International Business Subway and the Challenges of Franchising in China

1. International Business Subway and the Challenges of Franchising in China Instructor: Asst. Prof. Dr. Senem Göl Ebru Huntalar Dolar Arda Arıcak Baran Esin Yeditepe University, MBA Programme, Spring 2010

2. SUBWAY • An American fast food franchise that primarily sells submarine sandwiches (subs), salads, and personal pizzas. • Owned and operated by Doctor's Associates, Inc. (DAI). DAI was founded by Fred De Luca and Peter Buck, Ph.D. in 1965, when they opened the first Subway restaurant.The term "Doctor's Associates" was chosen due to Peter Buck having a Ph.D. • One of the fastest growing franchises in the world with 32,781 restaurants in 91 countries and territories as of April 2010. • Produces more than US$9 billion in sales every year. • Largest single-brand restaurant chain globally and is the second largest restaurant operator globally after Yum! Brands

3. SUBWAY (cont.) • Main operations office is in Milford, Connecticut. Five regional centers support Subway's growing international operations (Europe: Amsterdam; Australia and New Zealand: Brisbane; The Middle East: Beirut; Asia: Singapore; Latin America: Miami). • Operates in many non-traditional locations in addition to traditional restaurants. For instance, there are over 900 Subway locations inside of Wal-Mart stores and 200 on military bases, including several in Iraq and Afghanistan, in addition to three located inside The Pentagon, as well as an increasing number on college and university campuses. In UK and Ireland some Subways are located inside Londis stores.

4. Subway’s Mission To provide the tools and knowledge to allow entrepreneurs to successfully compete in the QSR industry worldwide by consistently offering value to consumers through providing great-tasting food that is good for them and made the way they like it.

5. Subway’s Core Values and Philosophy • Committed to customer satisfaction through offering high quality food with exceptional service and good value. • Take great pride in serving each other, customers and communities. • Seek continuous improvement in all that Subway does. • Value a sense of urgency and emphasize an innovative, entrepreneurial approach to business. • Expect fairness and mutual respect in all activities. • Know Subway’s success depends upon the initiative taken individually and the ability to work as a team.

6. History • Fred De Luca borrowed $1,000 from family friend Peter Buck to start his first sandwich shop in 1965, when he was only 17 years old. He was trying to raise money to pay for college. He chose a mediocre location for his shop, the corner of East Main Street and Boston Avenue in Bridgeport, Connecticut, but by noon on opening day, customers were pouring in. On the radio advertisement they had promoted the name as Pete's Submarines, which sounded like "Pizza Marines", so they changed the name to "Pete's Subs"; eventually it adopted the "Subway" name and decorating the store with maps of the New York City subway system; a theme that continues to this day. • In 2007, Forbes magazine named De Luca number 242 of the 400 richest Americans with a net worth of $1.5 billion. • Subway restaurants have been consistently ranked in Entrepreneur Magazine's Top 500 Franchises, and was selected as the #2 overall franchise in 2008. Additionally, it was ranked as the #3 "Fastest Growing Franchise", and the #1 "Global Franchise" as well.

7. Subway in World • Opened its first international restaurant in Bahrain in 1984. • Generates about 1/5 of its annual revenues abroad. • Expects foreign markets to contribute to much of its future growth.

8. Location Opportunities Franchise fee $12,000 Start-up cost $69,300 to $191,000 Basic royalty8% Advertising royalty 3.5%

9. Subway’s Growth

10. China - Overview • Population - Over 1,300,000,000. 1st in the world. 1/5 of the world population. • Ethnic Groups - Han Chinese 91.5%, Zhuang, Manchu, Hui, Miao, Uyghur, Tujia, Yi, Mongol, Tibetan, Buyi, Dong, Yao, Korean, and other nationalities 8.5% (2000 census) • Religions - Officially atheist. There are Daoists (Taoist), Buddhists, Christians(3%-4%), Muslims(1%-2%). • Languages - Standard Chinese or Mandarin (Putonghua, based on the Beijing dialect), Yue (Cantonese), Wu (Shanghainese), Minbei (Fuzhou), Minnan (Hokkien-Taiwanese), Xiang, Gan, Hakka dialects, minority languages. • Legal System - based on civil law system; derived from Soviet and continental civil code legal principles; legislature retains power to interpret statutes; constitution ambiguous on judicial review of legislation; has not accepted compulsory ICJ jurisdiction

11. China - Economy • Has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economyduring the past 30 years. • Annual inflows of foreign direct investment rose to nearly $108 billion in 2008. • GDP increased more than 10-fold since 1978. • 2nd largest economy in the world after the US in 2009 measured on a purchasing power parity (PPP) basis that adjusts for price differences. (In per capita terms the country is still lower middle-income.) • Economic development has been more rapid in coastal provinces than in the interior.

