Why Did Pizza Hut in China Quit Franchise

Why did Pizza Hut Quit Franchise Team 9 1. Introduction: In 1993, Pizza Hut made a 10-year agency contract with Hong Kong’s famous agent, Jardine Matheson. It gave power of agency and its market expansion business in southern part of China to Jardine, which became the only agent of Pizza Hut in China. And from then on, Pizza Hut went on a hard way of expansion.However, in late May, 2004, Yum Brands declared that they had taken back the management and administrative powers of all 130 branch canteens of Pizza Hut in China, and from then on, Pizza Hut would be managed and operated by Yum Brands directly instead of taking the pattern of franchise . 1. 1 Research question: Why did Pizza Hut quit franchising in China? 1. 2 Sub-questions: (1) What is the explanation given by Yum Brands and what are other guesses of why Pizza Hut quit franchise? (2) What are the changes of Pizza Hut after it quit franchise? (3) Why did Pizza Hut quit franchise in China but still continues franchise ab road? 4) Are there similarities between Pizza Hut and other firms quitting franchise? 1. 3 Motivate: Since the franchisor can use franchise to expand the scale of his firm with lower cost than using directly management, franchise becomes the most popular business model among catering services. And thus, it’s such a strange and rare adverse action that Pizza Hut quit franchise. What caused it to do so? Is it problem of franchisee, Jardine Matheson or the problem of the franchise pattern itself? And what does it want to do? We want to find out the answer. 2. Theoretical framework: 2. Explanation of Porter’s 5 Force Model. Porter’s five-force framework is an important tool for ensuring systematically using these principles to assess the current status and likely evolution of an industry. The five-force model contains internal rivalry, entry, substitutes, supplier power and buyer power, which is presented as following: Also, the model has some shortcomings. It doesn ’t take the environment into consideration, which means that it lacks the role of demand and government. And the emphasis of the model is on the competition between firms while recent trend is towards cooperation between firms.What’s more, the model is primarily an analysis of industry rather than analysis for a particular firm. 2. 2 The Forces will be used in our Case Analysis of the model must begin with market definition. When defining the market, we must be sure to include all firms that constrain each other’s strategic decision marking and pay attention to both the product market and geographic market definitions. Some of the five forces we use include: (1) Internal rivalry For most industries, the intensity of internal rivalry is the major determinant of the competitiveness of the industry.Internal rivalry refers to the jockeying for share by firms within a market. (2) Entry Entry is the beginning of production and sales by a new firm in a market. Entry er odes incumbents’ profits in two ways. First, entrants divide marker demand among more sellers. Second, entrants decrease market concentration and heat up internal rivalry. (3)Supplier Power Supplier power takes the point of view of a downstream industry and examines the ability of that industry’s upstream input suppliers to command prices that extract industry profits.Also, we will analyze our case by explaining the influence of the government, which is a shortcoming of the model. 2. 3 Application of the Model to our research question: We will choose to apply the principles of internal rival, entry, and supplier power to our answers of the research question. We think that after Pizza Hut quit franchise, it can choose price competition and benefit leadership, which will affect its rivals and entrants. Also, it has more power when purchasing inputs, which links with supplier power. And the government plays a significant role in our case, too. We will analyze them in deta il later. 3. Data and Methodology: 3. Data: We searched the data from (1) the official website of Pizza Hut China to get the number of canteens it reported; (2) the menus of Pizza Hut in different years to get the price of a pizza; (3) some questionnaires made by others to find customers’ degree of satisfaction; (4) Suning’s annual statements in 2006 and 2008; (5) Some essays 3. 2 Methodology We made broken line graphs and pie charts to make the data we collected easier to analyze. We also list other data in form of tables to make it more clearly. 4. Results & Analysis: 4. 1 The number of canteens is an important index reflecting the expanding speed of Pizza Hut.So we show the following figure. (Pizza Hut has recently declared that it will invest 0. 