Question

MGMT 440-03: INTERNATIONAL MANAGEMENT

[Assignment to Replace the Group Project]

Case: Subway’s Franchising Challenges in China

Subway, the sandwich and salad fast-food chain, operates the largest number of restaurants worldwide—more 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. Subway’s 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 didn’t believe the tuna salad was made from fish because they could not see the head or tail. Others didn’t 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.

Subway—or 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. China’s 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 win–win 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

China’s 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 China’s legal system closely regarding contracts and intellectual property rights. China’s 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. McDonald’s 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. Subway’s 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 world’s 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. McDonald’s 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 Friday’s 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 Subway’s 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 Bryant’s 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.

Answer 1

Q1.1. What are the specific threats to subway’s intellectual property in china?

The threats to the intellectual property in china are due to ambiguous legal environment, and underdeveloped legal system that does not avoid loopholes. These factors threaten intellectual property of Subway Company. It is found that franchisor needs to be aware of different connotations related to franchise business in china because some of critical elements are not included by Chinese law. Therefore, franchisors also have to protect trademark. It is found that a local company in china can easily imitate the logo of the Subway Company. Branding in franchisee business has a significant role to play as it creates awareness regarding products and services offered by the company. But imitation of branding not only threatens the intellectual property right of Subway Company, but also confuses the customers. Many Chinese imitators already are already similar logo that Subway Company uses.

Q1.2. What can subway do to protect its intellectual property in china?

Until the government legal system is improved and addresses the loopholes in china, it is difficult for the Subway Company to protect its intellectual property in a legal way. But there are other ways through which the company can protect its intellectual property. It needs to strengthen its logistical infrastructure to penetrate into the Chinese market. It is similar with the approach of McDonald Company that establishes a successful supply chain network in china. Subway Company should invest money to build a robust distribution network with the help of suppliers. With strong distribution network, the logo of Subway Company will be familiar to the Chinese people and imitators will be discouraged to use similar logo. It can also provide a distinct image of Subway Company. To increase the franchisees numbers in china, the company should use the benefits of credit being offered by banks now in china. It should also provide complete training to the franchises to run the business. Another crucial aspect to consider by company is selection of location. The company should locate its business in malls and shopping centers. The next thing the business should do is to develop local cuisine and tastes for Chinese people. While developing local tastes in products, the company can attract more eyeballs and in turn, people may engage in viral marketing. This can also provide a distinct image for the company’s logo. Another good strategy to promote the business in china is setting franchises in Hong Kong that can provide a good idea of doing business in mainland china. These strategies employed by the Subway Company can protect the business logo and intellectual property rights in china.

Q2.1 what are the advantages and disadvantages of franchising in china from Jim Bryant’s perspective?

According to Jim Bryant’s perspective, advantages of franchising in china are huge and growing market, long term growth opportunity, and increase in disposable income of Chinese people, and supporting socio-cultural factors. It is found that urban population of china prefers to go for casual dining. Chinese prefer to eat outside and this gives a very good opportunity for Subway Company. Starting franchisee business in china is relatively easy because most of Chinese people are willing to start their own business. Another benefit to open franchisee business in china is initial cost borne by Chinese entrepreneur as the Subway Company receives $10000 initial fee from Chinese entrepreneurs and one third of 8 percent royalty fee. Brand consistency can also be acquired by franchisee business as the Chinese franchisees have to follow the Subway policies and procedures. Next advantage of opening franchisee in the china is avoiding legal constraints in FDI and exporting. Thus, there are many benefits that Jim Bryant receives while running business in china. The disadvantages are knowledge gap due to limited knowledge of Chinese people regarding starting and operating a franchisee business, ambiguous law terms related to franchisee business, cultural and linguistic barriers, unavailability of right partners, issue of repatriation of profit to the home country, and unavailability of proper locations to provide franchisees.

Q2.2. What can Bryant do to overcome the disadvantages?

Bryant should provide sufficient training to the franchisee’s owners to assist them to understand pros and cons of running a franchisees business and how to avoid the issues associated with running business in china. Bryant should also develop local tastes in the products and hire local people to run the franchisee business. He should use local language to advertise the business. Bryant should also assist franchisees owners to run the business in malls and shopping centers. To avoid the issues of repatriation of profit, Bryant should reinvest the profit in china. It can also protect the business against the fluctuation in exchange rate. Bryant should also make aware of credit giving banks regarding the franchisees business in china and its potential to help entrepreneurs in obtaining fund from banks. These efforts take by Bryant can surely mitigate disadvantages of franchising in china.