 132 388 424 419Dining Out 16 44 50 51Clothing 26 68 67 57Household Facilities 22 81 71 57Healthcare 1 14 24 32Traffic & Communications 6 36 48 46Recreation, Education & Culture Services 28 56 46 47Residence 11 44 65 80Others 8 32 32 38

(Source: Statistical Yearbook of Shanghai, Editor: Shanghai Municipal Statistics Bureau. China statistical publishing house, 1999) 

The Statistical Yearbook of Shanghai (2000) indicates that urban

household per capita annual consumer expenditures rose to $1,072, with annual food expenditures of $473, and dining out expenditures of about $82.

According to the same source, there are over 29,000 restaurants in Shanghai, ranging in size, age, and ethnicity of offering and with gross sales $1.55 billion, about 7.5% of the $20.8 billion in total retail sales. Traditional Chinese restaurants carve out a formidable share in the restaurant industry. They are typically less expensive than foreign restaurants and obviously more consistent with Chinese tastes. Many western restaurants have set up shop in Shanghai to capitalize on the city’s growing middle class, high level of urbanization, and increasing standard of living. More foreign-owned restaurants are expected to set up their businesses in Shanghai in the near future with China’s entry into the WTO, which will accelerate economic growth, tourism, and trade. 

Ownership Structure of Restaurants

Restaurants fall into four categories in terms of their ownership: state-owned restaurants, private-owned restaurants, foreign-owned restaurants and joint ventures. Restaurant franchising is an organizational form of expansion that is gaining acceptance rapidly, particularly among foreign-owned restaurants that wish to exploit the market opportunities, but have neither the market knowledge nor the required skills to succeed in that environment. The franchise format gives the franchisor access to the Shanghai market, and also allows the franchisor to exploit much-needed local knowledge and expertise. 

Cost Structure  In comparison to the West, restaurants’ labor costs are low in China, even in the most developed areas such as Shanghai. Table 3 illustrates the labor costs of a restaurant in Shanghai.  

TABLE 3: RESTAURANT LABOR COSTS IN SHANGHAI (U.S. $)

Job Number of Employees

Salary(US $/month)

Manager 1 605Cook 1 423Assistant Cook 2 242 per personWaiter/Waitress 3 121 per personPart-time workers

3 2.40/hour/person

The information was obtained from an interview with a small foreign restaurant manager in Shanghai who asked to remain anonymous (June, 2000). 

The additional costs of running a restaurant in Shanghai mainly depend on its location, the price of raw materials, and facilities. Because in recent years China has experienced drought and consequently unsatisfactory harvest, the price of some raw materials, such as grain and meat, increased. However, this is a burden that is shared somewhat equally by all restaurants in the Shanghai market, since all restaurants will utilize many of the same local materials and supplies.

MARKETING STRATEGY IN SHANGHAI, CHINA

Developing a Business Presence in China

Once the international franchisor has decided to commit resources to the Chinese market, he will have to establish a business presence in the country. This is true whether the franchisor will be engaging in direct franchising, master franchising, or some variation of these. It is therefore useful to briefly discuss the most likely options for establishing a business entity in China. Nair (2001) outlines six ways that a foreign company can establish a business presence in China. Three are of relevance for the international franchisor. They are:

Equity Joint Venture – a limited liability corporation in which both partners invest in and manage operations through a Board of Directors. Partners share in profits/losses in proportion to their

investment. Although this form may be suitable for some franchisors, it is often problematic in that a well-known international franchisor may be unwilling to share profits with a local partner. Conversely, a strong local partner may be unwilling to work with a weak international franchisor.

Cooperative Joint Ventures – A very flexible arrangement wherein the Chinese and foreign partners contribute in kind. The specific terms of the investment, as well as the distribution of profits and losses is spelled out in the agreement.

Wholly Owned Foreign Enterprises – All capital is provided by the foreign investor, who has full control over the operations of the enterprise. This form has become an increasingly popular entry vehicle into China. However, the Chinese government typically restricts this entry form to firms who are either engaged in substantial technology transfer, or export-oriented firms.

Virtually all foreign companies operating multiple retail outlets in China either manage with a Chinese partner or sell to a master franchisor (U.S. Department of State, China Country Commercial Guide, 2000). This leaves the international franchisor the critical decision of finding the right local partner, and using the appropriate entry structure. In many ways, successful market entry depends upon the quality of the local partner. Local knowledge and connections are extremely valuable for both short-term and long-term success.

