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Dynamic Quad

Yum! Brands in China


Darius Hubbard
Grace Ma
Denise Odaro
Monica Perez

MGTO 651W Doing Business in China


3/23/2009
Contents

Contents............................................................................................................................... 2

Background on Yum! Brands.................................................................................................3

Foodservice Industry in China...............................................................................................4

As recently as the early 1990s, China consumers had very few options in the way of fast
food. If consumers wanted quick service restaurant dining, they typically had two options –
street side vendors or hotel restaurants. In a little over a decade, the landscape of China’s
fast food market has changed dramatically. Chinese consumers now have a plethora of
fast food options to choose from. These options include McDonalds, Japan’s Mos Burger
and Rongua Chicken. However, with 2500 KFCs and 400 Pizza Huts, Yum Brands has a
leading position in China’s Quick Service Restaurant market. Yum restaurants in total
make up an astounding 16% of the fast food market. The company’s restaurants
outnumber McDonalds 3 to 1 – an amazing statistic given McDonald’s dominant position
elsewhere in the world. ........................................................................................................4

Yum! Brands Successes ....................................................................................................... 4

Competitive Advantages....................................................................................................4

Challenges............................................................................................................................5

Recommendations................................................................................................................ 7

Appendices ..........................................................................................................................8

Appendix 1 - Historic Sales Growth - CHINA DIVISION SYSTEM SALES GROWTH (Local
Currency)
(Mainland China, Thailand, KFC Taiwan) ...........................................................................8

Appendix 2 – Restaurant Counts (2008) ...........................................................................9

2
Background on Yum! Brands

Yum! Brands is the world's largest restaurant company with a whopping 36,000 restaurants in over 110
countries and territories – 19,790 of which are in the United States. The company employs more than 1.4
million associates with revenues in excess of $11 billion in 2008, Yum! is ranked #253 on the Fortune
500 List. The company runs a group of diverse fast food eateries under different brands;

• A&W Restaurants (Global)


• Kentucky Fried Chicken (Global)
• Pizza Hut (Global)
• Taco Bell (Global)
• WingStreet (United States and Canada)
• Long John Silver's (United States, Puerto Rico, New Zealand, Australia and Singapore)
• Angelina's (United States)
• Dong Fang Ji Bai 东方既白 (East Dawning) (People's Republic of China)
• Ayamas pronounced: uh-yum-ahs (Malaysia)

Four of Yum’s restaurant brands: KFC, Pizza Hut, Taco bell and Long John Silver’s are the global
leaders of the chicken, pizza, Mexican-style food and quick-service seafood categories.
Yum! Brands was spun off from PepsiCo as Tricon Global Restaurants, Inc. in 1997 with the established
goal to be “the best in the world at building great brands and running great restaurants”. The company
grew as it acquired Yorkshire Global Restaurants which owned Long John Silver’s and A&W All-
American Food chains in 2002 and soon after changed the name of the consolidated company to Yum!
Brands. The growth of Yum! Brands in the United States has stifled as the domestic market is at
saturation point. Thus, Yum! Brands targets foreign areas for growth in its business. Yum’s international
division is the platform for the company’s growth and China is undoubtedly one of the major focuses.
The China Division includes mainland China, Thailand and KFC Taiwan and is based in Shanghai.
However, mainland China is Yum! Brands focus market for new company restaurant development
outside of the United States. In 2008, operating profits for the China Division were $469 million and the
company opened more than 500 new restaurants last year in mainland China. Due to its size, unique
strength and importance, the division has reported directly to the headquarters, bypassing Yum!
International in the reporting line, since the beginning of 2005.

Yum’s strategy is to be the market leader in every major food service category in mainland China. Yum
took KFC to China in 1987, the first quick-service restaurant chain. The company was also first to take
franchising to China in 1992 and in 2002, it was also the first to open a drive-through in China. KFC
continues to be the number one quick-service restaurant brand and the largest and fastest growing
restaurant chain in mainland China today, with approximately 2,500 restaurants in 500 cities. Though
this number is way below the c.20,000 KFC restaurants in the US, Yum! opens nearly one new KFC
every day in mainland China and there still exists a lot of depth for penetration. The company’s goal is
to reach 20,000 units in the long term.

