By Nicholas Hopper
China’s restaurant and food retail market is a difficult one to break into. Competition is fierce and prices are low. Nevertheless, the prospect of getting a share of the most populous market in the world outweighs the associated risks for many foreign restaurant chains.
Guillermo García is one of the entrepreneurs in the process of entering the China market. He recently opened a Shanghai subsidiary of San Gines, a famous Spanish churro restaurant from Madrid. Selling churros (Spanish fried dough pastries) in China is not an easy thing to do, as most locals are not yet aware of what the product is and tend to associate it with youtiao, a Chinese breakfast snack, which is sold at much lower prices.
About his experience Guillermo notes, “Opening the first San Gines shop in Shanghai has probably been the biggest challenge of my life. To some extent I had to reinvent myself. There were several difficulties to overcome: finding the right location and keeping the balance between adapting the product to please local palates without losing the foreign flair of the concept were probably the toughest to manage. However, the business started off well and the market has given me a positive response.” He goes on to say, “Now the most important thing is to focus and fulfil the potential of this project. To achieve this, it will be crucial to keep in touch with the costumers and properly manage their feedback.”
Guillermo moved to Shanghai in 2007 to spearhead the expansion of Café Los Portales, one of the biggest Mexican coffee producers, into Asia. The job as Los Portales representative, as well as his role in seasonal collaborations with Mi Tierra Mexican Restaurant, gave Guillermo crucial insight into the food and beverage (F&B) industry in Shanghai. This experience became an invaluable foundation for when he was eventually approached by San Gines to setup their brand in Shanghai.
San Gines inaugurated their international expansion through a franchise model in Japan with locations in Tokyo and Osaka. Now that its first privately owned Shanghai outlet is operational, it is considering opening its second location in Shanghai before the end of the year. Further expansion plans to Bangkok, Thailand, are in the making. The Asian market seems to be receptive to churros, but the key to success for the company lies in its marketing strategy.
Set-up and structure of the business
Registering a company in China is a complicated and time intensive process. In the “Ease of Doing Business” index published by the World Bank, China ranks at 151st place out of 183 economies in the category of starting a business. Without taking on a local partner in the scope of a Joint Venture (JV), the only other option foreign entrepreneurs have is a Wholly Foreign Owned Enterprise (WFOE). The WFOE lets foreigners hold 100 percent of the shares and issue invoices (fapiao), which are required to generate revenue. At least three governing positions must be filled to establish a WFOE: the legal representative and director can be the same person, while the supervisor position needs to be held by someone else.
China’s food & beverage industry is far more regulated than most foreign entrepreneurs expect and additional license requirements in the sector further complicate the setup. Depending on individual F&B license requirements, the setup process usually takes at least 4 to 6 months, however close to a year should be expected before the establishments is up and running.
For foreign companies who are planning to expatriate their profits at a later stage, a holding company in Hong Kong or Singapore should be considered. The registration process is fast, fairly easy and makes dividend transfers across the Chinese border more tax efficient. Total dividend tax on expatriated profits shrinks from 10 to 5 percent in either location and virtual offices can be used in some cases, which are inexpensive to operate.
Recent regulation changes have made it tougher to profit from these tax reductions and generally require multinationals to generate parts of their revenue in Hong Kong or Singapore in order to legally take advantage of lower expatriation taxes of Mainland China profits. However, when the business grows, the holding can be used to offer franchise licenses in other Asian countries and new investors can easily join in or take over the business through an acquisition of the holding company.
San Gines decided on a Hong Kong holding company to manage the distribution of shares between its three Mexican shareholders. This setup facilitates licence applications and administration of the China WFOE, as it serves as a single owner of the WFOE in Mainland China.
Industry specific regulations
As previously mentioned, several licenses need to be acquired to operate a restaurant or fresh food retail establishment. Usually a “Health and Food Hygiene License,” an “Environmental Impact Assessment Report” and a “Fire Protection Opinion” need to be acquired. Depending on the locality of the establishments several others might be necessary, as local authorities set most of the standards.
Opening a restaurant before the licenses and reports have been fully processed is not advisable. Foreign enterprises should take local legislation seriously and not assume that the relaxed standards of local street vendors and traditional restaurants apply to every location and every type of business. This is not the case! Certain establishments – especially food chains setting up in malls, food courts and more developed areas of first tier cities – need to go through rigorous licensing processes, and some rental spaces have their own standards they want to see fulfilled. Foreign businesses attract attention and random inspections are not uncommon. Abiding to all regulations is important, as non-abidance has cost some foreign enterprises substantial fines.
The minimum registered capital requirement varies depending on the specific venture. Local government authorities decide on the specific amount by trying to determine how much capital is required to fund operations on a case-by-case basis. Many foreign enterprises only inject the minimum capital required by local authorities, however this is usually not advisable. China is more expensive than most foreign investors think. In the Eastern first tier cities rent and wages are constantly on the rise and have already reached levels comparable to some western countries. Getting more registered capital approved can take around two months and some companies go bankrupt before they are allowed to inject new capital.
