Retail in China (I): Choosing your Business Model

Has the Chinese retail boom lured you to consider this market for your products? You are not alone. The rapid growth of the Chinese middle class is increasing this market’s attractiveness. AmCham 2010-2011 China Business Report shows Retail performs highest in all indicators analyzed in their survey (Success, Confidence, Welcoming).

I had been wanting to write a series about retailing in China so when I met Angela López Molina, corporate lawyer at DS AVOCATS in Shanghai, I thought she would be the right expert to contribute to a series of articles on the topic.

We will divide this topic into the following 3 posts:
Retail in China (I): Choosing your Business Model (Distributor/ Agent/ Franchise)
Retail in China (II): Choosing your Business Model (Corner/ Shop / Internet)
Retail in China (III): 10 Expert Tips to Help a Successful Set Up

(*Update: this series has now been completed. Links provided at the end of this article)

And today we will kick off with Retail in China (I): Choosing your Business Model 

1. DISTRIBUTORS & AGENTS:
Selling your products through distributors or agents is the “easiest” way to penetrate the Chinese market. It does not require a high investment and it allows assessment of the Chinese consumer’s reaction to your product.
It is not free of risks, though, as you may find yourself in the middle of a chaotic distribution network that is difficult to control.

a) Distributor vs Agent: Different Roles/Responsibilities
- Distributors buy and sell the products; their profit is the difference.
- Agents act in the name and on behalf of the foreign investor; they receive commissions on sales.
- Degree of trust: The agent generally enjoys a higher degree of independence and is able to change certain conditions without the explicit consent of the principal.

b) Tips on how to deal with agents/distributors in China
- Tip #1. Licences: Ensure your distributor/agent has the required licences to retail your products.
- Tip #2.  Exclusivity: Try to reduce the exclusivity territory (you may attach a map to the contract). Generally, exclusivity for all China is a bad idea.
- Tip #3. Establish sales targets and regulate your rights in case they are not met (e.g. termination or end of exclusivity).
- Tip #4. Commissions: describe clearly the calculation basis for commissions in the agency agreement.
- Tip #5IP Rights: Define the use of IP rights, promotion and publicity materials. Do not grant property on IP rights; grant instead a licence of use.
- Tip #6.  Termination: Reasons for termination are a key issue in distribution/agency contracts. Do not forget to regulate the consequences of such termination (e.g establish sale of stock to third parties / to the foreign investor, destroy / return the promotion materials, etc.).
- Tip #7. It is quite common for entrepreneurs and SMEs to initially “test the waters” with a distributor or an agent, and once they understand the market better and how their product works, they take it to the next level.

2. FRANCHISE:
a) Franchisors: Laws & Regulations
Under applicable laws and regulations, there are certain conditions imposed on franchisors in China:
- Legal form: Having a commercial company in China (JV or WFOE) or abroad. Individuals cannot establish a franchise in China.
- Previous experience: Having at least 2 own shops operated directly by the franchisor (in China or abroad), for  more than one year.
- Business model: Having a business model and the ability to render assistance and give instructions to the franchisee, as well as technical support, training and other services.
- IP rights: Having a trademark, patent or know-how (suggestion: register your IP in China).
- Registration of confidential business information: For every signed contract, franchisors must register with the competent authorities highly detailed (and usually confidential) information, such as: original franchise contract, marketing plan, franchisee manual, etc.

b) Franchisees: Some things you should know about their rights
Your Chinese franchisee has some rights that you should be well aware of:
- Your franchisee has the right to unilaterally terminate the contract without paying an indemnity if:
1) the franchisee claims that the information supplied is incomplete or untrue.
2) after a “reflection period” the franchisee decides to back out.

c) Tips on how to deal with your potential franchisee
- Tip #1. Make the franchisee sign a receipt acknowledging that the information received is complete.
- Tip #2. Clearly define in the contract how long this “reflection period” will last and try to make it as short as possible (i.e. within 1 day from the execution of the franchise contract).
- Tip #3. Enter a non-disclosure agreement (“NDA”), as you will be sharing all your business information.