7 billion RMB to open another 150 canteens only in the year 2012. ) Figure3. 2. 1 shows that the curve of Pizza Hut’s growth rose slowly in the first 13 years, just about the time before Pizza Hut quit franchise. How ever, the curve jumped sharply almost after Pizza Hut quit franchise As we know, by franchise a firm can expand quickly with lower cost, we have thought that the expanding speed would decline after Pizza Hut quit franchise and expand it by itself, because of larger cost. However, what the Figure3. 2. shows to us is opposite. There is a fact that Jardine Matheson only opened 15 canteens in southern China after it gained the agency right, which of course, would disappoint Pizza Hut. So it must be that Jardine lacked the ability of expanding canteens, so Pizza Hut didn’t let it agent any longer. And since Jardine is the best agent in China,(It ranked 319th in the world 500 strong enterprises by †Fortune†. ), Pizza Hut can’t think of a better agent, so it quit franchise and just to expand by itself. . 4. 2 The price of a product shows whether a firm can have competitive advantages in price competition.So we collect the data. Figure3. 2. 2 (2) Annual Inflation r ate of China Figure3. 2. 2 shows that the price went down after quitting franchise in 2004, and came to the minimum in 2005 and 2006, then it rises later. So we can see that before Pizza Hut quit franchise, the average cost of a pizza in southern China in 2003, which is still managed by Jardine, is 60 RMB. It’s reported by manager Luo of Pizza Hut China that its price is 15% higher than any other part of China. That was because Jardine positioned the canteen as the high grade canteen, while Pizza Hut positions its canteen as middle-high grade canteen.So after Pizza Hut quit franchise in2004, as manager Luo said, its price would go down by 15%. We can check it in the figure3. 2. 2 that in 2005, the average price of a pizza decrease to 50, approximately by 15%. However, after the year 2006, the average price of a pizza grows up again, which we will ignore because by calculation (Figure3. 2. 2 (2) shows the annual inflation rate of China from 2003 to 2009), we can make a conclus ion that it happened mainly due to inflation.. 4. 3 Then we think of the brand image, here is the information we found. Figure3. 2. 3 shows overall satisfaction of Pizza Hut’s consumers in 2006.Only 20% of consumers were very satisfied with Pizza Hut and only 30% of consumers were satisfied with Pizza Hut. However, another 30% of consumers thought Pizza Hut is just so-so. Figure3. 2. 4 shows overall satisfaction of Pizza Hut’s consumers in 2010. Consumers who were satisfied with Pizza Hut grew to 50%, the those felt very satisfied with Pizza Hut grew too, although only a little, 1. 43%. The consumers thinking that Pizza Hut was just so-so fell to 21. 43%. Since Pizza Hut said that they quit franchise in order to promote its brand image, we want to see whether or not it would really do so and whether or not it has had an effect.We can see from the results the customers are more satisfied with Pizza Hut in 2010 compared to 2006. So Pizza Hut must have done a lot of work to improve its brand image. And after 4 years efforts, it really has improved its image in people’s minds. It’s comprehensive that it’s easy for Pizza Hut to improve its brand image by itself than by its agent, Jardine Matheson, because the principal and the agent may have some different views. And it’s a bit difficult for Pizza Hut to manage what his agent does 4. 4 Figure3. 2. 6 mainly shows profits in 2006 and 2008 of Suning, which quit franchise in 2007.We can see that its gross profit, year growth, net profit and total assets all grow up. According to Yantai daily newspaper’s report, the Quality Inspection Department found many unqualified products of Supor, a firm owned Suning. The unqualified products were produced by the franchisee of Suning. However, certainly it would do harm to the brand image of Suning. The customers were very upset about the incident. Franchisors depend on franchise to enlarge themselves since the expanding cost is low , but many of them didn’t take care of the quality of the franchisee, they just expand the scale without destination, just as Suning in those years.So the franchisee may take different actions against the principle in order to improve their own profits. Some products franchisees make are not eligible, but the principle can’t notice them. It’s the errors of the franchisee, but franchisors will suffer most because their brand image will be damaged. So quitting franchise must be wise strategy for Suning. As we can see in the figure, it really contributed to higher profits. 