Hong Kong: Advantages and Practical Difficulties Associated with Franchising in the PRC

Last Updated: 26 September 1995
This article is intended to provide a general guide to the subject matter. Specific advice should be sought about individual circumstances. Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

Advantages

Franchising offers a foreign manufacturer or retailer an entry into the PRC consumer market without some of the difficulties associated with direct investment in a retail venture in the PRC. Some franchise operators in the PRC include Giordano, Benetton, Crocodile and Bossini and the French retailer Printemps is reportedly franchising its name and mark to a Hong Kong retailer in respect of a store which will be established in Shanghai.

The following are some advantages, commercial and legal, to franchising in the PRC:-

- permits the franchisor a relatively low cost entry into the PRC and fast expansion;

- lends a consistent image to the products;

- avoids the more difficult approval process required for retail joint ventures. Although the Foreign Investment in Retailing Provisions ("Retail Provisions") promulgated in 1992 sanction foreign participation in the retail sector in the PRC through retail joint ventures established with a PRC party, this requires approval by the State Council and the Ministry of Internal Trade. Such approval is still relatively difficult to obtain;

- avoids geographical constraints. The Retail Provisions allow retail joint ventures to be set up in only 11 cities and zones in the PRC, i.e. Beijing, Tianjing, Shanghai, Guangzhou, Dalian, Qingdao and the five special economic zones. These restrictions do not apply to franchising arrangements;

- avoids the 30% import limitation applicable to retail joint ventures. Under the Retail Provisions, retail joint ventures can import only up to 30% of the goods which it sells. This import limit does not apply to the product supply arrangement between franchisor and franchisee;

Practical difficulties

It is difficult to generalise the difficulties which a foreign franchisor may encounter with regard to franchising, or for that matter, other sorts of transactions in the PRC. However, the following concerns have been generally recurring problem areas.

1. Payment of royalities and fees in hard currency. A franchisor should not expect a high level of fee revenue in hard currency until the Renminbi becomes more effectively convertible. Placing a demanding hard currency requirement on the franchisee may not always be constructive - generally the franchisee's revenue is in Renminbi and therefore in order to balance its hard currency payment obligations to the franchisor, the franchisee's ability to import tied supplies from the franchisor to comply with agreed quality control standards may be impaired. Or else, the price of the products may be raised to accommodate the import requirements of the franchisee.

2. Imports. The main concerns to bear in mind here are:

(a) the tariffs barriers levied on imports;

(b) importing by the franchisee may also cause difficulties in the balancing of its hard currency flows and may raise the price of the product;

(c) the franchisee may not have direct import rights and may be required to import through a foreign trade corporation. The commissions charged by the foreign trade corporation (between 2 to 4 per cent. generally) may again raise the price of the products. See further the article headed "Import licensing in the PRC".

These concerns mean that, insofar as is possible, the franchisor should investigate channels of local sourcing in the PRC. However, the trade off may be in quality control.

3. Capacity of the PRC franchisee to contract with a foreign party or to retail. Care should be taken to examine the scope of the PRC franchisee's business capacity in its business registration licence - this should include the capacity of the PRC party to contract with a foreign party and to conduct retailing operations. Where the PRC franchisee does not have a general capacity to contract with foreign parties, a specific authorisation to enter into the franchise and licensing agreements must be obtained or the PRC franchisee must contract through a foreign trade corporation who will sign the agreement on behalf of the PRC franchisee.

Further information or advice may be obtained from Linklaters & Paines, Hong Kong office, 14th Floor, Alexandra House, Chater Road, Hong Kong; telephone: (852) 2842 4888; fax: (852) 2810 8133; contact David Mullarkey or Jeremy Parr.

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