Road to China paved with fortune, risk

 
Jan. 30, 2008
For hundreds of years, outsiders have viewed China as a mysterious, backward land. Although the country has vast resources and a population topping 1 billion, the Communist revolution of the 1950s and Mao Zedong's "Great Leap Forward" left the country's education system and its economy in disarray.
 
Beginning in the late 1970s, however, China's economy began to awaken from its slumber. While the size of the U.S. economy has doubled over the past 30 years, the size of China's economy has tripled. While the purchasing power of the average U.S. citizen has stagnated, the purchasing power of the average Chinese citizen has multiplied tenfold. If the Chinese economy continues to grow at its current rate, the purchasing power of Chinese citizens soon will surpass that of their U.S. counterparts.
 
Such tremendous growth presents vast opportunities for U.S. businesses entering the Chinese market, but along with those opportunities come corresponding pitfalls.
 
To illustrate the potential rewards of doing business in China, one needs to look no further than Louisville, Ky.-based Yum Brands Inc., operator of the KFC, Pizza Hut and Taco Bell brands. KFC was the first quick-service restaurant to operate in China, launching its first location in that country in 1987. Today, KFC is the No. 1 quick-serve brand in China, operating about 2,000 restaurants in more than 400 cities. 
             
Likewise, Yum's Pizza Hut brand was the first restaurant chain to introduce pizza to the Chinese market, opining its first restaurant in that country in 1990. Pizza Hut now operates nearly 300 casual-dining restaurants in more than 60 cities and more than 43 home-delivery units in six cities.
 
"Our biggest consumer issue is the length of consumer wait times during dinner," said Yum CEO David Novak in the company's third-quarter 2007 conference call to investors and analysts. "The good news is that it simply means more growth opportunities."
 
Overall, Yum operates nearly 2,400 restaurants in mainland China, Thailand and Taiwan. As of the 2007 third quarter, the company saw 11 percent same-store sales growth and systemwide sales of $581 million, up 30 percent from the first nine months of 2006.
 
Other pizza chains are taking notice. Papa John's International operates more than 60 restaurants in China and plans to open 250 more restaurants there over the next four years. Domino's calls its presence in mainland China "small," but in 2006 the company signed a master franchise agreement with Formosa International Hotels Corp. for the rights to build Domino's restaurants in Taiwan, Beijing and Shanghai.
 
According to a report compiled by research firm Market Avenue, the Chinese fast-food market continues to enjoy rapid growth. The market for fast food in China in 2005 was valued at more that $27 billion per year, up 40 percent from the previous year; however, by the end of 2006, the market topped $34 billion, an increase of 33 percent over the previous year.
 
Not all good fortune
           
Despite the rosy reports coming from Yum's headquarters, the company has experienced its share of problems. In the fall of 2005, sales at KFC units in China fell sharply following fears of an avian flu outbreak in several Asian countries.
 
In 2006, a newspaper in the city of Guangzhou accused KFC and Pizza Hut, along with McDonald's, of underpaying workers by as much as 40 percent below the legal minimum wage. Although labor officials later cleared the companies of wrongdoing, saying the workers in question were part-timers, and therefore not covered under minimum-wage rules, the Chinese newspaper Kuai Xin Bao accused Yum and McDonald's of exploiting loopholes in China's labor laws at the expense of workers.
 
More recently, an editorial in the Shanghai Daily newspaper compared the spread of Western companies such as KFC and Pizza Hut to the influence wielded by foreign powers in China in the 1800s and early 1900s. The editorial decried the fact that in a land famed for its diverse cuisine, the largest restaurant chains are KFC and Pizza Hut.
 
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"Whilst the opening up of China has brought unprecedented economic growth and prosperity, it has drawn the foreigners back with a vengeance," wrote Shanghai Daily columnist Douglas Williams in the Sept. 20, 2007, editorial.  "Many of the changes are for the good, but many are not. A great deal are the result of, if not foreign powers as such, then certainly foreign corporate powers."
 
A backlash against Western companies operating in China could have very real consequences. Last year, public outcry led to the closure of a Starbucks location in Beijing's Forbidden City. Critics charged the coffee shop, opened in 2000, was an insult to Chinese culture. The outlet was replaced by a café serving coffee and Chinese tea.
           
Despite the bumps, Yum continues to look at China as the future of the company. The company is projecting at least 425 new restaurant openings in mainland China in 2008, including 310 KFCs, 85 Pizza Hut casual-dining restaurants and 20 Pizza Hut home-delivery units.
 
Yum has a long-term goal of opening 15,000 KFC stores, 2,000 Pizza Hut restaurants and 5,000 home-delivery units in China. The company considers China to be its No. 1 market for new restaurant development.
 
"Believe me, this number is more than realistic when you consider that mainland China has over 1.3 billion people with growing wealth and significant personal savings, while McDonald's has over 14,000 restaurants serving 300 million customers in the U.S.," Novak said.

Topics: Operations Management , Pizza Hut


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