WTO & Its Impact On China's Retail and Franchise Industries

By Ron Cai
[November 29, 2001]

I. Background Information

A. Retail Market

Prior to China's entry into WTO, foreign investments were severely restricted from providing retail services in China for both their own proprietary operations and for third parties.

The PRC retail sector was first opened to foreign investment with the promulgation of the Official Reply to Utilizing Foreign Investment in Commercial Retail issued by the State Council in July, 1992 ("Official Reply"). The Official Reply allowed foreign investors to establish equity joint ventures and cooperative joint ventures on a trial basis in Beijing, Shanghai, Tianjin, Guangzhou, Dalian and Qingdao, as well as in China's five special economic zones. The Provisions specifically provided that applications to establish Chinese-foreign retail joint ventures must be examined and approved by the State Council. The Chinese party must have at least a 51% equity interest in the joint venture.

On June 25, 1999, the State Economic Trade Commission (SETC) and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) jointly issued the Measures for the Trial Establishment of Foreign-Invested Commercial Enterprises (Measures). The Measures expanded the scope of foreign participation in the PRC retail sector to all provincial capitals and cities directly under the State planning. To gain access into the China market, foreign retailers must apply for permission from the Chinese government in accordance with the Measures, which have high market entry 'thresholds' for foreign investment enterprises.

B. Franchise

Although franchise operation only has a history of about 10 years in China, its pace of development outstrips that of other business models. As at the end of 2000, there were more than 400 franchised enterprises with over 1,000 outlets in the country. Their business covers more than 30 industries, with food and beverages, garments and retail being the three pillars.

The former Ministry of Internal Trade promulgated the trial measures for the administration of franchise operation in 1997 to regulate franchise (including convenience stores and services).

Under the current policy, foreign-invested retail enterprises are not allowed to operate chain stores in the form of franchise. The trial measures for the administration of franchise operation were only applicable to domestic enterprises, but not foreign invested enterprises. McDonald's, KFC, and many Taiwan and Hong Kong food, beverage brands and garment chains all entered the mainland market in the name of processing trade and domestic sales rather than as commercial franchise.

In addition, China lacks a clear regulatory structure that would permit foreign retail companies to franchise their brands and retail outlets on a national basis.

II. Present Regulations in China

A. Current Regulations

1. Establishment options

Approved foreign investors may establish equity joint ventures and cooperative joint ventures to engage in retail and wholesale business operations. Wholly foreign-owned enterprises are currently prohibited.

2. Qualifications

A foreign partner to a retail joint venture must have had an average annual turnover of more than US$2 billion for the three years prior to the application to establish the joint venture and must have assets of more than US$200 million during the previous year.

A Chinese party must have assets of RMB 50 million (RMB 30 million in Central and Western regions) in the previous year. Where the Chinese joint venture party is a Commercial Enterprise, it must have had an average annual turnover of more than RMB 300 million (RMB 200 million in Central and Western regions). Where the Chinese joint venture party is a foreign trade enterprise, it must have had annual import and export turnover from its own operations of more than US$50 million of which export turnover must not be less than US$30 million for the three years prior to the application.

3. Capitalization

Joint ventures engaged in retail must have registered capital of no less than RMB 50 million (no less than RMB 30 million in Central and Western regions).

4. Equity requirements for chain stores

For joint ventures adopting the chain store structure consisting of more than three branch stores (excluding convenience stores, specialized stores (zhuanye dian), and exclusive stores (zhuanmai dian)), the Chinese party to the joint venture must have not less than a 51% equity interest in the joint venture. Upon approval of the State Council, a foreign party may have a controlling interest in such joint ventures where the foreign party can expand exports of Chinese products.

For joint ventures with three or less branch stores, convenience stores, specialized stores, or exclusive stores, the Chinese party's equity stake must not be less than 35%.

For joint ventures engaged in wholesale (including retail enterprises engaged in wholesale as an ancillary business (jianying)), the equity stake of the Chinese party to the joint venture must be not less than 51%.

5. Term

The term of Chinese-foreign commercial joint ventures must not exceed thirty years. For such joint ventures established in Central and Western regions of China, the joint venture term must not exceed forty years.

6. Geographic scope

The Measures expanded the geographic scope of foreign involvement in the PRC retail and wholesale sectors from Beijing, Shanghai, Tianjin, Guangzhou, Dalian, Qingdao, and five Special Economic Zones to the capitals of provinces and autonomous regions, municipalities directly administered by the central government such as Chongqing, and cities directly under the State planning (collectively, "Pilot Test Areas").

B. Approval Procedures

The present procedures and documentary requirements for applying to establish a Chinese-foreign commercial enterprise, to expand the scope of an existing Chinese-foreign commercial enterprise to open branch stores or to change joint venture parties are as follows.

1. Joint venture establishment procedures

The procedures for establishing a new commercial joint venture are relatively straightforward.

1) The Chinese party must submit the feasibility study report and other relevant documentation to the Economic and Trade Commission of the Test Area in which it is located.

2) The relevant Economic and Trade Commission and the department in charge of internal trade will then report to SETC in Beijing.

3) After soliciting MOFTEC's opinion regarding the project, SETC will examine and approve the joint venture.