12. China – Economic Development Challenges • Reducing high domestic savings rate and correspondingly low domestic demand through increased corporate transfers and a strengthened social safety net; • Sustaining adequate job growth for tens of millions of migrants and new entrants to the work force; • Reducing corruption and other economic crimes; • Containing environmental damage and social strife related to the economy's rapid transformation.

13. Current Franchising Climate in China • As the world’s largest country and fastest growing economy China provides an enormous opportunity for foreign franchisors. The key factor is to be prepared and have the resources to survive in this rapidly growing and highly competitive market • The concepts and products with the most interest in China include fast food and restaurants, auto-after market, fashion and clothing and children’s products and services. American brands in particular are very popular • The China strategy, which KFC, McDonalds and other franchisors employed, was to open and operate corporate locations before franchising • A foreign franchisor must have operated two pilot locations for a minimum of one year before offering franchises in China. • The foreign franchisor must be registered with the Chinese government.

14. Fast food Franchising Climate in China • The market for fast food is estimated at $15 billion per year. • The target market for casual dining, China’s urban population, has expanded at a 5% average annual growth rate over the past several years. • Changing 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 food.

15. Major Benefits of Franchising in China • A win-win proposition – combined know-how of Western franchisors with the local market knowledge, entrepreneurial instincts and eagerness of franchisees. • Minimal entry costs – Much of the cost of the initial investment is undertaken by the franchisee. • Rapid expansion – Having the ability to use the resources of numerous local entrepreneurs, the franchisor can get set up quickly. • Brand consistency – easier to maintain thanks to the requirement for strictly adhering to company operations and procedures. • Circumvention of legal constraints – Franchising allows the franchisor to avoid trade barriers associated with legal arrangements.

16. Major Challenges of Franchising in China • Knowledge Gap – Still much confusion about franchising among lawmakers, entrepreneurs, and consumers. • Ambigious Legal Environment – China’s legal system has to be closely examined from the view point of contracts and intellectual property rights. Imitators can be a real headache. • Escalating Start-Up Costs – Various challenges such as linguistic, cultural and logistics barriers can increase the initial investment and delay profitability. • Difficulty in finding the right partners – Entrepreneurs either lack start-up capital or the needed business experience.

17. Franchising in China – Key Steps to Follow • Have the experience of operating in another country • Have the financial resources to operate in China • Be sure that your marks are registered in China • Be flexible in terms of your entry strategy • Be willing to adapt • Temper your expectations

18. Subway in China • Subway, the world's largest sandwich chain entered China when the fast food business in the country was witnessing a huge growth. • But Subway learned that establishing a strong presence in China was not an easy task. • The Chinese were alien to the American way of ordering and eating a sandwich and at the same time were aware of the rising obesity concerns in the country due to high calorie Western fast foods. • To familiarise the Chinese to sandwiches, Subway had to provide printed signs to explain the processes of ordering a Subway sandwich. • Also Subway faced formidable challenges establishing and managing the franchisees.

19. Subway’s Master Franchisee James Bryant • Mr. James Bryant is a veteran of franchising in China. • He brought the Subway franchise system into China. • He is known in Beijing as “The Franchise King”. • He receives half of the every initial Subway franchising fee in China; that is half of $10,000. • He also receives one third of the 8% royalty fee paid by franchisees in China.

20. Subway in China – Franchisor’s thoughts From a REUTERS Article on March 8th, 2010 • U.S. sandwich chain Subway hopes to match McDonalds in China by store count in 10 years, its President Fred DeLuca said. • DeLucatargets 500 stores in the next 5 years, with 35 to 50 set to open in the coming year. • According to DeLuca, Subway is looking particularly at second tier Chinese cities for expansion as major ones such as Beijing and Shanghai where it had already built a good foundation. • He thinks that their biggest challenge was getting customers to try the product

21. Subway in China – Franchisees’ thoughts • "Subway is a business for tomorrow, not for today," says one of the system's newer franchisees, Peter Chen, an ex-IBM executive who fell for Subway while studying at the University of Southern California. • Luo Bing Ling, the Haidian franchisee, who closed her import-export company to open a Subway and gain more flexible hours, says her store lost about $6,000 in its first eight months, but now that it has started to make a profit, she recently bought a second outlet.