5. Discussion: Before applying the theoretical framework to our case, we will discuss the market definition first: Production market:Pizza Hut sells not only pizza and Italian noodles, but rice as well since it’s in Chinese market. So any canteen sells no matter eastern or western food around Pizza Hut must be its rivals. So we define the market as the western-style food market. Geographic market: It’s obviously that most consumers strongly prefer to choose the nearby canteen to have a meal. So we consider the geographic market is a certain area around Pizza Hut’s canteens, which is within the consideration of consumers when they choose a canteen to eat.Then we will answer each sub-question by the tool of theoretical framework: Sub-question 1: What is the explanation given by Yum Brands and what are other guesses of why Pizza Hut quit franchise? Only by knowing the explanation and guesses can we find the possible reasons. Then we can select the right ones. The explanation given by Pizza Hut: Some media reported that Yum Brands wasn’t satisfied with the expanding speed of the franchisee, Jardine Matheson, for it lagged the speed of development of those chain canteens.Also Jardine didn’t obey the ideas and strategies of the Yum Brands thoroughly. Direct at this statement, Shao Xiaowei, the member of public affairs section of Yum Brands, deni ed completely and told Economy Times News that since Pizza Hut chain canteens entered in Chinese market in 1990, all of them had been run by themselves until 1993 when they signed a 10-year contract with HK agent Jardine Matheson to pass franchise authority and the task of marketing extension in South China to it. And Jardine Methoson also became the only franchisee of Pizza Hut in China inland market.Pizza Hut wasn’t unsatisfied with the speed of expansion, instead, they thought Jardine did pretty well and Pizza Hut absorbed lots of experience from it. all in all, compared with other districts in China, South China market has its own specific features. Meanwhile, according to Wanqun, director of public affair of Yum Brand. , Pizza Hut hadn't reached economics of scale and it would impose great risks in franchise. He added that Pizza Hut wasn't mature enough in China, but it didn't mean that franchise door would be closed forever.With support and experience from Yum Brands, P izza Hut would open its franchise door again after the brand name becoming mature enough. In conclusion, Yum Brands arose three reasons for quitting franchise as followings (1) The routes and positions in the market of Yum Brands and Jardine Matheson to develop Pizza Hut are quite different (2) Since Pizza Hut hasn’t reached the economics of scale, it had to quit franchise to avoid risk (3) Since the market of Pizza Hut isn’t mature enough, the risk of having a large scale of franchise is really high.The above-mentioned parts are the reason given by Yum Brands. We don’t know whether it’s exactly the true ones. We also collect other people’s guess as following: (1) Yum Brands wasn’t satisfied with the expanding speed of the franchisee, Jardine Matheson, for it lagged the speed of development of those chain canteens. (2) Pizza hut wants to enhance its brand image so that it will be easy to expand later. Sub-question 2: What are the changes of Pizza Hut after it quit franchise? We want to find out whether quitting franchise is good for Pizza Hut, which can be reflected by the changes. 1)Its open canteens measure the expanding speed of Pizza Hut. From Figure 3. 2. 1, we can see that it opened approximately more and more canteens in one year, which means that its expanding speed became faster and faster. We can apply entrants to the above. According to the principles of entry of theoretical framework, locations can be barriers to entrants. As we know, most consumers have specific geographic preferences when choosing a canteen to have a meal. Then Pizza Hut would lose geographic market if it continued franchise, because the expanding of canteens by Jardine is too slow.So Pizza Hut quit franchise to expand by itself, carrying on a faster expanding speed to get more geographic market. By doing so, it can build barriers to new entrants. (2)Its price first went down immediately after quit franchise. We can apply supplier power, internal rivalry, and entry to explain this condition. According to theoretical framework, the suppliers in a competitive market will have indirect power on downstream firms because they can sell their goods to the highest bidder.We know that Pizza Hut have many rivals when buying inputs, Papa John, KFC and any firms sell similar food because they need similar raw materials. So if Pizza Hut