FOREIGN TRADE UNIVERSITY

FACULTY OF ECONOMICS AND INTERNATIONAL BUSINESS



MID-TERM REPORT:

COCA-COLA’S ENTRY MODES IN CHINA

Course: International Business

Instructor :
Class
: KDOE307.1
code
Group : 7

Ha Noi, March 2020

TABLE OF CONTENTS

INTRODUCTION............................................................................................................3
PART I. MARKET ENTRY MODES REVIEW...........................................................4
1. Franchising.................................................................................................................. 4
2. Joint venture................................................................................................................4
PART II. COCA-COLA’S ENTRY MODE IN CHINA................................................6
1. About the company......................................................................................................6
2. FDI in China................................................................................................................6
3. Coca-Cola’s Choice of Entry Modes in China.............................................................8
3.1. Franchise (1979 – 1984)........................................................................................8
3.2. Joint Venture (1985 – 1992)..................................................................................9
3.3. Hybrid (1993 – present)......................................................................................11
4. The repercussions to the long-term strategy entry of Coca-Coca’s............................13
CONCLUSION...............................................................................................................14
REFERENCES...............................................................................................................15

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INTRODUCTION

Why do enterprises enter foreign markets? By creating new markets in foreign countries,
they may expect an increase in profit or sales in a market growing faster than the domestic
market. China is one of the fastest growing economies in the world, which is attracting a
lot of Multinational Corporations (MNCs) as its markets have been constantly improving.
Although China used to have imperfect markets that discouraged many MNCs due to
uncertainties, opportunism, the limited number of agents, and inadequate knowledge
about the markets, the markets began improving. Through the improvements, the Coca-
Cola company saw opportunities in the country. Consequently, they decided to invest in
the country by opening a branch. It used various entry modes that enabled it to survive in
the Chinese markets even though they still faced many imperfections.

To clarify the way Coca-Cola has operated a business in China, this essay will focus on
explaining the three modes of entry, which are Franchising, Joint Venture and Hybrid (the
combination of these two), used by the company when they started entering the market, as
well as suggesting some repercussions for a long-term strategy of the company in China.

Our report comprises two main parts:

Part I. Market Entry Modes Review

Part II. Coca-Cola’s Entry Modes in China

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PART I. MARKET ENTRY MODES REVIEW

1. Franchising

According to Business Dictionary, Franchising is “the arrangement where one party (the
franchiser) grants another party (the franchisee) the right to use its trademark or trade-
name as well as certain business systems and processes, to produce and market a good or
service according to certain specifications. The franchisee usually pays a one-time
franchise fee plus a percentage of sales revenue as royalty, and gains immediate name
recognition, tried and tested products, standard building design and décor, detailed
techniques in running and promoting the business, training of employees, and ongoing
help in promoting and upgrading of the products”.

When a business wants to increase its market share or increase its geographical reach at a
low cost, it may create a franchise for its product and brand name. A franchise is a joint
venture between a franchisor and a franchisee. The franchisor is the original or existing
business that sells the right to use its name and idea. The franchisee is the individual who
buys into the original company by purchasing the right to sell the franchisor's goods or
services under the existing business model and trademark.

Franchises are a very popular method for people to start a business, especially for those
who wish to operate in a highly competitive industry like the fast-food industry. One of
the biggest advantages of purchasing a franchise is that you have access to an established
company's brand name, meaning that you do not need to spend further resources to get
your name and product out to customers.

2. Joint venture

A joint venture (JV) is a business arrangement in which two or more parties agree to pool
their resources for the purpose of accomplishing a specific task. This task can be a new
project or any other business activity.

In a joint venture, each of the participants is responsible for profits, losses, and costs
associated with it. However, the venture is its own entity, separate from the participants'
other business interests.

There are three main reasons why companies form joint ventures:

Leverage Resources

A joint venture can take advantage of the combined resources of both companies to
achieve the goal of the venture. One company might have a well-established

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manufacturing process, while the other company might have superior distribution
channels.

Cost Savings

By using economies of scale, both companies in the JV can leverage their production at a
lower per-unit cost than they would separately. This is particularly appropriate with
technology advances that are costly to implement. Other cost savings as a result of a JV
can include sharing advertising or labor costs.

Combined Expertise

Two companies or parties forming a joint venture might each have unique backgrounds,
skill sets, and expertise. When combined through a JV, each company can benefit from
the other's expertise and talent within their company.

Beside applying these two modes of entry separately, the company also combined them
together, which played an important role in shaping its third stage of development in
China.