Franchising is a niche strategy that works; a proven concept that provides a business format within the environmental constraints that the franchisor operates in. Fundamentally, international restaurant franchising trades expertise and a proven business format for local knowledge, connections and contacts. The success of an international restaurant franchisor depends on its ability to transplant the strategy that was successful in the home country. In short, can the model be efficiently reproduced in Shanghai, and is there a market for the model’s output? Are there sufficient, and sufficiently developed inputs, a supportive or at least compatible legal/political/social environment, and is there a market segment large enough to support the restaurant?

Inputs refer to the materials necessary to establish and maintain operations, and the infrastructure to deliver these materials efficiently. These include labor, transportation and communication systems, and established suppliers. Shanghai possesses sufficient labor and infrastructure, but international franchisors may need to be actively involved in developing local supply chains. Since the franchise system depends on brand loyalty, recognition or prestige, the franchisor must insure adequate supplies of materials that meet the franchisor’s quality standards.

The legal and political environment is rapidly evolving. Generally, the environment is becoming far more receptive, from the perspective of the international franchisor. As discussed earlier, recent legal developments have made China, at least on paper, far more attractive to the international franchisor. This assessment is equally appropriate for Shanghai, perhaps more so in light of the Chinese government’s desire to shift emphasis away from Hong Kong.

The social environment in Shanghai is likely to be very supportive of international franchisors. The combination of youth, international business people working in Shanghai, tourists from all over the world and the overall globalization of markets all will serve to increase the likelihood of success for international restaurant franchisors in Shanghai. These three major market segments would all be very attractive target markets for international restaurant franchisors. All are substantial in size, with significant buying power. And all are likely to be quite receptive to a variety of international restaurant franchisors.

Within China, as in the U.S., many of the fundamentals of successful restaurant franchising are the same: consumers want flavorful foods, delivered quickly and efficiently in a clean environment with a pleasant atmosphere at an affordable price. One can argue that each of these dimensions can be interpreted differently depending on one’s cultural orientation. In this section we focus on the differences, the possible adjustments, and strategies that western marketers need to make when entering Shanghai. 

One small survey of 20 people in Shanghai, attempting to measure the suitability of a new restaurant in Shanghai, revealed that consumers rated taste, service, atmosphere, price and brand name in declining order of importance when selecting a restaurant (Chen Jie et al. 2000).

Modes of Entry -- Foreign franchisors are subjected to a unique legal and regulatory environment affecting their businesses, including labor law, foreign control in retail joint ventures, technology transfer regulations, approval and registration procedures, etc. Traditional franchising, as practiced in the West, is still in its infancy because of a lack of cohesive regulatory structure, a lack of domestic franchise candidates with sufficient capital and management skills, and insufficient protection of intellectual property rights. Under the current legal structure, various aspects of the franchise documentation are governed by different Chinese officials. Thus, some franchisors have selected to enter via (1) master franchising, (2) cooperative joint ventures, (3) licensing know-how and trademark, and (4) direct offshore franchise (For more information on the legal environment of franchising in China see Han, 2001).  

Adaptation of the Marketing Mix

A fundamental strength of the franchise format is the standardization of procedures, products and, to a lesser extent, promotion and distribution. Franchisors must assess each aspect of the marketing mix to ascertain what degree of standardization is acceptable and what adaptations will be necessary. Complete standardization is unlikely, so the critical decisions relate to the degree of adaptation required in each element of the marketing mix.

Product is the key element of the marketing mix and includes not only the physical object but the whole package the customer buys --- the total product. Both KFC and McDonald’s are successful because they bring the concept of fast food and Western (American) culture. Young people consume the products because they provide a different experience, not only in terms of taste, but also from such factors as environments, service, and

culture. Western restaurants are frequented by visitors who use the restaurant for romantic outings, birthdays, and family events.

Cultural congruence is helpful for product acceptance. For example, KFC was able to grow faster than McDonald’s partly because chicken is more consistent with Chinese tastes than the beef patty (hamburger) and this helped KFC assimilate into Chinese culture, gaining faster acceptance and diffusion.

A substantial part of the “total product” is the experience that goes along with the meal. Diners are often variety and sensation-seekers. Consequently, these restaurants are not, strictly speaking, direct competitors of traditional Chinese restaurants in Shanghai. With this in mind, the franchise model should be more successful than if the franchisor is truly competing with local restaurants. It is important to recognize that international franchisors may be more successful by emphasizing the difference and “Westernness” of their product offerings, thereby making product standardization a viable strategy. However, minor modifications of the products will still be necessary to adapt to local cultural tastes and to maximize sales. For example, Starbucks in Shanghai offers a sausage Danish while McDonald’s serves seafood soup.