wants to purchase good raw materials, the transaction cost will be high to the franchised canteens. However, when it quit franchise to become vertical integrated firm, it can depend on its parent company, Yum. Because Yum has a network of 1000 firms to provide raw materials, it can reduce the threat of supplier power so that the cost fell and so did the price.And through vertical integration, Pizza Hut has superior access to inputs with the help of Yum as mentioned before, which is also a type of impediments to imitation, a group of isolating mechanism. That will help Pizza Hut to protect its com petitive advantage by preventing other firms from replicating its success. When Pizza Hut reduced the price, it can also have an advantage in price competition with its internal rivals. According to the theoretical framework, price erodes profits by driving down price-cost. And it’s more efficient than nonprice competition though more difficult.There is high price elasticity of demand in food industry because most kinds of food have many substitutes, so when Pizza Hut reduce its price, its rivals’ profits will suffer. And Pizza Hut can also deter entry by limit pricing to build strategic barriers to entry. Limit pricing is that the incumbent sets the price sufficiently low to discourage entrants before entry occurs. When Pizza Hut quit franchise and it lowered the price, it can also lower the expectation of potential entrants. If entrant infers that post-entry price will be low, entry may not be likely.When Pizza Hut quit franchise and become vertically integration, al l of its daily issues are decided by Yum rather than the franchisees. As we know, Yum is a strong company full of management experience and network advantages, so Pizza Hut has new advantages. The established relationships with Yum and its suppliers and customers is not easy to replicate. And because of learning curve effects, Yum has competitive advantages in the market. These can also be entry barriers. (3)From Figure3. 2. 3-3. 2. 4, is brand image was improved, which links with internal rivalry.According to Porter’s Five Forces Model, internal rivals may compete on a number of price and nonprice dimensions. Nonprice competition erodes profits by driving up fixed costs and marginal costs. To the extent that firms can pass cost increases along to consumers in the form of higher prices, non price competition is less likely to erode profits that price competition. So in fact, many firms choose nonprice competition to enjoy solid profits over an extended period of time. And the y are often engaged in vigorous by improving the quality of their products. We can apply this proposal to Pizza Hut.And by franchise, Pizza Hut can also have benefit leadership to keep its competitive advantage. Benefit leadership creates a large value by achieving a higher maximum willingness to pay than its rivals. Since Pizza Hut’s products, pizza and rice, etc, are experience goods, (i. e. quality of the good is only known after purchase and when it’s used for a while) it’s suitable for Pizza Hut to choose benefit leadership to outperform its rivals, because a benefit advantage could be based on image, reputation or credibility, which are more difficult to imitate or neutralize.And for experience goods, a firm’s reputation for quality provides a significant advantage also because consumers who have had a positive experience with a firm’s brand will be reluctant to switch to competing brands if there is a chance that the competing products will not work. It’s known as reputation and buyer uncertainty, a type of early mover advantages, which will help Pizza Hut to sustain its competitive advantages. So it’s very important for Pizza Hut to quit franchise and concentrate on brand improving.Pizza Hut thought its brand image was not so good in South China before 2004 since Jardine had different views in managing the canteen. So it quit franchise and started to operate the canteen by itself and has been focusing on its brand value. It has improved its products’ quality, its service, its environment of canteens and so on, in order to make the overall satisfaction of canteens go up. By doing so, it has advantages in the competition. And improving brand image also links with entry.According to theoretical framework, there are some entry barriers, one of which is that consumers highly value reputation, which means that consumers are brand loyal. Entrants must invest heavily to establish a strong reputation and b rand awareness. Diversifying entrants using a brand umbrella may be more successful than entirely new entrants. It’s reported that in 2003, Saizeriya, a canteen also sells pizzas entered Chinese