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PART II. COCA-COLA’S ENTRY MODE IN CHINA

1. About the company

Coca-Cola is the world’s largest cola producer and one of the biggest MNCs. Coca-Cola
has a relatively long history of investment in China since 1979, when economic reform
was implemented under the de facto leadership of Deng Xiaoping. Coca-Cola was the
first mover in cola industry and it successfully captured a large market share. However,
now it faces keen competition from its close competitor, Pepsi-Cola, and an unfamiliar
and highly versatile local market environment.

Through improvement of China’s economy, the Coca-Cola company saw opportunity in

the country. Consequently, it decided to invest in the country by opening up a branch.

By 1992, the Coca-Cola company had established approximately ten bottling plants in the
form of joint ventures. However, it had minority shareholding. By 2000, it had established
18 additional joint ventures. Currently, Coca-Cola products are dominating the Chinese
markets. In the year 2000, the products of the company had taken 40 percent of the
carbonated soft drink market in china.

The company used the franchise entry mode between 1979 and 1984. In 1979, China
adopted an open-door policy that enabled it to trade with other countries. Following the
launch of the policy, Coca-Cola company is allowed to sell its imported products only to
foreigners living in China’s economic cities, including Shanghai, Guangzhou, and
Beijing.

In 1993, Coca-Cola decided to have a long-term investment in China by the combination

of joint venture with local partners and franchise arrangement with foreign partners
shaped the features of the development of the Coca-Cola company’s third stage
development in China.

2. FDI in China

China has been considerably successful in attracting FDI since the implementation of
economic reform in 1979. According to the Ministry of Foreign Trade and Economic
Cooperation (MOFTEC), the total utilized value of FDI reached US$385 billion till
October 2001 (Table 1). Equity joint ventures have been the most popular mode for
MNCs to enter the Chinese market during this period. The total number of equity joint
ventures reached 213,780 in October 2001, accounting for 56 per cent of the total number
of FDI firms in China. Together with other types of joint ventures (e.g. contractual joint
ventures and joint R&D ventures), joint ventures owned and/or operated by Chinese and

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foreign firms accounted for 69 per cent of all firms with FDI. In comparison, there were
119,589 wholly owned subsidiaries of foreign firms, which accounted for 31 per cent of
the total number of firms with FDI.

In terms of the share in the total utilized value of FDI, Equity joint ventures accounted for
45 per cent, amounting to US$172 billion, during the period 1979-October 2001 (Table
1). In comparison, wholly owned subsidiaries accounted for 34 per cent of the total
utilized value of FDI at the same time. This suggests that the mode of equity joint
ventures was popular in China among foreign direct investors. During the two decades of
economic reform, the Chinese market remained a relatively new territory for foreign
firms. In other words, China was a typical ‘imperfect market’ for foreign MNCs – the
result of, among others, uncertainty, small numbers of agents, opportunism, bounded
rationality and a lack of knowledge about the local market. To reduce the risks associated
with the ‘imperfect market’, joint ventures in many cases could be a more effective mode
of entry than wholly owned subsidiaries for the MNCs. Coca-Cola’s decision to invest in
China represents one MNC’s response to the growth opportunities that are available. That
Coca-Cola considered different market entry models is indicative of the company’s efforts
to produce a strategy that was capable of coping with the potential problems of a new and
‘imperfect’ market. The choice of entry mode will be the focus of the next section.

Actual Utilization Percentage of

Number Percentage of
Mode of FDI of FDI (US$100 Total Utilization
of Firms Total Firms
million) of FDI
Equity joint
213,780 55.59 1,717.64 44.64
ventures
Cooperative
51,046 13.27 761.69 19.79
joint ventures
Joint R&D
180 0.05 70.78 1.84
ventures
Wholly-owned
119,589 31.09 1,297.73 33.73
subsidiaries
Total 384,595 100 3,847.84 100
Table 1. FDI in China, October 2001

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3. Coca-Cola’s Choice of Entry Modes in China

3.1. Franchise (1979 – 1984)

Coca-Cola used the franchise entry mode between 1979 and 1984. It allowed Chinese
companies to own exclusively its enterprises. Right after China launched its open-door
policy in 1979, Coca-Cola began negotiating with the Chinese Government on accessing
the Chinese market. The negotiations led to Coca-Cola being allowed to sell its imported
products only to foreigners living in China’s three economic cities which were Shanghai,
Guangzhou, and Beijing.

