Question:-What are the main governance issues in the case, Explain?

The Coldwell Opportunity

By 1999, SinYi had decided to re-evaluate its Chinese operations. The company could continue to grow its company-owned branches, a strategy that offered the advantage of allowing carefully control over the implementation of SinYi's philosophy and the establishment of its own brand on the mainland. However, growth in the number of company-operated branches was slow, and employee turnover was much higher than that experienced in Taiwan. This slow growth and the expansion activities of very aggressive competitors meant that SinYi experienced a significant decline in market share.

Faced with these growth challenges, in 1999, SinYi decided to form an alliance with Coldwell Banker. Under this arrangement, Sinyi took on the Coldwell Banker master franchise in China, with a term of 40 years. The cost to Sinyi for this master franchise was NT$105,472,000 paid up front. In addition, SinYi was obliged to pay annually 9 per cent of the revenues collected from franchise stores for the first 10 years and 7 per cent for the remaining life of the contract. All franchised stores would be dual-branded (i.e., bearing both the Coldwell and the SinYi name).

Franchisees were required to pay the franchisor an up-front fee of RMB30,000 to obtain the franchise for a store as well as an annual fee of RMB3,000. Franchisees were to pay all their own costs of setting up and operating the franchise stores.

This new contract enabled SinYi to introduce Coldwell Banker's famous brand and operating resources directly into China's local market. Although Coldwell Banker had not previously established itself in China, it was apparent that Chinese consumers (and especially offshore companies) favoured dealing with international companies with an established reputation, and there was a large market for rentals among foreigners. According to the deal, SinYi was responsible for selling the franchises, marketing the brand, training the franchise owners (but not the salesmen), setting the operating rules, and instigating all communication.

This franchising arrangement was expected to allow the company to grow faster since it freed SinYi from the constraint of internally trained human resources. Furthermore, as a master franchisor, SinYi could decide where the franchises would be located, thus protecting its own standalone operations. Having such a large number of branches offered a variety of economies of scale as well as the opportunity to offer a broader range of services; however, it had the disadvantage of having to share the branding of the franchised units with Coldwell Banker, which meant that SinYi would not be able to follow its usual approach of promotion from within accompanied by rigorous (albeit time-consuming) training.

Renegotiating the Coldwell Deal

By 2007, SinYi had 70 directly owned branches and 90 franchised branches in mainland China in cities such as Shanghai, Beijing, Suzhou, Chongqing, and Hangchow; however, the growth of SinYi in China was still relatively slow compared to that of its competitors, and Chou was considering renegotiating the arrangement with Coldwell Banker.³

On the one hand, management felt that the relatively slow growth of franchised stores and company stores was due to the fact that the same brand was being used for both the 100-per-cent-owned branches and the franchised stores, which made it difficult for customers to distinguish between the two entities. On the other hand, if the Coldwell and SinYi brands were clearly separated, it was felt that customers with different preferences could be attracted to each operation, thus increasing the sales of both.

With the foregoing in mind, SinYi contemplated transferring the Coldwell master franchise to a new company called Coldwell Shanghai (95 per cent owned by SinYi and 5 per cent owned by Coldwell Banker). All franchised stores would use the Coldwell Banker brand, in Chinese and in English. All SinYi's 100-per-cent-owned branches would use only the SinYi brand in Chinese and English. This arrangement was expected to help customers in distinguishing the company-owned branches from the franchised stores. It would also help SinYi to foster its namesake brand. As a result of this new arrangement, SinYi expected to open 100 new franchised stores in the next year and about 200 new stores each year from then on. Hence, the incremental number of stores in the first year was 90 and, in subsequent years, 190.

SinYi's initial investment in Coldwell Shanghai was estimated to be NT$15,995,000 (RMB$6,161,000).⁴ In addition, the contract for annual payments to Coldwell was modified in that the new contract had an additional requirement that SinYi would have to meet annual "minimum" payment obligations as follows: NT$3,903,000 in 2009, NT$4,198,000 in 2010, NT$5,346,000 in 2011. Thereafter, the minimum payment would be the same as the amount in 2011, but it would be adjusted to meet the consumer price index.⁵ Thus, SinYi was required to pay the greater of two amounts: (1) a percentage of revenues (9 per cent for the first 10 years and 7 per cent thereafter) or (2) the minimum payment. Further, the annual costs of running the head office of Coldwell Shanghai needed to be factored into the equation.⁶ From each franchise store, SinYi asked for an initial franchise fee of RMB30,000 and an annual fee of RMB3,000. The average duration of a franchise contract was three to five years.

In making the decision, Chou took note of the profitability of SinYi's 100-per-cent-owned branches. The upfront investment in a new standalone SinYi branch (including facilities, training, initial advertising and so on) was around RMB 310,000. Exhibit 5 provides the subsequent yearly cash flows for a typical 100- per-cent-owned branch.

To assist in the analysis, SinYi also obtained certain information about Taiwan's capital market (see Exhibit 6).⁷ It was expected that the internally generated cash flows would be more than enough to support the company's expansion in China, and no borrowing would be necessary.

Although a public company should engage in strategies that will enhance shareholder value, Chou was also a strong believer that a company should behave in a socially responsible fashion toward its customers, its employees, and towards the public at large, and he wondered whether the franchising model would allow him to pursue those important goals. The franchisee would be an independent businessman, and for this reason, it would be more difficult to impose SinYi's standards on the operations. Moreover, the franchisees were likely to be situated at rather remote locations from Shanghai. It was clear that the franchisees' service levels would be much lower than those in a SinYi branch, and the compensation system would be much more incentive based as well.