market because its manager found that the price of Pizza Hut’s pizzas was so high while the quality of that didn’t catch up with the price, which made people not so satisfied with Pizza Hut.And with the same reason Barbera was opened in China, too. So that’s another reason why Pizza Hut quit franchise to establish a strong reputation and brand awareness. By using a brand umbrella it will be successful from protecting itself from stealing its market share by new entrants. Sub-question 3: Why did Pizza Hut quit franchise home but still continues franchise abroad? It’s often the case a kind of business pattern isn’t always useful in every situation, so we want to find whether or not Chinese market is suitable for franchise.There is a prominent phenomeno n that foreign firms would not like to adopt franchise in China. Besides Pizza Hut, its brother firm, KFC is also slow in franchise. Only 40 of 1000 canteens are franchised, and most of them are in small cities. Pizza Hut and KFC developed quickly by franchise, why they become cautious when they enter Chinese market? We think the following reasons can explain it. (1)The government in the firm environment can be an important cause. Porter’s Five Forces Model doesn’t have explicit role for the government.But according to Porter Diamond, the government plays an important role in influencing the firm’s strategy. Franchise took place in China in early 1990’s. And China government cancelled all limitation on franchise into Chinese market in 2002 when China entered into WTO. So by 2004, the time when Pizza Hut quit franchise, some related departments, professional service institutions, and policies and regulations still needed improving. At that time, adopt fran chise would take the firm into trouble. (2)The market for franchise is not mature enough.Since the success of a firm’s organization and strategy depends on the characteristics of the firm, the market, and the environment. So we must take the market into consideration when analyzing the firm’s strategy. Since it’s too short for franchise to improve in Chinese market, related departments, professional service institutions, franchisors and franchisees, potential investors and professional employees have large differences in understanding franchise. They also have few preparations and lack the abilities of franchise.However, the two reasons above don’t happen abroad because franchise happened early in foreign countries. It originates from the United States in 1851. The time is long enough for the market of franchise to become mature. (3) Franchisors lack confidence in franchisees. Pizza Hut has tried hard to seek out franchisee. One of the strategies the firm has chosen to make its franchise more attractive to franchisees is to make all canteens uniform. Pizza Hut became a part of the Yum’s franchise group. Other restaurants such as Taco Bell, KFC and Long John Silvers are lso part of this network. This grouping together of franchises has allowed franchisees to increase their potential for income by having both Pizza Hut and Taco Bell items for sale in a canteen. Yum is one of the world’s largest franchisors, and around 76% of the 325,000 Pizza Hut’s canteens around the world are franchised. It believes in focusing on its competition advantages in market and product development, and complementing these advantages with the expertise of its franchise partners in the areas of customer service and restaurant operations.This combined expertise of Yum and franchisee ownership is the key driver in achieving global growth. An analyst explained that by franchise, franchisor might lose control of some resources and become too dependent on franchisees, and the quality of products and services couldn't reach a uniform standard, while uniformity was crucial to enterprises such as KFC. A KFC staff told the journalist in private that in fact, KFC didn't have the courage to open its franchised canteens to a large scale since it didn't have sufficient confidence in most of the franchisees.Also the cost to run well a franchised outlet is really high, the minimum financial requirement to open a Pizza Hut franchise in the United States is $700,000 Net Worth and $350,000 in liquid assets [Figure 3. 2. 