Between 1980 and 1984, Coca-Cola built three bottling plants and then transferred all its
ownership rights to various Chinese state-owned enterprises due to the restriction of
Chinese government policy on the beverage sector. Foreign firms, such as Coca-Cola,
were not allowed to own bottling plants in China. In return, the Chinese-owned bottling
plants bought concentrates imported by Coca-Cola. Carbon dioxide, syrup, sugar, and
water were added to the concentrated and produced ready-to-sell soft drinks. Under this
type of arrangement, Coca-Cola operated as a wholesaler while the bottling plants acted
as market agents with the roles of producing and distributing the manufactured products.
In the first stage of entry in China, the return on investment for Coca-Cola was the
provision of the imported concentrates to the bottling plants. The company gained little
profits under this form of arrangement (Tian, 2007).

Advantages

The franchise mode of entry helped Coca-Cola to have the first contact with Chinese
market and establish relationships with Chinese government.

Disadvantages

As all bottling plants were wholly owned by local Chinese enterprises, Coca-Cola had
neither management rights in the operation of the plants, nor control over the volume of
production, sales or distribution strategy, not to mention a long-term policy on penetration
into the vast Chinese market. The company faced uncertainties on the accessibility of the
markets. It lacked information concerning the market and was not allowed to expand its
operations into the Chinese markets. Besides, it faced opportunism problems (Wuhrer &
Bilgin, 2014).

The market agents were passive and merely focused on their own bottom lines. They did
not have the same goal as Coca-Cola to pursue a long-term marketing strategy for the soft
drink business in China. This can largely be explained by the typical problem of a

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socialist regime in which the ownership rights of enterprises were not clearly defined.
Claims on the residuals of enterprises were vague. On the operation side of the bottling
business, Coca-Cola did not

have any say on the output level. Even though local partners were responsible for the
management and control of company operations, their behaviors in production were
constrained by production targets (Wuhrer & Bilgin, 2014).

Under the Chinese production policy, the production units produced amounts based on the
availability of raw materials, production ability, and the energy supply. Distributors took
over the role of marketing outputs and provided information concerning the markets to
producers. However, the producers had the power to determine the amount of production
based on the availability of input materials. In fact, they rarely adjusted their outputs of
production to the market information. As a result, there were disparities between output
and market demand.

Apart from the opportunistic behavior of its market agents in China, Coca-Cola faced
various market uncertainties such as transportation and wholesale systems. The transport
systems were primitive, and there was a lack of an efficient wholesale network during that
time. Market distribution involved the use of tricycles. This was ineffective in terms of
cost and delivery time. The market challenges limited the expansion of the company. As
late as 1984, it had established only three bottling plants and had a market share of less
than two percent in 1985 (Wuhrer & Bilgin, 2014). The constraints made Coca-Cola
unable to realize its long-term objectives of FDI in China.

3.2. Joint Venture (1985 – 1992)

The market constraints forced the Coca-Cola company to change its entry mode into a
joint venture with an objective of internalizing market transactions through the acquisition
of management rights of the bottling plants through joint venture establishments. In the
mid-1980s, Chinese government decided to implement a liberalization policy to attract
FDI. Through the policies, Coca-Cola was permitted to form a joint venture with its
bottling partner in Macau and a local enterprise in Zhuhai in 1985. The venture
established by the three firms was the first bottling venture in china.

In order to manage the uncertainty of market expansion and to eliminate the constraints
compounded by the opportunistic behavior of its local partners, Coca-Cola started to
actively involve in the operation of the bottling plants by entering into joint venture
arrangements with local partners. This marked the beginning of the second stage of mode
of entry in China (Field survey, 2000).

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In 1986, Coca-Cola was allowed to build a concentrate plant in Shanghai in the form of
wholly owned subsidiaries. To keep concentrate plants in the form of wholly owned
subsidiaries was, and still is, Coca Cola’s strategy to safeguard the formula of producing
its concentrate. The company was allowed to register the concentrate plant as a sole
proprietorship firm. In return for this permission, Coca-Cola let its Chinese partners hold
the ownership of the bottling plant, which was jointly built near the concentrate plant in
Shanghai. Coca-Cola entered a 50-50 joint venture with the former Ministry of Light
Industry (now called the State Light Industry Bureau, reporting to the State Economic and
Trade Commission) and the Shanghai Investment and Trust Company to establish the
Shanghai Shenmei Beverage Co. Ltd. in 1986 (Field survey, 2000).

Meantime, the Chinese Government actually still maintained tight control over the
development of soft drink industry in China with an aim to nurture local Chinese brands.
This was mostly due to the shortage of funds for local soft drink makers to catch up with
foreign soft drink makers, notably as Coca-Cola and Pepsi-Cola. Coca-Cola might have
had limited knowledge about the paternalistic attitude of the Chinese Government to
protect its local brands. This was a problem of bounded rationality faced by foreign firms
(Field survey, 2000).