d) China Franchise: Main issues
- Lack of payment by the franchisee is common; there is not a real franchise culture in China.
- Lack of confidentiality.
- Difficulty in controlling brand image.
- Legal uncertainty due to:
a) franchisee’s right to unilaterally terminate the contract.
b) reclassification risk: if, in order to avoid the disadvantages, the franchisor has established a distribution network that works as a franchise in practice, authorities may reclassify the legal relationship and impose a penalty (RMB10,000 to RMB500,000).

e) Recommendation
- If possible, enter the market initially managing your own stores, so that you can fully understand the market before you start granting franchises.

f) Conclusion
For obvious reasons, the franchise regime is very restrictive for franchisors and inevitably favours franchisees. As a result, some companies establish a distribution network that works de facto as a franchise. As we have pointed out, there is a risk of reclassification into franchise and the consequent sanction. In addition, in the new draft of the Catalogue for Foreign Investment (which regulates which are the encouraged, permitted, restricted and prohibited activities to be carried out by foreigners in China), the franchising business is now encouraged, which make us think that in the future the regime will be less restrictive and more favourable for foreign investors.

Would you like to share your retail experience?

Update: This series has now been completed. All the links shown bellow.

* Retail in China(I): Choosing your Business Model (Distributor, Agent, Franchise)
Retail in China (II): Choosing your Business Model (Corner, Shop Lease, Internet)
Retail in China (III): 10 Expert Tips to Help a Succesful Set Up

10 Reasons Why your Chinese Employee is Leaving You

I recently attended an event hosted by Servcorp Shanghai where Christian Groeger and Valourie Xuan, from Fiducia Management Consultants, delivered a presentation entitled “Winning the Talent War (in China) in 2011”.

High staff rotation is a big challenge for companies in China. Mr. Groeger approached the “talent war” drivers from both the employee and the employer’s perspective. Today I reproduce here Mr. Groeger’s insights about drivers and external influences from the employees perspective:

1. Problems with supervisors and leadership
This is a universal driver, which usually does not get that much attention because people are usually not that honest about their personal feelings. Interpersonal problems are easily compounded in intercultural (foreigner/local, returnee/local) settings.

2. Work-Life Imbalance
This issue is rapidly gaining importance, especially with younger employees – the  generation born in the 90’s or 90后 (jiu-ling-hou) as they are called in China. Members of this generation tend to be more self-conscious and have higher expectations about life than their parents generation.

3. Mounting expectations of one-child policy offspring to succeed
Single children have to deal not only with the expectations of their parents, but also their 4 grandparents and further. Often even the extended family contributes financially to the education and upbringing, creating a pyramid of expectations in turn.

4. Overestimation of own role/capabilities
Being used to be the centre of attention, many single children lack a realistic view of their capabilities.

5. Fast-track promotion and salary jumps available through job-hopping
Promotion and salary jumps of more than 20% (for middle management positions) provide a strong incentive to switch in an overheated HR market.

6. Pay inequality in the labour market (up to 300 percent difference in the same job category)
Differences in pay for the same job within the same industry, as well as across industries are 3-4 times more pronounced than in developed countries. This is because of huge gaps in the underlying productivity, as well as market standing of private Chinese companies, FIE’s and state monopolies.

7. Financial pressure for young families (housing, cost of education)
Married couples are expected to move into their own apartment, which puts especially young men looking for spouses under heavy pressure to buy property in order to receive approval by the spouse’s family.  As the cost of education soars, young families also start saving for schooling and university tuition at a reputable university or abroad.

8. Short-term focus and materialism
As young Chinese constantly engage in social benchmarking with their friends and student peers, short-term material gains sometimes count for more than long-term perspectives.

9. Group orientation (leaving together with other team members)
Often entire teams leave a company together with a manager out of stronger linkage to the person than to the company. In some industries this is becoming more customary as in hospitality, where Chefs are expected to bring along their own crew.

10. Increasing attractiveness of state-sector companies and institutions
A few years back, there was a distinctive group of individuals targeted by FIE’s and a different, more “local” group by private and state-owned enterprises. This distinction is gone, now all companies vie for the same pool of graduates and experienced staff.

Have you identified the same drivers?

…Coming soon, “Drivers of the Talent War. Employer’s Reasons