4) After SETC approves the project, the relevant authority in charge of economy and trade in the Test Area where the joint venture will be located will submit the joint venture contract and articles of association to MOFTEC in Beijing for approval.

5) The approved joint venture must then register with SAIC within one month of receiving approval by submitting the approval certificate issued by MOFTEC to the SAIC.

2. Modification of existing joint ventures

Existing commercial joint ventures may apply to open branch stores, or to change one of the joint venture parties.

1) Such amendments are approved by MOFTEC, which will consult with SETC prior to issuing such approvals.

2) A joint venture must register all amendments within one month of obtaining MOFTEC's approval of the amended joint venture contract and articles of association.

C. Operational Issues

1. Business scope

Under the Measures, a properly approved Chinese-foreign retail joint venture may engage in the following business activities:

1) commercial retail (including agency sales and consignment sales);

2) organizing the export of domestic Chinese products;

3) importing and exporting of commodities for its own operations; or

4) supporting services.

2. Restrictions

Chinese-foreign commercial joint ventures may not engage in commodity import/export agency business. Joint ventures dealing in commodities subject to special regulations of the State or dealing in the import and export commodities involving quotas and licenses must complete the examination and approval procedures pursuant to relevant State regulations.

III. Case Study

A. Model 1

B. Model 2

C. Model 3

IV. WTO Rules

A. Four Sub-sectors of Distribution and Trade Services

According to WTO documents, distribution trade services are divided into four categories:

1. Commission agency services

Commission agency services consist of sales on a fee or contract basis by an agent, broker or auctioneer or other wholesalers of goods/merchandise and related subordinated services.

2. Wholesale

Wholesale consist of the sale of goods/merchandise to retailers to industrial, commercial, institutional, or other professional business users, or to other wholesalers and related subordinated services.

3. Retail

Retail services consist of the sale of goods/merchandise for personal or household consumption either from a fixed location (e.g., store, kiosk, etc.) or away from a fixed location and related subordinated services.

4. Franchise

Franchise services consist of the sale of the use of a product, trade name or particular business format system in exchange for fees or royalties. Product and trade name franchise involves the use of a trade name in exchange for fees or royalties and may include an obligation for exclusive sale of trade name products. Business format franchise involves the use of an entire business concept in exchange for fees and royalties, and may include the use of a trade name, business plan, and training materials and related subordinated services.

B. Services Involving Distribution

The principal services rendered in each subsector can be characterized as following:

1. reselling merchandise, accompanied by a variety of related subordinated services, including inventory management;

2. assembly, sorting and grading of bulk lots;

3. breaking bulk lots and redistributing into smaller lots;

4. delivery services;

5. refrigeration, storage, warehousing and garage services;

6. sales promotion, marketing and advertising, installation and after sales services including maintenance and repair and training services.

C. Retail Services

Following discussions are applicable to all merchandises except tobacco.

1. Upon China's accession to the WTO

Geographical location	Five Special Economic Zones (Shenzhen, Zhuhai, Shantou, Xiamen and Hainan) and Beijing, Shanghai, Tianjin, Guangzhou, Dalian, Qingdao, Zhengzhou and Wuhan
Number	In Beijing and Shanghai, a total of no more than four joint ventures are permitted respectively. Two joint ventures among the four to be established in Beijing may set up their branches in the same city (i.e. Beijing).In each of the other cities, no more than two joint ventures will be permitted.
Form of establishment	Joint venture retail enterprise
Equity ratio	Foreign majority control not permitted with some exceptions

2. Within two years after China's accession to the WTO

Geographical location	All provincial capitals, Chongqing and Ningbo
Number	N/A
Form of establishment	joint ventures
Equity ratio	Foreign majority control will be permitted.

3. Within three years after China's accession to the WTO

There will be no limitations on the geographical location, number, equity ratio and form of establishment of foreign service suppliers, except for:

1) retail of chemical fertilizers, (permitted within five years after accession);

2) those chain stores which sell products of different types and brands from multiple suppliers with more than 30 outlets.

For such chains stores with more than 30 outlets, foreign majority ownership will not be permitted if those chain stores distribute any of the following products:

• motor vehicles (for a period of five years after the accession at which time the equity limitation will have been eliminated),
• products listed above and in Annex 2a of the Protocol of China's WTO Accession (certain types of silk and cotton yarn products).

The foreign chain store operators will have the freedom of choice of any partner, legally established in China according to China's laws and regulations.

4. Products

Foreign service suppliers will be permitted to engage in the retail of all products, except for:

Within one year	books, newspapers and magazines
Within three years	pharmaceutical products, pesticides, mulching films and processed oil
Within five years	chemical fertilizers

5. Additional commitments

Foreign-invested enterprises may distribute their products manufactured in China, including those excepted products as listed in the market access or sector or sub-sector column, and provide subordinate services as defined above.

Foreign service suppliers are permitted to provide full range of related subordinate services, including after sales services, as defined above, for the products they distribute.

D. Retail Services away from a Fixed Location

Within three years after China's accession to the WTO, there will be no limitation on commercial presence of retail services away from a fixed location.

E. Franchise Services

Within three years after China's accession to the WTO, there will be no restrictions on the geographical location, number, equity ratio and form of establishment of foreign service suppliers.

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