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Franchising In China

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1.0 Introduction

The catering industry in China is booming. In this report, we aim to enable the readers to gain a better understanding of some of the factors that the authors believe to have significantly contributed to the success of fast food catering industry in China.

The report will first look into ChinaÐŽ¦s socioeconomic and legal environment, and explain how each of the factors within the two categories have procured the success of the catering industry. Two case studies will then be introduced to illustrate how a domestic brand and an international brand have achieved success in the Chinese market.

2.0 Socioeconomic Environment

It has been long recognized that food is vital to human survival. When the household income is low, expenditure on food will, without doubt, take up a significant portion of a familyÐŽ¦s income. As income rises and people are better fed, a familyÐŽ¦s spending focus will slowly shift from food to other areas.

In order to determine the poverty or surplus level of a population, EngelÐŽ¦s Law was developed to address the above mentioned phenomenon, with Engel coefficient commonly being used to measure the living standard of a population from a given country or region.

2.1 EngelÐŽ¦s Law

Engel's Law is the observed phenomenon that when a familyÐŽ¦s income increases, the proportion of money they spend on food decreases. Engel had discovered, based on surveys of families' budgets and expenditure patterns, that the income elasticity of demand for food was relatively low. With rising incomes, the share of expenditures for food declines. The resulting shift in expenditures affects demand patterns and hence the employment structures .

However, Engel was not suggesting that the consumption of food product remains unchanged as income increase. Instead, he is stating that the proportion of income spent on food falls, even if actual expenditure on food rises

The EngelÐŽ¦s Law can be expressed in a mathematical expression as follow:

Equation 1: Relationship between Income and the Engel Coefficient

2.2 Engel Coefficient

Engel coefficient measures the proportion of food expenditure in consumer expenditure.

Equation 2: The mathematical expression of the Engel Coefficient

According to the EngelÐŽ¦s Law, the closer a family is to poverty, the larger its Engel coefficient, vice versa. According to the Food and Agriculture Organization (FAO), the Engel coefficient can be interpreted as follow:

Engel Coefficient Range Family/ PopulationÐŽ¦s Living Standard

Engel Coefficient ≥ 59% Poverty

59% ≥ Engel Coefficient ≥ 50% Adequately fed and clothed

Engel Coefficient ≤ 50% Able to afford beyond the basics

Table 1: FAO Standard for Engel Coefficient

2.3 How are People in China Doing?

The two graphs below are generated based on data obtained from China Statistical Year Book 2003.

Figure 1: Net Annual Income and Engel Coefficient of Rural China from 1989 to 2002 inclusive

Figure 2: Net Annual Income and Engel Coefficient of Urban China from 1989 to 2002 inclusive

In the rural area of China, the Engel coefficient dropped under 50 between 1999 and 2000, while the Engel coefficient of the urban area reached the milestone between 1995 and 1996. This observation helped to explain the success of Xiaofeiyang (Little Fat Sheep) and Yum! Brands, Inc - China Division (Yum!) through adversely different business tactics.

Little Fat Sheep started its very first store at Baotou (Inner Mongolia) in 1999 which coincided with the time when people became started to become well-off. Their living standards had improved to a point where they started to look for better alternatives beyond the basics. While this did not procure Little Fat SheepÐŽ¦s success, it provided a favourable environment with availability of potential consumer base.

Yum! on the other hand, due to its earlier existence in China since 1987, diffusing into the Chinese market via the major cities was indeed a more appropriate strategy. In the early 90s, until 1995, the Engel coefficient of rural China was above 58%, indicating that the household is relatively close to poverty. Introduction of fast food restaurant at that stage to the rural area is a lot riskier due to the unfavourable market environment, apart from the logistic, hygiene, management and human-resources issue.

2.4 Consumer Price Index and Savings Rate

Due to ChinaÐŽ¦s relatively confined investment environment especially in the mid 90ÐŽ¦s before the existence of stock market, the growth in savings is a relatively good indicator of the financial well-being of people in the market. The wealthier the people, the higher the consuming power.

Figure 3: Savings & Average Consumer Price Index vs Times

Based on the date obtained from Statistic China, both the fixed and current deposit had recorded a steady increase from 1989 onwards. The slight slow down in the rate of increase for the current and fixed deposit beyond 1998 can be attributed to ChinaÐŽ¦s introduction of stock market in 1997, where people have an alternative way to manage their savings.

Note that the consumer price index (CPI) curve is recorded in comparison to the previous year. When the CPI of a given year is recorded to be above 100, it essentially means the price of the basket had inflated compared to the previous year. It is noticed that the CPI has been approximately 100 since 1998, indicating that the price of the same basket for measurement had not changed much over the years. Taking the CPI of 1998 equal to 100 (base year), the CPI of China in 2001 in calculated to be 109.22.

When CPI remained unchanged while people continue to accumulate more wealth in the form of savings, it

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