Again, Yum! made another debut in China with the introduction of Pizza Hut in 1990, the first
restaurant chain to introduce pizza and Western-style casual dining to China and in 2001 it became the
first pizza delivery restaurant in China. Today Pizza Hut is one of the leading casual dining brand in

3
mainland China with 400 Pizza Hut Casual Dining restaurants in nearly 100 cities and an additional 79
Pizza Hut Home Service delivery units.

Foodservice Industry in China

As recently as the early 1990s, China consumers had very few options in the way of fast food. If
consumers wanted quick service restaurant dining, they typically had two options – street side
vendors or hotel restaurants. In a little over a decade, the landscape of China’s fast food market has
changed dramatically. Chinese consumers now have a plethora of fast food options to choose from.
These options include McDonalds, Japan’s Mos Burger and Rongua Chicken. However, with 2500
KFCs and 400 Pizza Huts, Yum Brands has a leading position in China’s Quick Service Restaurant
market. Yum restaurants in total make up an astounding 16% of the fast food market. The
company’s restaurants outnumber McDonalds 3 to 1 – an amazing statistic given McDonald’s
dominant position elsewhere in the world.

Yum! Brands Successes


Yum! Brands was first to Market with the first KFC outlet in Beijing in 1987. 1 As such, they have been
able to maintain their market leadership in China. KFC’s menu also happened to match local taste
preferences. With its chicken-based menu favored by the Chinese palate, KFC has always stayed ahead
of McDonald’s, both in terms of store numbers and brand awareness. KFC has also focused on
extending its reach into second- and third-tier cities, where it is the top fast-food brand in the minds of
local residents2 Yum! Brands has pushed KFC the farthest in tailoring its menu to Chinese tastes, with
offerings ranging from pumpkin porridge to Beijing chicken rolls. Earlier this year it even added the
traditional Chinese deep-fried twisted dough stick (youtiao) on the breakfast menu. 3

Competitive Advantages
The company owns and operates the entire distribution system for its restaurants in mainland China.
This competitive advantage gives the company coverage in every major Chinese province, which has
allowed it expand so aggressively, which is critical as the Chinese population grows. Moreover, this
gives Yum! an advantage in bringing ideas and products to market as well as the ability to quickly pull
unsuccessful items off the menu.

As a market leader, Yum! has invested heavily in innovation and progress. In 2005, Yum! Brands
introduced East Dawning, which is their new Asian style fast food in 2005 after perceiving potential for
another Asian fast food provider. As of the fourth quarter 2008, there were 17 stores. As a result, this
confirms that Yum! holds the leading position in fast food in China. 4

The combination of Asian foods and Western operational methods is expected to be the trend. Even
with the general increase of disposable income and fast expansion of Western-style fast food, consumers
are less interested in KFC and McDonald’s and Chinese foods remain the main choice. However,
advanced Western operational methods, speedy and efficient service, are still necessary for the further
development of the industry and East Dawning operated by Yum! may be able to meet that need. 5

1
Economist Intelligence Unit. “China industry: Here comes a Whopper.” September 15, 2008.
2
Economist Intelligence Unit. “China industry: Here comes a Whopper.” September 15, 2008.
3
Economist Intelligence Unit. “China industry: Here comes a Whopper.” September 15, 2008.
4
Euromonitor International : Country Sector Briefing. “Fast food in China.” October 2008.
5
Euromonitor International : Country Sector Briefing. “Fast food in China.” October 2008.
4
Yum! Brands franchises its stores, which has reduced their risk and costs as they aggressively open
stores in Tier 2 and Tier cities. Out of the total restaurants operated by the company internationally,
72% are franchisees.6 Yum! Brands is currently reducing the number of company-owned stores. The
lower costs and risks involved are increasingly appealing to the company as pressure grows for the
company to compete on its primary markets.

