How Chinese Businesses Can Test Unit Profitability Before Franchising

Before turning an existing business into a franchise network, a company needs to answer a specific question: can a typical outlet remain viable without the founder’s hands-on oversight and with all the costs it would face as a franchise? The purpose of a company-owned pilot is not to showcase the most impressive results, but to identify which profits are repeatable and which depend on special advantages. This article focuses on how businesses in mainland China can carry out that assessment.

1. Separate the ‘two outlets, one year’ rule from commercial validation

Article 7 of China’s Regulations on the Administration of Commercial Franchising requires a franchisor to have a mature business model and the ability to provide ongoing operational guidance, technical support, business training and related services. To engage in franchising, it must have at least two company-owned outlets that have been operating for more than one year. Organisations other than enterprises, and individuals, may not act as franchisors.

The ‘two outlets, one year’ rule is a legal requirement, not a certification of profitability. Two outlets meeting the operating-history requirement does not automatically prove that a typical franchisee can replicate their results. Equally, even exceptional profits at a flagship outlet cannot replace the statutory requirements.

When preparing a pilot, create two separate checklists: one to verify the entities operating the company-owned outlets, their actual trading histories and supporting evidence; another to record outlet profitability, reliance on particular people and the support required from head office. For specific questions, such as whether outlets operated by affiliated companies can count as evidence, check in advance with the commerce authority responsible for the intended filing rather than making your own assumptions.

Under the Regulations and the Measures for the Administration of Commercial Franchise Record Filing, franchisors must complete their filing within 15 days of signing their first franchise agreement. Filing is not government endorsement of commercial returns, nor can it compensate for an immature business model.

2. Choose replicable outlets, not just the best showcases

Pilot conditions should be as close as possible to those available to future franchisees. The catchment area, floor space, rent, equipment and staffing should all be realistically attainable. Outlets that rely on the founder’s personal connections, low-cost premises owned by the business or a one-off influx of customers can offer useful insights, but should not be the sole basis for assessing profitability.

For each existing company-owned outlet, record at least the following:

• Sources of customer demand: How much revenue comes from walk-in customers, platform orders, head-office campaigns and the founder’s or team’s personal contacts?
• Operating conditions: Are rent concessions, fit-out subsidies and supplier discounts sustainable?
• Staff input: How much work do the founder and head-office staff actually contribute each week?
• Exceptional factors: What impact do opening promotions, public holidays, temporary closures and equipment failures have?

The observation period should capture representative trading fluctuations, rather than just peak season or the initial opening rush. Its length should reflect the nature of the business; an internal testing period should not be presented as a separate, standard legal requirement.

If the two outlets perform very differently, investigate the causes before discussing averages. When a high-traffic outlet masks losses at a low-traffic one, it often means the limits of the site-selection model are not yet clear.

3. Recalculate outlet economics from the franchisee’s perspective

A company-owned outlet’s reported profit may exclude costs borne by head office. Keep the actual accounts, but also prepare a separate ‘franchise scenario forecast’, clearly distinguishing actual figures from estimates.

On the revenue side, account for refunds, discounts and similar adjustments, and use a consistent basis for platform settlements. Costs should include raw materials, wastage, labour, rent, property management charges, utilities, platform fees and routine repairs. If the owner works on site without pay, estimate the salary needed to replace them with a suitably qualified manager.

Then add the proposed ongoing franchise fees, system fees, marketing charges and costs arising from the intended purchasing terms. Head-office support must not be treated as free labour: training, outlet visits and opening assistance all require staff time. The fee structure should be aligned with the support the franchisor can actually deliver.

List the initial franchise fee, fit-out, equipment, deposits and opening stock separately according to their nature. A refundable deposit is not a day-to-day operating expense, but it still ties up cash; equipment depreciation is also different from the cash payment for that equipment. A single ‘monthly profit’ figure is no substitute for a full assessment.

Track three outcomes together: whether the outlet generates an operating surplus, whether it has enough cash to meet payments as they fall due, and whether the initial investment can be recovered under reasonable assumptions. Any payback calculation must state its assumptions and must not be presented as a promise of returns.

4. Test independence from the founder before offering franchises

Let a manager who has completed the standard training run the outlet independently. The founder should stop stepping in to resolve routine problems, while retaining necessary oversight of safety, quality and compliance. Record the reason, time spent and cost each time head office intervenes. If profitability depends on the founder frequently working on site, the model is still not readily replicable.

Next, run stress tests by varying order volumes, raw material prices, labour costs and rent, then assess any cash shortfalls. There is no need to apply a standard percentage change across the board. Base scenarios on historical fluctuations, rental quotations and purchasing terms, and document the evidence used.

Before seeing the results, agree internal approval criteria. These might include continued viability after allowing for a manager’s salary and the proposed franchise charges; routine problems being resolved without the founder’s personal involvement; and sufficient head-office staffing to honour support commitments. These are the company’s own management standards, not statutory profitability thresholds.

For outlets that fall short, decide whether to change the outlet format, improve supply terms or pause expansion. Retest after revising the model. Do not remove unfavourable months from the data or present untested improvement targets as established facts when recruiting franchisees. China’s Regulations on the Administration of Commercial Franchising prohibit franchisors from advertising franchisees’ earnings from franchised activities, so pilot data cannot simply be turned into earnings-based franchise recruitment advertising.

Practical takeaway: Start with a pilot report covering actual trading data, costs under the franchise scenario, head-office staff hours and cash-flow stress tests. Decide whether to expand the franchise network only once an ordinary trained manager can run the outlet and the costs borne by both parties are fully visible.