A Study on KFC's entry into China

Jonas Short: 4123861


Economics of Strategy and Applications

Module Convenor: Dr. Jing Zhang

An Analysis of KFC’s strategies in China

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An analysis of KFC’s strategies in China

In 1987 KFC became the first genuinely global restaurant to enter into China with its first store in

Beijing. The venture was successful, serving an average of 9,000 customers each day, and it was

profitable after just one year (China Economic Daily, 2011). With a combination of effective

leadership, efficient distribution network, and localized goods; KFC’s internationalization and

innovation strategies have been remarkably successful in a very difficult market. In less than three

decades, KFC owns over 4,200 stores in China (Yum! Brands, Inc. 2012), and continues to expand; in

mainland China a new KFC restaurant goes up every 18 hours (Farm Futures, 2010). Located in all

provinces and autonomous regions except Tibet, the outlets serve more than 2 million Chinese each

day (China Business Review, 2004: 18). More than just being the first global restaurant in China, the

business has changed the culture. Firstly, KFC put customer service on the agenda of companies

across China, where previously customer service wasn’t in the lexicon of Chinese restaurateurs.

Secondly, KFC brought the concept of the fast food chain over to China, and has since spawned

successful local imitators. All of these remarkable statistics and cultural imprints have been made in

China despite very difficult circumstances. They have created a nationwide distribution network

from scratch, which even involves a barge crossing the Qionghou straight for ten hours in order to

deliver necessary ingredients (Liu, 2008: 91). In addition, KFC have brought American fast food to a

country that is renowned for an eclectic, regional cuisine; a culture where food is at the centre of

everyday life. This essay will seek to describe how the twin strategies allowed KFC to gain a

significant edge over its rivals in the Chinese market.

In order to assess the macro environment for China, this essay will adopt the PESL analysis

considering that it is more tailored to internationalisation strategy than the more traditional PESTLE

analysis (Political, Economic, Social, Technological, Legal and Environmental).

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Political: The growth of the Chinese economy has stemmed from its opening up to foreign

businesses. The Chinese government actively encourages foreign direct investment; not only for

growth and profit purposes, but also to learn business practices from western firms (Qingfen & Lann,

2011). However, the government struggles with transparency, according to the World Bank's Doing

Business (2013), China is 91st in the world. Furthermore, Xinjiang remains vulnerable to the outbreak

of small-scale ethnic violence due to the Islamic separatist movement. The volatility of these areas

poses a high political risk to the country.

Economic: The Chinese economy is perhaps the biggest driver for KFC’s international strategy. Its

strategy could be altered as a result of unequal economic development. East and Southeast China

are much more developed than the impoverished North and West of China. The country’s highly

industrialized east coast represents a stark contrast with the impoverished western provinces and

regions with many ethnic minorities (Marketline, 2012). The reason economic factors could be the

most important drivers for KFC is its impact on consumption. Private consumption stood at an low

35.5% of GDP as of 2011, which is among the lowest for any major economy. One-year deposit rates

have also been negative in real terms because of high inflation. In addition, due to its undervalued

currency, domestic consumption is further restrained. However, China’s per capita income adjusted

by PPP was $8,400 as of 2011, one of the highest levels in Asia (Marketline, 2012).

Social: Since 2009, China has embarked upon restructuring the healthcare system. Between 2009

and 2011 the government spent $125bn on revamping the structure (Marketline, 2012). The reforms

accomplished a number of goals, such as providing insurance coverage and increased

reimbursement to nearly 95% of the population. The 12th Five-Year Plan seeks to extend the social

safety net by increasing social welfare payments, increasing wages, and improving healthcare. The

12th Five Year plan will seek to increase wages by a minimum of 40% by 2015.

Laws: Reporting and accounting standards in China are well behind the Western system of

transparent and accurate accounting. Moreover, in China there is only a very small group of certified

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accounting professionals (Marketline, 2012). In June 2012, China will accelerate tax cuts in specific

sectors. Furthermore, the government has initiated several pilot programs to replace business tax

with VAT, simplifying the system. However, Chinese judges have not been provided with effective

safeguards to counter external and internal interferences. It is well-known that bureaucrats and

senior officials exert influence over judges, which results in preferential rulings. Consequently, the

legal system is perceived to be ineffective and unfair (Marketline, 2012).