The additional time and capital requirements for the pre-registration process should be taken into account when drafting market entry plans. Before the pre-registration process can commence, a suitable location for the first restaurant must be found and letter of intent for a rental agreement acquired. Specific industry licenses and permits need to be applied for at this point, before being able to start the company registration process. To proceed to this step, the actual rental contract is necessary. This means that rent has to be paid for several months before the business can start its operations. If the budget does not account for this expense the business might experience financial difficulties very soon after opening. In order to avoid this expense some foreign WFOEs register an administrative entity and once the right location is found, an additional branch company to manage that specific outlet.
Getting higher amounts of capital approved during the registration process should still be considered. Usually a minimum of 20 percent of the capital needs to be injected at the outset. It is advisable to choose a realistic amount that reflects the needs of the organization and gradually work up to fulfilling the target within the required time-frame of two years.
Understanding the Chinese customer and your product
Most successful multinational food chains, whether SMEs or billion-dollar corporations, succeed in China because they customize their products to suit local tastes and trends. Few foreign restaurants are able to survive by focusing on expats and well-traveled Chinese alone.
Kentucky Fried Chicken has become immensely successful by customizing their products according to the local tastes of their customers in China. Furthermore, they have designed a wide variety of products to specifically target the local market. Many foreign entrants underestimate this factor and fail for this very reason.
San Gines only serves churros with chocolate sauce in Madrid, but upon setup in China decided to expand their palette to products like ice cream, green tea chocolate sauce and cheddar cheese. This last one has been especially successful given that a substantial segment of the Chinese population prefers savory snacks to sweet ones. Although for the average Spaniard, the idea of savory churros sounds strange, it is selling considerably well in China.
Another adjustment that was made for the Chinese market was the transformation of San Gines into a fast-food establishment. In Madrid, San Gines is a sit-down restaurant where waiters take the order, churros are prepared in the kitchen and costumers pay at the end of their visit. Since the beginning, Guillermo became convinced that is was necessary to rely on a fast-food format, with an open kitchen and an over-the-counter selling method in order to attract first-time customers.
China specific marketing
Before entering the market, the current brand should be thoroughly analyzed. Some companies have opted for a complete redesign of their corporate identity for the Chinese market. The traditional Spanish San Gines logo features simple lettering without any icons. To create brand awareness, Guillermo decided to include an icon displaying a chef and a Chinese translation of the brand name underneath. Even though the majority of Chinese people know the alphabet, many cannot pronounce and remember foreign names that easily. “How would you become a regular customer and tell your friends about something you cannot even name?” Guillermo asked.
When deciding on a Chinese name for San Gines, he tried to follow the Starbucks example by mixing phonetics with meaning. The Chinese name for Starbucks is “Xingbake“, which is a combination of the Chinese word for star and a phonetic equivalent of “bucks”. In San Gines’ case, the first character is the Chinese character for “saint” and the second two characters are phonetic transliterations of “Gines.” The Chinese San Gines name (Shengjinuo) can literally be translated as holy promise of fortune, or luck. This is easily associated with Spain’s image in Asia, has a positive connotation in Chinese culture and reflects the identity of the Spanish brand, which was named after a famous church.
If you wait around the San Gines kiosk in Hongkou Plaza you often see curious locals stop and ask what kind of product is for sale there. Playing on this curiosity, Guillermo decided on a glass front for the stall to give customers a better view of how churros are prepared. Every time a new batch is being fried, people gather around to watch. This educational measure gets customers momentarily invested in the product and receptive to giving it a try.
Most foreign F&B enterprises aren’t really familiar with the Chinese social networking scene. Due to restricted access, Facebook and Twitter are barely used in China, but there are many alternatives. Successful marketing campaigns often rely on Chinese micro blogs such as Sina Weibo, Renren and Kaixing Wang to spread the word. Guillermo notes that many people show up at the Hongkou Plaza kiosk and point on their mobile phone indicating what kind of product they are looking for. The word of mouth spread through these mediums can make or break the launch of a new product.
Choosing the right location
In the business-to-consumers (B2C) retail and service sector, location often matters more than anything else. Finding affordable rental space that also attracts the right customers and gives you a strong starting point, is crucial from both a financial and an operational perspective. “Choosing the right location is the most important factor to a successful food start-up,” Guillermo agrees. “Having visited over 100 different places across Shanghai, it took me a very long time to find a suitable, decently priced location.”
Starting in second tier cities is often easier, as the market is less saturated and growth rates are higher, but first tier cities like Shanghai and Beijing set the trends for the rest of the country. “If you make it in Shanghai you can make it anywhere in China,” notes Guillermo.
After the interview, it becomes apparent that while the market offers great potential, it is not for the faint of heart. Chinese business regulations can be complicated and occasionally counter-intuitive to what westerners are used to back home. However, for entrepreneurs with a strong business model and a profound understanding of the market, success or failure often just comes down to one factor: location.
Guillermo did not rush the decision of where to start his venture and hasn’t regretted doing so. “If you hand me a blank sheet of paper I can draw you the entire Shanghai metro map, because I have been everywhere.”
This article first appeared on China-Briefing.com
Nicholas Hopper works with the business advisory division of Dezan Shira & Associates in Shanghai.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia.
Sep 12, 2012