Promotion is the element of the marketing mix that is the most difficult to standardize (Cateora and Graham 2002). Differences in language, culture and infrastructure available often make a standardized promotion strategy impossible. In addition, the degree of adaptation required in promotion is directly related to product strategy decisions. If products are going to be standardized, it is at least possible to standardize the message strategy. However, if different products are going to be offered, this makes it highly unlikely that standardized promotion will be possible. The close relationship between product strategy and promotion strategy yield four possible strategic options with regard to the degree of adaptation; standardization of both product and message, adaptation of both, or standardization of product (message) and adaptation of message (product).

Pizza Hut recently adopted product adaptation and message adaptation strategy for the Spring Festival Season. It 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 filled with red; offering customized “Xinyi” (goodwill) pizza between the Chinese New Year to the Lantern Festival.  

Prices are in general lower on most consumables in China. First-time visitors to Shanghai are often amazed at the low prices of locally made goods. While franchisors coming into the market have to lower prices for mass acceptance, they need not use the prices in common Chinese restaurants for reference. As long as the product is of high quality and presents a new concept of consumption, setting a relatively high price will lead to an interpretation of high quality and credibility, especially among high income young white collars. As mentioned above, dining in a western restaurant is often an occasional experience, one that may actually be enhanced by a relatively high price.

To achieve mass acceptance, the franchisor should attempt to minimize the price of the final product by using locally produced ingredients. The Chinese are price conscious and since their income is substantially lower than that of Americans, for example, they are cautious about spending excessively. Both McDonald’s and KFC ran 1-yuan ice-cream specials to entice customers to the stores (equivalent to about 12 U.S. cents).

Similarly, franchisors should consider minimizing the franchising fee to achieve rapid expansion. This may be critical to brand name recognition and consumer acceptance. Oftentimes, tie-in sales or fixed sum payments are substituted for royalties, possible because of monitoring difficulties.

Place: The old adage “Location, Location, Location” applies in Shanghai. There are three location strategies an international

restaurant franchisor can adopt when entering the Shanghai market: (1) locating in the Downtown Area, (2) locating in the Special Economic Zones, and (3) locating near an upscale residential area.

Downtown Shanghai:  The Downtown area of Shanghai is the cultural and the commercial center of the city and boasts the greatest variety of restaurants. However, perhaps because of the very high rental costs, only about 2,100 of the over 29,000 restaurants in Shanghai are located in the Xuhui and Jing-an districts, the busiest sections of the city and the center of the downtown area. Here many foreign restaurants and retail outlets can be found, often concentrated in Huaihai Lu, Maoming Nan Lu, Henshan Lu. These are the streets in the French Quarters in old Shanghai and now the most upscale neighborhoods.

Special Economic Zone:  Despite its relatively recent development, the new district of Pudong already has over 2,700 restaurants. Pudong has become the financial center of Shanghai where a large number of multinational corporations and many government financial institutions have established offices. It is also an area that has seen substantial residential construction. The combined business and residential population provide a large customer base to support international restaurant franchising. As the area becomes more developed and cultural and entertainment centers are developed, more consumers will be drawn to this and other similar areas.

Another noteworthy economic development zone is the Hongqiao area west of Shanghai. Over 1,300 restaurants currently operate in the area, a favorite of expatriates and foreign investors. As the Hongqiao economic zone expands, it is developing as a substantial residential area as well, which suggests that it may offer an excellent customer base for international franchise development.

Upscale Residential Areas: Residential areas around Shanghai are also increasingly important since a number of infrastructure projects have increased the commutability of residents to the city. About 2 million people have moved to these areas in recent years, and an additional 1 million are planning to move (Ware et al., 1999). These areas have not yet been developed by restaurant franchises, despite being upscale areas with wealthy residents. In comparison with downtown Shanghai, they are still lacking upscale attractions, including foreign restaurants.

Potential Target Markets

Based on the discussion of promotion and location, there are three major market segments that are potential target markets for foreign franchises in China. These are (1) foreigners and expatriates, (2) business people and young professionals, and (3) “young emperors.”

Foreigners and Expatriates 

Foreigners include long-term and short-term workers, visitors, and tourists. This market segment is attractive to restaurant franchisors because their income is high relative to the Chinese population and because they are more likely to have been exposed to foreign brand names. Foreigners are more likely to pay a premium for a familiar food with consistent quality they can trust. As shown in Table 4, the number of tourists visiting Shanghai yearly has increased significantly from 1990 to 2000. China is expected to be the world’s largest tourist destination by the year 2020.