Challenges
Economic growth in China has dipped to a seven-year low of 6.8% in Q408, dragging full-year growth
for 2008 to 9.0%, which is a sharp decline from the 13.0% in 2007. This is the first time since 2002 that
the world's current third largest economy has failed to reach double-digit growth. Analysts predict that
recent macroeconomic data shows that economic activity continues to cool and any turnaround for the
Chinese economy will not occur until the second half of 2009 at the very earliest. It is much more likely
that the economic recovery will not occur until 2010. Expected real GDP growth will most likely slow
to around 5.6% in 2009, before recovering to around 6.8% in 2010.7

Price is still too high for some Chinese and it is the most important consideration for consumer. In the
United States, fast-food chains often thrive in tough times. Unfortunately, this is not the case in China.
Western quick-service food is not the cheapest option for the Chinese consumer and in some target
markets like Shanghai, there is simply too much competition for fast food. 8

Additionally, fast casual dining is still negligible in China. Fast casual is defined as the combination of
fast food and casual dining, which targets the high-end market with high-quality food and speedy
service. However, because price is still the first consideration instead of dining environment for Chinese
consumers when choosing fast food, providers will have to be aware of their price with respect to their
competitors’ prices. In first tier cities, it has been difficult for fast casual dining to develop because
KFC and McDonald’s have such wide coverage. This has been to the advantage of Yum! Brands. For
lower-tier markets, it is even harder for the casual dining environment because consumers simply cannot
afford the expensive fast food.9 Additionally, Pizza Hut’s image in the China is drastically different
than in the U.S. It is seen as a classy, up-scale place for dining, which reinforces that the image of
luxury and a splurge for a consumers and families.10

The awareness of health in China is growing. Consumer are starting to take more care in what they
choose to eat and consumers are showing more interest in nutritional and dietary considerations, which
can be a potentially significant challenge for fast food chains. Some, including Warren Liu, author of
“KFC in China: Secret Recipe for Success." consider this to be the first signs of a long –term trend. 11 To
make a bad situation worse, Western fast food, chicken and hamburgers, are attractive, but are not seen
as a daily meal by Chinese consumers. Asian fast food is still more popular and dishes that include rice
are considered healthier and more balanced in nutritional terms. 12

Politics in China should always be a consideration for a multinational. A few years back there were
highly publicized reports about poor working conditions and the backlash in the media has created a
6
Datamonitor. Company Profile. “Yum! Brands, Inc.” October 20, 2008.
7
Business Monitor International. “BMI View: China.” February 11, 2009.
8
Los Angeles Times. “China’s appetite for western fast food fades.” February 13, 2009.
9
Euromonitor International : Country Sector Briefing. “Fast food in China.” October 2008.
10
Datamonitor. “Yum! Brands embarks on expansion drive in China.” May 5, 2008.
11
Los Angeles Times. “China’s appetite for western fast food fades.” February 13, 2009.
12
Euromonitor International : Country Sector Briefing. “Fast food in China.” October 2008.
5
shift towards the creation of unions. Wal-Mart was the first case for unions. In 2007, Yum! Brands and
McDonald’s had to agree to worker representation after the Chinese press criticized them for not paying
minimum wages. It was of no consequence that the charges turned out to be false. If companies oppose
the implementation of unions, according to a senior union official who was quoted in the China Daily,
those businesses will be blacklisted. Unlike in democratic countries, these companies will not face, but
instead they will be subject to endless audits, tax examinations and, as in the cases of McDonald’s and
Yum! accusations of employment-law violations.13

The competition in the consumer foodservice industry is intense, with both local and foreign players
vying for market share. With Burger King entering the market and planning on opening up to 450 stores
over the next five years, Yum! will have to be able to differentiate its product in order to gain a loyal
customer base in an industry with low market entry barriers. Moreover, domestic outlets in China are
still unable to compete with multinationals in store or non-free-standing locations. In comparison to
multinationals, domestic consumer foodservice operators are experts at Chinese-style food, which is
generally not as convenient as Western fast food. As a result, consumers would rather choose the
convenient Western food in travel locations rather than having a full dinner in a Chinese restaurant.
However, in order for non-free-standing locations to share the market, these domestic outlets are trying
to develop fast food with convenient packaging, which will only increase the competition in the fast
food market. 14