However, with the liberalization policy to attract FDI and partly due to the opening up of
the beverage market in China since the mid-1980s, foreign soft drink makers such as
Coca-Cola were allowed to jointly own bottling plants with local partners but at minority
shares. The number of Coca-Cola’s bottling plants had increased rapidly from four in
1985 to ten in 1992. A decade after re-entering the Chinese market, Coca-Cola’s business
in China started to become profitable in 1990.

The growth of the bottling plants encouraged the Coca-Cola company to design a strategy
that would make it acquire management rights of the joint ventures regardless of the
shares it had in the plants. The main objective of the strategy was to exert control over the
bottling operations, otherwise, the opportunistic behavior of the market agents would
seriously hamper the growth of Coca-Cola business in China. For example, Coca-Cola
only acquired 25 per cent of shares in its joint venture bottling plant in Hainan, yet its
local partners focused on retaining a controlling block of shares. By surrendering their
management rights to their Western partners, the local partners could earn decent profits
by off-loading part of their shares in bottling plants. In addition, the local partners hoped
to learn the management expertise of western MNCs. On acquiring management rights,
Coca-Cola had the authority to appoint general managers to consolidate the production
and marketing of its products in China (Field survey, 1999).

During the second stage, the Coca-cola company was still constrained by some limitations
to further expand its business in China under the joint venture entry mode. Some of them

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were basically the same as those in the first stage. The behavior of its local partners was
still opportunistic. They wanted to focus on their own bottom lines rather than the
maximization of Coca-Cola’s market share in China. The problem was raised from the
fact that the local partners did not have a strong grasp of the concept of marketing and
market share. Moreover, there was a yichan dingxiao policy that highly constrained the
growth potential of the joint ventures in the carbonated soft drinks market. Another
serious difficulty faced by Coca-Cola was its limited knowledge (i.e. bounded rationality)
to fully appreciate the financial difficulties that were faced by its local partners for a long-
term expansion strategy of their joint venture businesses. This was largely because Coca-
Cola’s partners were partially owned by local governments or various ministries which
had inadequate finances that were necessary for the expansion of the joint venture.
Furthermore, any major decisions about additional investment from the joint venture
partners had to be approved by the corresponding governments or bureau. The transaction
costs that were involved in cutting through local government red tape were very high.
Besides, the Chinese labor markets were rigid, and China did not have adequate
professionals that could be employed to take control over the production processes of new
plants.

As a result, the company’s market share increased only slightly during the second stage of
its entry. Between 1992 and 1993, when local soft drink producers controlled up to 70 per
cent of the market, Coca-Cola’s market share stagnated at 12 per cent. The small market
share limited the profitability of the company.

3.3. Hybrid (1993 – present)

In 1993, Coca-Cola decided to manage its local bottling partner through a franchise
agreement with foreign partners: Malaysia’s Kerry Group and Hong Kong’s Swire Group,
in an attempt to further internalize market transactions and increase efficiency. Teaming
up with these local firms, which were engaged in locally sourcing human resources and
capital, is the underlying success of Coca-Cola’s third entry mode, the hybrid strategy. In
the partnership, the Swire Group mainly produces and distributes Coca-Cola products in
southern and central China, while the Kerry Group focuses on northern and interior
China.

Advantages

Partnering up with Kerry and Swire enabled Coca-Cola to leverage their local knowledge,
unlocking their competitive advantage and gaining access to local resources, such as
networks with distribution partners and vendors. Its local partners have the advantages of
strong distribution arms and knowledge of local beverage markets, which helped Coca-
Cola know the soft drink marketing trends.

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The Coca-Cola Company could also take advantage of the human capital, which were
brought in by the foreign partners. This could be achieved thanks to the characteristics of
a business owned by the franchisee. The franchisee must operate under the franchisor’s
name, using his system and within the terms of the franchise agreement. They added that
the ability of a franchised business to achieve growth is by linking the franchiser with his
franchisees, who possess the capital and manpower to operate the business. This type of
agreement fundamentally addresses the shortages of capital and human resources faced by
Coca-Cola in its strategy of expanding market share in China.

The Kerry and Swire Groups are also rich in cash. They share the goal of long-term profit
and market share maximization of Coca-Cola and have strong political connections to the
Chinese Government.

Results

After years of coupling with each other, currently, the Swire and Kerry groups have
constantly provided Coca-Cola with the needed cash that has enabled it to achieve long-
term profitability and maximization of market share. Furthermore, the partnership enabled
the company to build strong connections with the Chinese government. The Chinese
government wished to give the Coca-Cola Company the power to transfer its knowledge
and equipment assets in the production of beverages to the local partners so that the
partners could establish a local brand. This arrangement worked out through a joint
venture with Coca-Cola using its 50-50 joint venture with the local partners to help the
local partners establish local brands. The brands that have been developed include
Xingmu and Tian YuDi.