TABLE 4: OVERSEAS TOURISTS IN SHANGHAI

1990 1999 2000

Numbers of Tourists visiting Shanghai (in 10,000) 89.3 165.68 181.4

1)Foreigners 46.06 128.73 139.14

Singapore 1.02 5 5.29

Japan 22.6 49.89 53.76

Germany 1.6 6.46 7.11

USA 4.67 12.46 13.78

Canada 0.81 1.98 2.25

2) HK& Macao Chinese 10.33 17.21 17.62

3) Overseas Chinese 1.88 4.64 4.76

Average Number of Tourists visiting Shanghai everyday 2447 4539 4970

Average Days Tourists stay in Shanghai (days/person) 2.83 3.77 3.92

(Source: Statistical Yearbook of Shanghai, Shanghai Municipal Statistics Bureau. Electronic Edition, 2000) 

While the increase in tourism may help foreign restaurants, many tourists come to a foreign culture to experience, to varying degrees, the new, exotic things including food that they find. Many tourists will not come to Shanghai to eat what they can have at home. Local Chinese restaurants are a competitive force in attracting overseas tourists. While the tourist market will support international franchisors, it would be unwise to target this group exclusively.

Expatriates, however, provide a substantial and growing customer base for foreign restaurants. Foreign investment continues to grow. Since China began allowing foreign direct investment, nearly 30,000 foreign investment projects have been initiated, nearly 2,400 of those in the year 2000 alone. This suggests that the expatriate population in China will continue to grow, offering an attractive market for international franchisers.

Business People and Young Professionals

Business people and young professionals include college-educated professionals between the ages of 25-50. This segment is likely to be more receptive to foreign ideas, possess sufficient discretionary income to at least occasionally visit relatively expensive restaurants, and to value the experience that a foreign restaurant might provide.

The Statistical Yearbook of Shanghai 2000 provides interesting insight as the growth and potential of this group, particularly in terms of their increased buying power. In 1990 only 51 families out of a survey of 500 (10%) reported a household disposable income over 2000 yuan (about $240). Ten years later, 100% of the 500 families surveyed reported a household disposable income over 2000 yuan, and more than 50% reported household disposable income above 10,000 yuan (about $1,210). This clearly suggests that there is a large and growing potential market for the international franchisor

Young Emperors 

Young Emperors include preschool children as well as students in all educational institutions from primary schools to colleges and universities. The registered number of children in one-child families in Shanghai is estimated at 1.246 million, slightly less than one tenth of the Shanghai population.

Two unique forces have combined to suggest that the Young Emperor market may be very attractive to international franchisors. First, because of Chinese government policy, most families have only one child. While this practice has curbed population growth, it has also changed the family dynamics. Children in China command the attention of their entire extended family and this can have substantial influence on family purchasing behavior. Foreign franchises are new and expensive, creating a feeling of exclusivity. If foreign restaurants, like KFC, can appeal to children, one child can take two parents, as well as extended family members, with him or her. McDonalds has

successfully used this strategy in the United States for decades; using Ronald McDonald, providing birthday parties, soft-play playgrounds, happy meals, etc. to target children, who must then influence their parents.

Quick service foreign restaurants have also become a popular outing for students and young couples. Because of the forces of globalization, the young generation across China and the world is increasingly exposed to foreign concepts and global brands through the media, advertising, the Internet, and travel. This generation is less constrained by tradition, and is more likely to try new things. Even with limited resources, students and young couples want to dine in a clean and culturally different environment.

CONCLUSIONS AND DISCUSSIONS

Shanghai is a market that offers substantial promise for international franchisors. Favorable economic, social and political conditions, as well as a large and increasingly affluent population, support this view. Franchisors that pass up the opportunity to enter Shanghai now will face more intense competition in the future. In addition to being an attractive market in its own right, Shanghai represents a logical market entry point for those firms that seek to exploit opportunities throughout China in the coming decades. Gaining experience in the relatively affluent and favorably predisposed Shanghai market will provide franchisors with valuable experience as well as a strategic springboard to other substantial Chinese markets.

Despite the great potential, doing business in China, and in Shanghai, is difficult and onerous for many companies, evident by the many failures of multinational companies. The language and culture are remarkably distinct. Franchisors should, thus, 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 help facilitate the success of the franchisor.

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