Given the nature of the foodservice business, Yum! Brands, is affected by any fluctuations in the price
of beef, chicken, or cheese, all of which are critical ingredients. The company is vulnerable to any
increases in food costs due to the economy, weather, food safety and may not be able to pass this
additional cost to its customers, primarily because of the existing competition in the market. Also,
significant increases in fuels costs could affect profit margins as can an increase in property costs, which
will also affect Yum! Brand’s bottom line.15

13
Economist Intelligence Unit. “China business: Membership required.” August 1, 2008.
14
Euromonitor International : Country Sector Briefing. “Consumer Foodservice by Location -
China.” October 2008.
15
Datamonitor. “Yum! Brands embarks on expansion drive in China.” May 5, 2008.
6
Recommendations
To address the problem of rising commodity prices
Rising food costs, due to global inflationary pressure, strong demand and lack of supply of commodities,
has affected Yum! Brand’s profit margins, where the restaurant’s 4th quarter 08 profits fell 12% as sales
slowed in China16 (See Appendix 1). Thus, we recommend that Yum! Brand should control its input
costs very carefully to maximize its profit margins. E.g., it should consider sourcing alternative supplies
from other Countries; or to manufacture it’s own products by going up the supply chain and setting up
its own factories and farmland. To address the adverse effects caused by tight pork supplies, lower than
expected output in chicken and increase in chicken exports that also affected input costs17, we
recommend Yum! China division to expand and regularly change the food menu to diversify its supply
needs, e.g., include other food categories its KFC menu to avoid over reliance on chicken supply etc.
Fierce Competition
To increase competitiveness, we recommend that Yum! China should continue engage in innovative
product differentiation by continue to tailor its menu to Chinese taste and consider commercialization of
Chinese cooking techniques, as this is particularly important for its East Dawning brand’s operation in
China. Moreover, Yum! China division should engage in continuous segmentation process depending
on geographic, demographic, behavioral variables18 and psychographics of consumers19 in different
regions of China, and target these niche markets using its different brands and change its marketing mix
(4 Ps) to gain market share in smaller cities such as 2nd and 3rd tier cities via expansion.
In order to support the aggressive expansion plans in China, Yum! Brand should continue to invest,
expand and upgrade its logistics and distribution network to increase efficiency and cut costs. E.g. it
should continue to invest in food safety such as securing clean freezer space; provide further staff
training and implement policies on food handling and OH&S issues; to build work-class distribution
system and facilities to support the distribution network in order to expand into 2nd and 3rd tier cities and
to support its online home delivery service business model. Yum! Brand should also build integrated
communication plans and marketing systems to support its diversification strategy20 to ensure that Yum!
China has true managerial control over all of its 3,582 stores in China (see Appendix 2 - information on
China, US and International restaurant counts for Yum! Brand Inc. in 2008) and that top management is able to track
sales, supplies, performance of its stores sand consumer preferences across China and worldwide in
order to implement necessary operational changes on a global basis rapidly to gain competitive
advantage. Moreover, it should align its HRM system with the organization’s culture and architecture,
such as implementation of incentive linked remuneration package, develop strategic recruitment and
training plans; talent management plans and performance appraisal systems etc. to build human capital.