In order to assess the attractiveness of the fast-food industry in China, Porter’s Five Forces

framework will be adopted. These five competitive forces include: the threat of entry, threat of

substitutes, power of buyers, power of suppliers, and the extent of rivalry among competitors

(Johnson, Whittington, and Scholes, 2011: 54). This pentagon provides a synopsis of the drivers in

the fast-food industry of China.

(Source: Marketline, 2012)

Buyer power: The main source of buyer power is the lack of switching costs. Within a given

price range, a consumer's choice of fast food provider is purely a matter of personal taste,

and can vary on a daily basis. Fast-food has a relatively high price elasticity of demand,

because it is not an essential good to consumers. High transaction volumes, however,

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means that the impact of any one consumer on revenues is small (Marketline, 2012). This

assessment is viewed as moderate.

Supplier power: Many of the foodservice suppliers are large companies, and the high

number of businesses they serve means that they themselves are under less pressure to

keep their prices down. Therefore, they have some leverage in exerting significant

negotiating power (Marketline, 2012). This assessment is viewed as moderate.

New entrants: Entry to the Chinese fast food market does not require large capital outlay,

meaning that new entrants are relatively plentiful. However, the market is still dominated

by large brands with KFC earning a 40% market share (Peterson, 2011). This assessment is

viewed as highly likely, but a moderate threat (Marketline, 2012).

Substitutes: Convenience and availability are the main drivers for choosing fast food; sales of

home convenience food in supermarkets offer strong competition against the industry.

Popular substitutes in China include instant noodles and microwavable frozen dumplings.

This assessment is viewed as moderate (Marketline, 2012).

Degree of rivalry: Brand power forms the greatest competition in the fast food market. While

particular segments of the fast food market can be concentrated in specific foodstuffs, the

market as a whole is fairly fragmented, with many independents as well as large chains

(Marketline, 2012).

A SWOT analysis of KFC in China suggests best practice to ensure that their competitive advantages

are sustained (Johnson, Scholes, and Whittington, 2011: 106). In addition, SWOT analyses lay the

path for a prediction into the future of health of the company. A SWOT analysis extends the ‘SWOT’

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acronym to, strengths, weaknesses, opportunities and threats. In regards to KFC China, their SWOT

analysis will include a brief summary outlined in the table below:

Internal Environment

Strengths Weaknesses

Strong human capital based on effective

staff training.

Diverse, localised menu – brand

acceptance

Efficient distribution network

Chicken scandal affecting brand image,

and a severe loss of consumer

confidence

External Environment

Opportunities Threats

Burgeoning middle class

Underdeveloped restaurant culture

leaves lots of room for growth

Domestic competitors and the rise of

McDonald’s

Health concerns in an age of social

media

Increases in consumer price inflation

Strengths

Strong human capital based on staff training

KFC’s strengths in China are as a direct result of its successful implementation of their internalization

strategy, twinned with an effective innovation strategy. KFC’s training of its staff has allowed the

company to gain a significant competitive advantage in terms of superior human capital. The key

benefit of human capital is that it should, in theory at least, be perpetually virtuous for the company.

The fact that KFC hires almost all of its employees in both junior and senior positions means that

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there is little disconnect in language and culture (Liu, 2008: 135). In addition, most of KFC’s staff

promotions come from within the company, so there is a unity in direction and a focus on corporate

culture. KFC’s employee growth is put best in the words of the CEO of YUM! Brands, David Novak,

“We found that people will leave a company for two reasons: They don’t feel appreciated or they

don’t have a good relationship with their boss. That’s why we have fun with recognition, and why we

help our leaders become coaches who develop people rather than be bosses.” (Galagan, 2013).

