Once a friend of mine visited Shanghai and asked me to recommend some quick restaurants. After listing a few options, I realized that he was not interested in them as he just wanted to find a simple restaurant providing real Shanghai cuisine. It dawned on me that, we were surrounded by national and international franchised stores with standardized products and services which often provide little local flavor. Franchising is ubiquitous in China, and not just the fast food chains.

 By Cecilia Lou, Partner at King & Wood’s Intellectual Property Group


I. Franchising Trends in China

A. Trend 1: Franchising of Services Derived from Product Trademarks

Generally, franchising is a complete and compact business model that focuses in one particular limited industry area. For example, "Ten Fu’ s Tea," is a tea shop where people may taste tea before they buy, but it is not a tea house with tea tasting “services". In franchising, very few companies mix product trademarks with service marks. Mostly, companies prefer to distinguish between the two, for example, IBM was mainly a computing brand, but its after-sale service brand is "Blue Express."

However, franchising in China recently saw the development of a new trend which extends the product trademark to the service sector. In other words, franchising may extend from the manufacturing industry to the service industry. For example, Shanghai Jahwa’s mark "HERBORIST" is a trademark for high-end cosmetics that can only be bought in company-owned stores. This limitation on the brand is a clear message to consumers that only company-owned shops sell that product line, and any other channel where the product line is available is not officially authorized. By doing so, the company greatly reduces the possibility of its products being counterfeited and crosses from the manufacturing phase to the retail phase. Moreover, it ensures the quality of the product line, and that the brand will always be connected with "high-end" products. Once this brand acquired market recognition, Shanghai Jahwa opened the "HERBORIST SPA" salons through franchising, which extends the brand from a product brand to a service brand as well.

B. Trend 2: Franchisees dissatisfaction with dependency

In order to maintain quality, franchisors often intervene into operations of the franchisees and take strict control of the franchisees’ management. The franchisors often set various restrictive provisions in their franchising agreement and franchisees are often controlled or restricted by the franchise agreements with respect to branding activities, management models, supplies and so on, and must give up control in strategic decisions. For example, franchisees do not have flexibility to adjust its operational model to suit local customers’ needs. As a result, although a franchisee is legally an independent owner, it is in fact a subordinate of the franchisor. As the franchisee improves over time, it becomes obvious that the franchisees will feel uncomfortable with their obligations on payment of royalties, advertising fees, and training fees to the franchisor.

During the current economic downturn, when a company wishes to expand, the first and foremost issue is looking for capital. Many multinational companies have since decided to expand into the Chinese market. Under such circumstances, multinational corporations often try to work with strong local Chinese companies under franchising arrangements. However, a franchisee who only obtained territorial authorization is often dissatisfied with its subordinate position. This is particularly apparent if the franchisor has to rely on a franchisee’ s financial support and distribution networks. The franchisee will then desire a stronger position which may lead to future conflict.

This situation is more likely during the current financial crisis as more franchisors need to rely on the franchisees’ financial support. This new imbalance may cause a franchisee to gradually deviate from the franchisor’s control, the unified management standards, and quality requirements. The faster a franchisor expands his franchising businesses, the bigger a franchising territory is, the harder for the franchisor to control franchisees. Any deviation from the spirit of franchising will ultimately damage the franchised brand, and result in losing its market completely.

As this series continues, we will examine how franchisees exert influence on franchisors and provide suggestions for franchisors to maintain control.