5], and to make the business profitable will make much pressure. Sub-question4: Are there similarities between Pizza Hut and other firms quitting franchise? Now we will compare pizza hut with other firms also quitting franchise to analyze the case. First, since Pizza Hut is in middle high level in catering service. So we choose some other firms in the same level as Pizza Hut in their own industry to do the comparison .Although they have some differences, it will be convictive to put them in their market and analyze the reason to give support to pizza hut, because we think the level will affect the strategy of choosing franchise or not. We choose Suning and Masha to do the analysis. Suning is a famous brand in China, mainly concentrating in electric appliance. In the beginning of the foundation, it expanded its scale fast and got many profits by franchise. It defeated Gome and became one of the leading electric appliance enterprises in China. But in 2007, it quit franchise because it wasn’t satisfied with its franchisee because the price hey produced didn’t meet the standard of quality as mentioned before. Another example is Masha department store, the biggest transnational retail group in England, who adopts directly management in China. The firm thought it is easier to control the management and keep their company’s future distinguishing. There are only 6 branches in China. Related to pizza hut’s direct management mentioned above, we can see franchise is not always favorable to the firm. Besides the quality and brand image problems, we have other reasons, the higher agent cost and the leak of private knowledge.Now we apply the framework to analyze these two reasons as followings. First, franchise can lead to high agency cost. Agency problems arise when the objectives of the principal and the agent are different and the actions taken and the information possessed by the agent is not observable by the principal, just as Suning and its agent, and maybe Pizza Hut and Jardine. The principle can’t have a very comprehensive control over the franchisees. As the firm becomes larger, it is harder for the principal to coordinate the work of different franchisees, thus the agency cost will be higher.And the principle should give more power to the franchisees so that they can have enough flexibility to react to the changes of the market. But if the p ower is too much, it may lead to decentralized organizations. The decision making authority will be dispersed. Agency problems may lead to coordination opportunities to be missed in decentralized organizations, which results in agency costs. As the organization becomes large, the coordination problems become more severe. Second, franchise will lead to the leak of the private information.As the franchisees work with the principal, they can learn more business management of the firm, learn the corporation culture, even the core technology, e. g. the special know-how. So the private information may be leaked. And once the franchisees quit cooperation, there will be a great threat to the principle and maybe its market share will get down. So we can see that if a firm is in middle high level or high level, or in other words, if a firm requires a lot in the quality of its product, they will possibly choose the pattern of vertical integration instead of franchise. Conclusion:We think the r easons why Pizza Hut quit franchise are as followings: (1) Yum Brands wasn’t satisfied with its franchisee, Jardine Matheson in expanding speed though Yum denied it. And so far it can’t find a better franchisee. (2) Pizza Hut wants to enhance its brand image so that it will be easy to expand later. (3) Since the market for franchise isn’t mature enough as in other developed foreign countries, the risk of having a large scale of franchise is really high. Our suggestions: (1) Since Chinese market for franchise isn’t mature enough, Pizza Hut can still be vertically integrated and concentrate on brand improving. 2) When Chinese market for franchise is mature and Pizza Hut’s brand is deeply loved by customers, Pizza Hut can reconsider franchise strategy to expand quickly with lower cost. (3) If Pizza Hut reconsiders franchise strategy, it must choose an experienced and high-quality franchisee. (4) It’s also good for Pizza Hut to adopt directly ma nagement as the main while franchise as the supplementary. (words:4435) Chen Yingying 2011123868 [email  protected] com Sherry 2011123870 [email  protected] com Kally 2011123826 [email  protected] com References & Bibiography:Economics of Strategy (David Besanko, David Dranove, Mark Shanley) http://www. pizzahut. com. cn/phdi/index. aspx#! handler/home. ashx? &tagid=&proid= http://bbs. gxsky. com/thread-595855-1-1. html http://zhidao. baidu. com/q? ct=17&pn=0&tn=ikaslist&rn=10&word http://www. sojump. com/publicsurveys. aspx? keyword=%E5%BF%85%E8%83%9C%E5%AE%A2 http://www. cfi. net. cn/newspage. aspx? id=20060830001759 http://www. cnstock. com/paper_new/html/2009-04/29/content_69247463. htm http://pizzahutfranchise. com/the-investment-pizza-franchise-opportunities. php http://www. gmw. cn/03pindao/2004-04/30/content_20233. htm