Diverse, localised menu

Before introducing a new product, the company conducts surveys, product sampling, and organizes

focus groups. Yum! Brand’s research revealed that Chinese customers prefer dark meat; KFC now

uses dark leg meat instead of white breast meat for its chicken burgers in China. The company also

serves the Dragon Twister—a wrap with Peking duck sauce, onions, and fried chicken strips instead

of Peking duck. KFC removed coleslaw from the menu when it did not sell well and replaced it with

Chinese style salads whose vegetables vary with the seasons (Miller, 2004). This strong adaptation

culture has enabled KFC to garner a respectable following; KFC China is not looked at as a foreign

outsider but rather as a trusted, admired western brand with local appeal (Farm Futures, 2010). This

extends not just to a localised menu, but to a large menu because Chinese customers like to buy a

few dishes and share them (Starvish, 2011). The stores are also double the size than in the US

because instead of a restaurant geared towards takeaway, KFC ensures its space is large enough for

its customers to sit down and enjoy a proper meal for a special occasion (Bell and Shelman, 2011).

Efficient distribution network

According to Bell and Shelman (2011), KFC now has the most advanced and integrated cold-chain

system in China, with 11 full service logistics centres and six satellite centres serving every province

except Tibet. Most products are sourced in China. Buying locally is essential to keeping costs low,

and it strengthens the parent company’s relationship with the Chinese government.

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Weaknesses

Chicken scandal affecting brand image and consumer confidence

In the final quarter of 2012, state run media became aware of the fact that a KFC supplier of chicken

had injected growth hormones and antibiotics in its chickens to grow them full size in just 45 days

(WSJ, 2013). Since then, KFC’s Q4 2012 same-store sales in China dropped 41%. Indeed KFC’s parent

company YUM! Brands said it would have to downgrade its global earnings estimates for 2013

(Brand Insight 2012). While in recent years, revenue from China was becoming a more significant

contribution over the last decade or so, in 2012 it was China that was dragging down profitability.

Figures obtained from Farm Futures (2012) show same store sales grew in Yum’s US and

international units, and in China contracted 20%, pushing profits down 40% to $154 million. This is a

large blip considering the same period a year ago; the comparable figure in 2011 was a 21% increase

(Economist, 2013).

Opportunities

Burgeoning middle class

Many retail companies all over the world have been entering China in order to gain access to the

spending power of the most populous nation on earth. KFC enjoys the early mover advantage of

being a trusted and recognised brand in every province and almost every city. The dramatic increase

in wages the last decade is evidenced in this graph below

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This graph only highlights the urban wage rate because the price of KFC China and its restaurant

locations make it only available to urban residents. The income of urban residents has been growing

on an outsized basis every year consecutively.

Underdeveloped restaurant culture

According to YUM! Brand’s 2012 annual report, the company has about 58 restaurants per million

people in the US and only has fewer than 2 restaurants per million people in the top 10 emerging

markets. KFC is opening one new restaurant a day, starting from a base of more than 4,200; the

eventual ambition is for KFC China to reach 15,000 outlets (Bell and Shelman, 2011).

The third quarter of 2010 marked the first time that China revenue (more than $1.1 billion) had

surpassed U.S. revenue, and many analysts expect that Yum! Brands’ China business will be twice as

large as its U.S. business within five years (ibid.).

Threats

Domestic competitors and the rise of McDonald’s

The retail food industry is highly competitive with respect to price and quality of food products, new

product development, price, advertising levels and promotional initiatives, customer service,

reputation, and restaurant location. While KFC enjoyed first mover advantage, this quickly

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diminished and the company has continued to innovate in order to stay ahead of rivals. However,

McDonald’s is planning to expand by more than 50% in China, from 1,300 stores in early 2011 to

2,000 by 2013 (China Economic Review, 2011). They have started to learn from the errors they made

early on in their endeavour, and are now more experienced in dealing with the complexities of

China. The existential threat of rivals from Asia is becoming more significant with each passing year.

In an interview for Insead Business School, Warren Liu reported that Ajisen Ramen, is a Japanese

chain that has been doing very well in various cities throughout China. Domestically, Zhen Gongfu, a

Chinese fast food chain is also showing a lot of promise. China Economic Review (2011) claim that as

the country grows wealthier and its domestic players become more mature, local rivals are bound to

emerge and eat up market share, just as they did in Japan, South Korea, Taiwan and Hong Kong.