The partnership has given Coca-Cola Company a huge benefit of achieving the objective
of Chinese beverage market share maximization. In 2000, Coca-Cola’s market share had
reached 40%t, which was higher than the market share of its largest competitor, Pepsi-
Cola. The ability of the joint ventures to reduce costs and enhance revenues has
outweighed the benefits the wholly owned subsidiaries. The company gave Swire and
Kerry groups management rights in order to guarantee the benefits on long-term benefits.
The foreign firms were given the rights to control bottling plants and directly control
distribution activities.

The above mode of investment by a combination of a joint venture with local partners and
franchise arrangement with foreign partners shaped the features of the development of the
Coca-Cola company’s third stage development in china. The joint venture and franchise
arrangements have formed part of Coca-Cola’s internalization strategy in China. The
strategy has promoted the growth of the company in China through the acquisition of a
larger market share.

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4. The repercussions to the long-term strategy entry of Coca-Coca’s

During the first two decades of Coca Cola market entry in China, the company has faced
four major challenges that limited itself in developing a long-term strategy.

The first challenge was at that time, the Chinese market was highly fragmented, and the
wholesale and distributional systems were outdated. That was more complicated when
Coca Cola was a de facto concentrate wholesaler and did not have access to the operation
of the bottling plants. Furthermore, the company’s local market agents were fully
responsible for production and distribution during the initial stages of market entry.

The second problem was although the local partners played a passive role in Coca-Cola’s
entry into the Chinese market, they acted out of self-interest and were opportunistic in
running the bottling business. As a result, the company had neither a strong incentive to
acquire market share nor a long-term development strategy. These two challenges can be
considered as the high transaction costs that happened due to uncertainty in the market
environment and the opportunistic behavior of market agents.

Thirdly, the Chinese government implemented strict controls for foreign companies in
favor of the local domestic brands. That prevents Coca Cola from entering the Chinese
market under the form of a joint venture. And the last problem was that the local partners
were too poor to finance further business expansion. Also, since they were partially
owned by local governments or various ministries, the major investment decisions that
were made by the JV partners had to gain official approval.

These two above challenges incurred as consequences of bounded rationality. Coca Cola
did not have a full understanding of the paternalistic attitude of the Chinese Government
in nurturing indigenous soft drink makers. Then, the company could not appreciate the
financial challenges of the local partner that limited the expansion of its operations.

In order to reduce the effects of the challenges, the company had to change its operations.
It internalized the market’s high transaction costs through a long-term investment
strategy. With the approval of the Ministry of Light Industry, Coca Cola was able to
coordinate this and increase its control in production and distribution of soft drinks.

The company acquired the majority of shareholding in bottling plants, which gave it the
power to assume managerial control. However, gaining this control was costly and having
high risks of direct investments. Therefore, Coca-Cola teamed up with two foreign
bottlers under a franchise agreement. The new entry model enabled the company to
expand its market share and become competitive.

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CONCLUSION

Our presentation is carried out with a view to providing an insight into market expansion
strategy of a global soft drink manufacturer in China. The changes of Coca Cola’s mode
of entry from franchise, joint venture to hybrid have contributed to the stable growth in
market share and a high degree of marketing penetration in China. Through the analysis
mentioned above, it is acknowledged that shifts in various entry modes can reduce the
effects of market imperfection.

We would like to express our special thanks to Mrs for your dedicating support and
guidance in the process of completing our presentation as well as in International
Business course.

Due to our own personal time constraint and limited knowledge, the mistakes in this
presentation are inevitable. Therefore, we look forward to receiving your comments and
suggestions. Thank you for your time and consideration.

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REFERENCES

Cavusgil, S.T., Knight, G., Riesenberger, J. R., ‘International Business: Strategy,

Management and the New Realities’ 2nd edition

Wang, Z. (1998), ‘The Investment and Development of Coca-Cola Business in China’,

Zhongguo Waizi Volume 10

Mok, V., Dai, X., Yeung, G. (2003), ‘An Internalization Approach to Joint Ventures:
Coca-Cola in China’, Asia Pacific Business Review Volume 9

Wührer, G., Bilgin, F. Z. (2014), ‘International Marketing Compact’

Tongji, W. (2002), ‘Statistics of Foreign Direct Investment’, Ministry of Foreign Trade

and Economic Cooperation. (MOFETC). Retrieved from:
http://www.moftec.gov.cn/moftec_cn/tjsj/wztj/wztj_menu.html

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