MGMT 440-03: INTERNATIONAL MANAGEMENT

[Assignment to Replace the Group Project]

Case: Subways Franchising Challenges in China

Subway, the sandwich and salad fast-food chain, operates the largest number of restaurants worldwidemore than 44,000 stores in 110 countries. Subway generates more than $19 billion in annual revenues and has more than 25 million Facebook fans.

The franchising chain opened its first international restaurant in Bahrain in 1984. Since then, Subway (www.subway.com) has expanded worldwide and generates about one-fifth of its annual revenues internationally. The firm expects foreign markets to contribute much of its future growth.

Subway is one of the most successful fast-food chains in China. Fish and tuna salad sandwiches are the top sellers. By 2006, Subway had opened about 40 stores in China. The franchise had its share of initial setbacks. Subways master franchisee in Beijing, Jim Bryant, lost money to a scheming partner and had to teach the franchising concept to a country that had never heard of it. Until recently, there was no word in Chinese for franchise.

Cultural problems are still an ongoing challenge. After Bryant opened his first Subway shop, customers stood outside and watched for a few days. When they finally tried to buy a sandwich, many were confused so Bryant printed signs explaining how to order. Some didnt believe the tuna salad was made from fish because they could not see the head or tail. Others didnt like the idea of touching their food, so they would gradually peel off the paper wrapping and eat the sandwich like a banana. To make matters worse, few customers liked sandwiches. Subway has had to create menu items that suit local tastes, such as Roasted Duck Sub.

Subwayor Sai Bei Wei (Mandarin for tastes better than others)has forged ahead. Bryant has recruited numerous committed franchisees that he monitors closely to maintain quality. He recruited local entrepreneurs, trained them to become franchisees, and served as liaison between them and Subway headquarters. For this work, he received half of their $10,000 initial fee and one-third of their 8 percent royalty fees. Today, there are about 500 Subway stores in China.

Other multinational franchisors still face significant challenges in China, particularly in dealing with the ambiguous legal environment, finding appropriate partners, and identifying the most suitable marketing, financing, and logistics strategies. Famous brands such as A&W, Dunkin Donuts, and Rainforest Cafe have all experienced these issues.

Why China for Franchising?

Franchising is an advanced form of licensing. On the surface, franchising in China is attractive because of its huge market, long-term growth potential, and dramatic rise in disposable income among its rapidly expanding urban population. Fast-food sales in China are around $150 billion per year. Chinas urban population, the target market for casual dining has expanded rapidly, a trend expected to continue. Increasingly hectic lifestyles have led to an increase in meals the Chinese eat outside the home. Surveys reveal that Chinese consumers are interested in sampling non-Chinese foods.

Market researchers have identified several major benefits to franchising in China.

• A winwin proposition. Franchising in China combines the Western expertise of franchisors with the local market knowledge of franchisees. Many Chinese have strong entrepreneurial instincts and are eager to launch their own businesses.
• Minimal entry costs. Because much of the cost of launching a restaurant is borne by local entrepreneurs, franchising minimizes the costs to franchisors of entering the market.
• Rapid expansion. By leveraging the resources of numerous local entrepreneurs, the franchisor can get set up quickly. Franchising is superior to other entry strategies for rapidly establishing many outlets throughout any new market.
• Brand consistency. Because franchisors are required to adhere strictly to company operating procedures and policies, brand consistency is easier to maintain.
• Circumvention of legal constraints. Franchising allows the focal firm to avoid trade barriers associated with exporting and FDI, common in China.

Challenges of Franchising in China

Chinas market also poses many challenges for franchisors.