Health concerns in an age of social media

The social media has changed the world; it has become a far more connected place, where news is

almost instantaneously reported. In the absence of verification, some false rumours can have

devastating consequences. The Wall Street Journal (2013) reports that local news and social media

frequently carry out allegations against companies, many of which are ill-founded. A highly visible

company could easily become the target of a consumer or government backlash against the

perceived negatives of fast food (Bell and Shelman, 2011). The main threat to KFC China comes from

the fact that foreign companies face particular scrutiny, KFC’s challenges in China demonstrate an

issue being magnified on the national level by the media (Brand Insight: KFC China). However, this

may not be an issue according to China Business Review (2004), as during the 2003 and 2004 SARS

outbreaks, many Chinese customers preferred to eat at Western QSRs. They believed that these

restaurants maintained more sanitary conditions than the average Chinese restaurant. Health

concerns do not stop at just food safety standards: as is akin to KFC’s threats in the West, it is a

consumer concern over health matters, which could prove to be a further headache to KFC China.

Rising health awareness among consumers is leading to a higher demand for low carbohydrate and

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calorie foods worldwide. Consumers are increasingly aware of the risks associated with obesity and

poor dietary habits. Unwelcome statistics can often provide the catalyst for regulatory change

against fast-food chains. The 2002 China National Nutrition and Health Survey revealed that 22.8%

of Chinese adults were overweight, up from 6% in 1982 (Bell and Shelman, 2011).

Increases in consumer price inflation

Increases in global inflation poses challenges for profitability. According to figures by Marketline

(2012), in 2011, commodity inflation in China has resulted in a rise of its commodity costs by 8% as

compared to the previous year. High inflation results in higher operating expenses which in turn

affects the company's margins. It also limits the company's flexibility to pass off its entire cost to

consumers as the company plans to extend its operations in price-sensitive emerging markets

(Marketline,2012).

This graph shows the annual change of China’s consumer price over four years, the prevailing trend

has been volatile but upward sloping overall. Inflation erodes the value of money over time. KFC

already targets China’s middle class (Yum! Brands Inc., 2012), since the prices are out of reach for

the average Chinese wage rate.

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In 1987, KFC began its joint venture partnerships with conglomerates such as the New Asia Group in

Shanghai. The importance of their joint-venture partnerships chiefly lay in the fact that their

partnered companies were in the food distribution business. At a time when joint ventures were the

only permitted entry mode for foreign firms, KFC China selected local partners with government

connections (Cho, 2009). The joint-venture partners were able to assist KFC China through

regulatory hurdles and government licencing, accessing logistical and distributional infrastructure

facilities, as well as accessing existing local suppliers (Liu, 2008: 47). As time progressed however,

problems arose in the joint venture partnerships. Warren Liu used to work for KFC China, he

describes his experiences working with joint ventures, “when trying to promote system-wide

standardization, the joint ventures were the hardest to convince. The partners had different

objectives” (Liu, 2008: 48). The author’s task was to centralise purchasing from suppliers, making it

standard across the board. The stiffest competition came from joint-venture partner (ibid.). Once JVs

were no longer required by Chinese regulations, and sufficient knowledge and resources had been

transferred from the local partners, KFC went direct in order to avoid the paralysis that can result

from disagreements between partners (Cho, 2009). However, those early years in KFC China’s

history sowed the crucial seeds for its current success. According to Bell and Shelman (2011), KFC’s

rapid expansion in China has allowed the company to widen the gap between its competitors:

McDonald’s has about one-third as many outlets and owns a 16% market share. While KFC had little

control as to its entry mode into China, KFC China struggled with a coherent expansion program.

Franchising is a very common choice for expanding fast food outlets. However, in KFC’s instance in

China the story did not follow past experiences of franchising in the United States. In 1993, KFC

franchised its business to a regional hub, Shaanxi’s provincial capital of Xian. However, KFC Xian

cooperated on many initiated programs, generally at a slower pace. A strained relationship lead by

differences in objectives caused KFC China to buyout KFC Xian. Yum! Brands intend on increasing

franchise stores as part of its next phase of development, however just 254 of its 4,260 stores are

franchised to different owners (Yum! Brands Inc., 2012). In neighbouring Hong Kong, the picture was

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very different. KFC first entered Hong Kong in 1973, and it quickly grew to 11 restaurants in the

following year. KFC quickly began to struggle as it misjudged the local market and the organic growth

model was ill-suited. By 1975, all 11 restaurants were closed. A decade later, KFC returned to Hong

Kong, franchising its operations to a company called Birdland, which was backed by a group of local

investors (Cho, 2009).