16
Dentch C, ‘Yum! Brands Profit Declines as China Sales Slow (Update 2)’ 3 February 2009
<http://www.bloomberg.com/apps/news?pid=20601089&sid=a0VbZo1elK7A#>
17
MacNealy J, ‘Food on Call: Yum! Builds a Chinese Dynasty’ 17 July 2007 <http://www.fool.com/investing/dividends-
income/2007/07/17/fool-on-call-yum-builds-a-chinese-dynasty.aspx>
18
E.g. the urban affluent, Gen Y, the upper middle class, the lower middle class (see Lane K, St-Maurice I & Dyckerhoff C,
2008, ‘Building Brands in China’, The McKinsey Quarterly) and consumers from different regions, cultures etc
19
Marketing Management, 2008, AGSM EMBA
20
Ansoff Product Market Growth Matrix
7
Build strong brand
To move forward, Yum! China division should leverage its competitive advantage by continue to build
strong brand in China by focusing on ‘consumer experience’21 using its multi-branding strategy for
different target niche markets in order to increase brand awareness, preference, loyalty and brand equity.
In addition to the abovementioned recommendations, we suggest that effective marketing and
promotional methods tailored to different consumer segments would assist in brand building given the
diversity of Chinese consumers. For example, the company could target the professional/business
segment by promotions in business newspapers, news channels and outdoor advertising in business
areas. It could target generation Y consumers via TV commercials using advertisements with contents
that bond with them similar Nike’s advertisement. It could also target young urban segment by continue
to collaborate with QQ.com22, China Basketball Association23 and other large organizations to organize
events and online activities; and to continue to sponsor Chinese celebrities and Olympic teams etc.
Moreover, Yum! China division could use its wide distribution channel for promotional and marketing
purposes. It should continue to expand its online distribution channel and home delivery service to
appeal to Generation Y consumers and to expand its Drive-thru distribution channel in retail outlets to
capture opportunities given increase in car ownership in China.
Food Safety and quality and social responsibility
Furthermore, given the history of food scares of New York rat infestation issue and the E Coli outbreak
at Taco Bell in 2007 in U.S 24, we recommend that Yum! China division should continue to constantly
monitor food safety and quality by ensuring proper implementation of food safety policies not just in all
stores, but also down the whole supply chain e.g., qualify all supplies base on food safety and quality
standards similar to Wal-mart’s ‘sustainability agenda’25; regularly monitor and audit hygiene standards
of its suppliers’ factories, its own factories and the whole distribution channel. It could also further
participate in environmental protection, animal welfare and further improve its Corporate Governance
practices given that these will be factors that differentiate themselves from other competitors, and what
Chinese consumers will value in the long term.

Appendices

Appendix 1 - Historic Sales Growth - CHINA DIVISION SYSTEM SALES GROWTH (Local Currency)
(Mainland China, Thailand, KFC Taiwan)
2008 2007 2006 2005 2004

1st Quarter 28% 19% 14% 26% 17%

21
Week 4 Course notes, Doing Business in China, HKUST MBA
22
QQ.com – chance to win free mobile phone for choosing a song that you would like to hear in KFC stores in China
http://kfcmusic.qq.com
23
CBA – Yum! China division’s sponsorship for 3-on-3 basketball tournament in the past 5 years: see
http://kfcsports.qq.com/html/news081222 01.html
24
Kaminis M, ‘Tasty Chicken, Tepid Price’, 28 June 2007 <http://www.fool.com/investing/general/2007/06/28/tasty-
chicken-terrible-price.aspx>
25
Where suppliers will be dropped if they failed to comply with the terms and conditions specified in the suppliers
agreement: see Winston A, ‘Wal-Mart’s New Sustainability Mandate in China’, Business Week, 28 October 2008
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2nd Quarter 28% 19% 29% 2% 34%

3rd Quarter 18% 23% 25% 11% 20%

4th Quarter 15% 30% 23% 6% 21%

Full Year 20% 24% 23% 10% 23%


Source: http://www.yum.com/investors/historic_sales.asp

Appendix 2 – Restaurant Counts (2008)


East
Dawnin
  KFC PH TB A&W LJS g Total

USA 5,253 7,564 5,588 363 1,022 – 19,790

Mainland
China 2,980 585 – – – 17 3,582

International 7,347 5026 245 38 264 – 12,920

              36,292

Source: http://www.yum.com/investors/restcounts.asp

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