BEIJING — McDonald’s is
planning to expand franchising in China’s biggest cities, such as
Shanghai and Shenzhen, for the first time since its entry into the
country.
Since its founding in 1955, McDonald’s has relied on
its franchisees to play a major role in the company’s global success.
Franchisees account for 80% of the 30,000 McDonald’s restaurants in 120 countries all over the world, and they create more than 70% of the fast food giant’s profits.
Unfortunately, this model has not been successfully
replicated in the Chinese market. When McDonald’s first entered China in
1990, it chose to operate its own restaurants, judging that its high
operating costs wouldn’t give franchisees much of a profit margin and
that China also had few regulations about franchising.
The company began seriously recruiting franchise
partners in certain provinces of China in 2010, but
McDonald’s franchises account for less than 5% of all its outlets China,
and they are mostly located in smaller cities.
Now McDonald’s plans to change the
situation. It hopes to double the number of its Chinese restaurants — to
more than 4,000 stores — in the next three years. “Developing the
franchise business will become an important factor for achieving rapid
growth in China for our company in the years to come,” one of its senior
executives says.
It is interesting to compare McDonald’s strategy with rival Kentucky Fried Chicken (KFC). “Compared with McDonald’s, KFC is a lot more open in this aspect,” says
Kang Jianhua, a researcher who follows hotels and
catering at CIConsulting. “Not only has KFC extended its regions
allowing franchising, it has also lowered the entry threshold in certain
regions so as to boost the retailer’s number of franchisees. Increasing
the franchisees is KFC’s important tactic in raising competitiveness.”
From 1990 to 2010, the number of McDonald’s
restaurants in China grew at an annual pace of 17% — far lower
than in certain other Asian-Pacific markets such as Japan. But by 2013,
China had become the company’s third-largest market in the world.
McDonald's Chinese New Year set meal — Photo: HenryLi
Though McDonald’s restaurants outnumber KFCs globally,
the latter has more stores in the Chinese market, with nearly 5,000
outlets. Even Dicos, a local chain offering Western-style food in 2,000
stores, outnumbers the American giant.
Supersize it
“Size advantage plays an important role for chain
store operation,” says Li Weihua, a franchising expert and professor at
China University of Political Science and Law. “In a competition the
value of the number of stores is not to be underestimated.” In Li’s
view, McDonald’s is under enormous pressure to be more competitive in China.
Much of this pressure comes from McDonald’s itself.
The company’s global income comprises three parts — earnings of its
direct sales stores, service fees from franchisees, and the real estate
operating income (property rental payments from franchisees). The latter
two revenue streams are particularly crucial.
In 2012, as the company’s annual report showed, the
franchisees had a $7.4 billion gross profit, more than twice the $3.4
billion of direct sale stores. Meanwhile, of the $8.9 billion of the
franchisees’ turnover, $5.8 billion came from rentals.
“People usually think that we sell hamburgers.
But in fact we are a real estate dealer,” the fast food empire’s
founder Ray Kroc once said. That’s the secret to the company’s long
success. Through long-term leasing or by purchasing land and then
building, the retailer sublets the stores to the franchisees to help
generate profits.
But this profit model didn’t work for McDonald’s in
China. Because of China’s restrictions on land purchases and buildings
with foreign funds, the food giant owns less than 10% of the properties
its stores operate in China. In the United States and Europe, this
figure is around 60%.
At the same time, rental costs in China’s first- and
second-tier cities are rising sharply. Most McDonald’s stores are
located in bustling commercial districts, and most of them have signed a
lease for 10 or 20 years. Because many of these stores’ leases are
about to expire, McDonald’s will be hit with soaring rental costs.
In Kang Jianhua’s opinion, expanding franchises will reduce pressure on the company in terms of rental costs and create more reveune with franchise fees.
Of course, challenges will follow too. The first
question is whether McDonald’s current management and overall
operational capability in China are strong enough to support the
franchising expansion. After all, the food giant’s development in China hasn’t been all that smooth, and China is still a less-than-ideal legal environment for franchising.
McDonalds can be profitable in China but I believe it is focusing on the wrong key factors. From my knowledge, in order for foreign investment to be done in China, the business needs to be done as a joint venture. If McDonald's were to create a joint venture contract with a Chinese company to acquire their real estates then McDonalds can continue to charge real estate fees to their franchisees. But I believe that is not the only thing McDonald's needs to look into. If McDonald's were to compete with KFC in China they would need to understand that they are going to either reeducate their target market or they are going to have to introduce more chicken products into their menus. McDonald's in the US is known for their beef burgers. Well in the China it doesn't work that way, the Chinese population is used to eating white meat, fewer than red. In order for McDonald's to change all of that they would have to spend a lot of money and time in order to sell franchisees a more legitimate profitable business.
ReplyDeleteChina is slowly evolving into a very attractive destination for franchising. Since McDonald’s franchisees had a $7.4 billion gross profit, compared to their direct sale stores that reported around $3.4 billion, for McDonald’s, franchising will be a very important factor for achieving significant growth in China. This supports the idea that franchisee operated stores generally do better because of the mutual incentive between franchisees and their franchisors to excel in order to generate more profit for both sides. Additionally, since most of the McDonald’s revenues come from rentals, expanding franchises is expected to reduce the pressure for the company in total rental costs and, at the same time, creating more revenue. At the moment there are attractive opportunities for franchising in China, and those include: an expanding consumer class, western franchises bring a new and modern business system, franchising laws are becoming more clear, and second and third tier cities in China are now open for franchising. Signs indicate that franchising will become easier in China in few years to come.
ReplyDeleteChina is slowly evolving into a very attractive destination for franchising. Since McDonald’s franchisees had a $7.4 billion gross profit, compared to their direct sale stores that reported around $3.4 billion, for McDonald’s, franchising will be a very important factor for achieving significant growth in China. This supports the idea that franchisee operated stores generally do better because of the mutual incentive between franchisees and their franchisors to excel in order to generate more profit for both sides. Additionally, since most of the McDonald’s revenues come from rentals, expanding franchises is expected to reduce the pressure for the company in total rental costs and, at the same time, creating more revenue. At the moment there are attractive opportunities for franchising in China, and those include: an expanding consumer class, western franchises bring a new and modern business system, franchising laws are becoming more clear, and lastly, second and third tier cities in China are now open for franchising. Signs indicate that franchising will become easier in China in few years to come.
ReplyDeleteIn the book "Rich Dad, Poor Dad", I remember reading one of the most interesting lines I’ve ever read. It quoted the founder of McDonald’s asking a graduating student what did he think his business was all about. The student confidently answered “burgers”, while the founder smiled and said “wrong.” He said his business was all about Real Estate. Now, I found this post interesting, because China’s legislations and regulations go against the founder’s principles. In countries such as Europe and the U.S., more than half of the franchisees turnover comes from rentals, whereas in China this is not the case. China has restrictions on land purchases and buildings with foreign funds, causing McDonalds to own less than 10% of the properties its stores operate. Therefore, China’s undeveloped franchising legal environment might not be the best target for the company until it opens its barriers for foreign business models such as franchising.
ReplyDelete