KFC’s expansion through innovation has lead a self-sustaining development plan, which may well

secure its future as the number one fast food brand in the coming decades. The innovation is both

product and process based. Under the capable leadership of Sam Su, KFC China assembled what was

known as the ‘Taiwan Gang’. A qualified and experienced leadership team was put in place; they

understood both the best industry practices outside China and the local context inside China. This

therefore enabled them to make the best judgement, concerning to what extent they should pursue

a localisation strategy across people, products, functions, geographic units, systems, policies, and

procedures (Liu, 2008: 135). Cho (2009) pointed out in an interview with former employee Warren

Liu that the ‘Taiwan Gang’ had accumulated at least 10, if not 15 to 20 years of fast-food industry

experience prior to landing in China. Though predominantly Western-educated, being ethnic

Chinese, they inherently understood China. Crucially, it is the innovative management scheme that

the Taiwan gang put in place that has allowed KFC China to become such a sustainable business. The

rotation scheme, whereby each new recruit works side by side with an experienced employee in

established outlets; once trained, they move to a new location (Bell and Shelman, 2011). This

practice of rotating a newcomer through KFC restaurant’s operation reflects their corporate culture:

a front-line centred culture (Liu, 2008: 113). Managers at Chinese KFC stores have familial

relationships with employees and encourage them to socialize with one another during breaks using

company provided video games. These methods have helped Yum! Brands to develop a culture of

customer service in China, a country where there is almost none (Galagan, 2013). The social aspect is

key because confident soft skills, are not easily taught, though it became a necessity when training

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Chinese employees. Research conducted by DDI (2011) finds that more than half of managers in

Chinese organizations lack skills in managing relationships, guiding interactions, and coaching for

improvement. Some China observers say the lack of these interpersonal skills is due in part to

China’s one-child policy. Most native new managers in China are only-children. To further the

education of their staff, every store manager is taken through a program that includes Stephen

Covey's self-help bible Seven Habits of Highly Effective People (Farm futures, 2010). In the words of

Yum! Brands’ President of Product Excellence, Joaquin Pelaez, “We are teaching a new generation of

Chinese how to think and innovate,". The KFC staff are taught that, in order to get great results, even

when there is no problem, they need a 'crisis-like' sense of urgency. Finally, Liu (2008: 135)

speculates that local employees will gradually replace the Taiwan gang, and the speed of localisation

at the top of KFC China’s organizational structure will accelerate, and eventually the baton will be

passed onto a truly local leadership team.

Another way KFC innovate is through product innovation. A key strength for the fast-food company

was to adapt to local Chinese tastes. Their competitive advantage is sustained through consistent

product innovation, catering to tastes not on a national scale, but on a regional basis too. For

example, Spiciness levels are very important to customers. The formative years of KFC China

involved selling the same recipes in all outlets. Shanghai customers complained that dishes were too

hot, while diners in Sichuan and Hunan complained that they were too bland. The company thus

changed its recipes to suit individual regions (Bell and Shelman, 2011). The Chinese KFC menu may

include fried dough sticks, egg tarts, shrimp burgers, and soymilk drinks (Starvish, 2011). As a result

of the complex geography of Chinese tastebuds, the company introduces about 50 new products a

year (some of them are offered only temporarily), compared with one or two in the U.S. (Bell and

Shelman, 2011).

This allows the essay to segue into KFC’s internationalisation strategy. KFC adopts a multidomestic

strategy at least in China. This is due to their adapting of local menus, but also of adapting to local

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culture; whether it is through tailored management schemes, or flexible eating environments.