• Knowledge gap Despite the likely pool of potential franchisees, Chinese entrepreneurs may have limited knowledge about how to start and operate a franchise business. There is still much confusion about franchising among lawmakers, entrepreneurs, and consumers. Focal firms must educate government officials, potential franchisees, and creditors on the basics of franchising, a process that consumes energy, time, and money.
• Ambiguous legal environment Franchisors need to examine Chinas legal system closely regarding contracts and intellectual property rights. Chinas legal system on franchising is evolving and has loopholes and ambiguities. Some critical elements are not covered. The situation has led to diverse interpretations of the legality of franchising in China. Franchisors must be vigilant about protecting trademarks. A local imitator can quickly dilute or damage a trademark a focal firm has built up through much expense and effort. Branding is important to franchising success, but consumers become confused if several similar brands are present. Chinese imitators have launched restaurants that use similar logos and menus and even accept coupons from Subway when consumers mix up the two stores.
• Escalating start-up costs Ordinarily, entry through franchising is cost effective. However, various challenges, combined with linguistic and cultural barriers, can increase the up-front investment and resource demands of new entrants in China and delay profitability. The franchisor may have to invest in store equipment and lease it to the franchisee, at least until the franchisee can afford to buy it. Franchisors must be patient. McDonalds has been in China since the early 1990s and has devoted substantial resources to building its brand, but few firms have its resources.

Perhaps the biggest challenge of launching franchises in China is finding the right partners. It is paradoxical that entrepreneurs with the capital to start a restaurant often lack the franchising business experience or entrepreneurial drive, whereas entrepreneurs with sufficient drive and expertise often lack the start-up capital. Subways franchise fee of $10,000 is equivalent to two years salary for the average Chinese. The banking system in China is still developing. Capital sources for small businesses are limited. Entrepreneurs often borrow funds from family members and friends to launch business ventures. Fortunately, Chinese banks are increasingly open to franchising. The Bank of China established a comprehensive credit line of $12 million for Kodak franchisees.

Availability and financing of suitable real estate are major considerations as well, particularly for initial showcase stores where location is critical. According to established Chinese law, local and foreign investors are allowed to develop, use, and administer real estate. But in many cases, the Chinese government owns real estate that is not available for individuals to purchase. Private property laws are underdeveloped, and franchisees occasionally risk eviction. Fortunately, a growing number of malls and shopping centers are good locations for franchised restaurants.

The Chinese authorities maintain restrictions on the repatriation of profits to the home country. Strict rules discourage repatriation of the initial investment, making this capital illiquid. To avoid this problem, firms make initial capital investments in stages to minimize the risk of not being able to withdraw overinvested funds. Fortunately, China is gradually relaxing its restrictions, and franchisors have been reinvesting their profits back into China to continue to fund the growth of their operations. Reinvesting profits also provides a natural hedge against exchange rate fluctuations.

Learning from the Success of Others

Experience has shown that new entrants to China often benefit from establishing a presence in Hong Kong and then moving inland to the southern provinces. Before it was absorbed by mainland China, Hong Kong was one of the worlds leading capitalist economies. It is an excellent pro-business location to gain experience for doing business in China. In other cases, franchisors have launched stores in smaller Chinese cities, gaining experience there before expanding into more costly, competitive urban environments such as Beijing and Shanghai.

Franchisors typically must adapt offerings to suit local tastes. Appropriate suppliers and business infrastructure are often lacking. Franchisors spend much money to develop supplier and distribution networks. They also may need to build logistical infrastructure to move inputs from suppliers to individual stores. McDonalds has replicated its supply chain, bringing its key suppliers, such as potato supplier Simplot, to China. There is no one best approach in China. For instance, TGI Fridays imports roughly three-quarters of its food supplies, which helps maintain quality, but heavy importing is expensive and exposes profitability to exchange rate fluctuations.

Assignment Questions:

1. Subway brings to China various intellectual property in the form of trademarks, patents, and an entire business system.

1.1. What are the specific threats to Subways intellectual property in China? (20 points)

1.2. What can Subway do to protect its intellectual property in China? (20 points)

2. Franchising has both advantages and disadvantages.

2.1. What are the advantages and disadvantages of franchising in China from Jim Bryants perspective? (25 points)

2.2. What can Bryant do to overcome the disadvantages? (25 points)

4. Grammar, spelling, and organization (10 points).

Grading Criteria:

1. Clarity and specificity of arguments. You should clearly answer whether Rob Parson should be promoted or not.

2. Soundness of arguments presented.

3. Quality of writing.

4. Grammar and spelling.

NOTE #2: DUE DATE: APRIL 17, 2020.