Ghemawat (2001) applies the cultural, administrative, geographic, and economic (CAGE) distance

framework helps managers identify and assess the impact of distance on various industries. Distance

also has cultural, administrative or political, and economic dimensions that can make foreign

markets considerably more or less attractive. Joaquin Pelaez at Yum! Outlines the reasons for a

multidomestic internationalisation strategy, "When you localize and embrace the culture of the

people, the people respect you. Cultures, languages and values are different around the world. So

you have to think, how do you adapt an idea so that it is in touch with the heart and mind of the

local consumer?" (Farm Futures, 2010). KFC have managed to win over the hearts and minds of the

Chinese consumer through measures such as having a larger menu, so diners can order multiple

items to share (Starvish, 2011). Furthermore, many quick service restaurants (QSR) debate whether

to provide customers with counter service or full service in China, though most companies realize it

would be unpopular to ask customers to clear their own tables when they are finished eating (Miller,

2004). Restaurants in China tend to be double the size of the US; this is so that diners can linger in

the restaurant (Bell and Shelman, 2011). This is contrary to the United States where KFC’s

restaurants are centred around takeaway because American diners prefer to eat at home.

Perhaps the largest obstacle that KFC faced upon entering China was acquiring a reliable, efficient

distribution and supply network. In the absence of logistics providers, KFC China created a

distribution system to ensure adequate and high quality supplies. They established a distribution

arm in 1997, building warehouses and running its own fleet of trucks (Bell and Shelman, 2011). This

has been a positive note on KFC since they had no need to persuade sceptical partners. Su’s team

could easily create a tailor-made system using a familiar pattern. They started by poaching HAVI

(McDonald’s global supplier) employees to rapidly establish its own supply chain network, create

one of China’s most sophisticated refrigerated shipping systems (China Economic Review, 2011). In

addition to food supplies, almost all hardware and service categories across the board have been

localised. These supply localisation efforts brought KFC China not only significantly lower costs

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compared to imports, but also reduced risk due to supply interruption from unforeseen events like

shipment delays or bad weather (Liu, 2008: 136). However, when these events do arise; in order

circumvent the traffic jams that sometimes extend for miles in the winter for example, KFC relies on

contingency plans that involve renting temporary warehouses and reserving space on cargo airlines

(Bell and Shelman, 2011). KFC’s distribution and logistics operation in China is a captive operation

directly owned and managed by KFC. Once a decision is made to enter a new province, a new city,

or a new township, KFC’s captive logistics and distribution team simply goes to work, quickly and

efficiently (Liu, 2008: 91). For other unforeseen events, such as a health scare, KFC has implemented

a supplier rating system that allows managers throughout China to concentrate purchasing with the

suppliers that perform best (Bell and Shelman, 2011). It is program called Supplier Tracking

Assessment and Recognition (STAR), effective in managing suppliers’ factories, third-party

warehouses, and KFC restaurants. Each poultry supplier is given a STAR rating for the last three

years. Based on STAR rating, KFC would choose whether to remain with the supplier or cast them off

(Liu, 2008: 84). In February 2013, the chain cut from its network more than 1,000 small poultry

producers used by the company's 25 poultry suppliers (WSJ, 2013). Joaquin Pelaez summarised KFC’s

strategy well when he said “"Localize, localize, localize. That's true for local taste and menu offers,

localized supply chains and distribution, local business partnerships, and localized management and

talent.”(Farm futures, 2010).

In conclusion, it is a combination of a continuous supply of qualified people, innovative products

which are not just about good tasting food but also dining environment, cleanliness and service. In

addition, a supplier base that is willing to invest in new technology and production capacity in order

to meet KFC’s growing demand for high quality, high value growth, and on-time delivery. A

competent leadership with a strong sense of time urgency, quick decision making, and a flexibility

based on market dynamics, which have caused KFC’s successful penetration into China (Liu, 2008:

46). Ghemawat (2005) finalises that regionally focused strategies are not just a halfway house

between local (country-focused) and global strategies but a discrete family of strategies that, used in

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conjunction with local and global initiatives, can significantly boost a company's performance. While

there are some future issues to be addressed, such as shareholder responsibility, and healthy food

products, their robust management training scheme, and localised corporate culture should

guarantee the future of KFC in China. However there are improvements to be made, KFC do have an

efficient STAR rating for suppliers, but it only takes one scandal to reduce profits by 40% (Economist,

2013). While Sam Su announced plans to cut suppliers, more drastic measures should be taken.

Depart from a localised supply system and be willing to outsource in the same way McDonald’s has

outsourced to HAVI. This will raise costs, but will guarantee food safety and against costly PR

scandals. Finally, with regards to good PR, a healthy eating awareness campaign could be enacted.

This could involve various corporate social responsibility programs.

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