Has Yum outlived its usefulness to China?

July 15, 2014

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A year after the massacre of pro-democracy demonstrators in 1989, Tiananmen Square was a preternaturally quiet place. Unlike the heart of Beijing today, bicycles and pigeons outnumbered cars and people. The only exception to the calm was a bustling corner near the square: the Kentucky Fried Chicken outlet.

With a pocketful of the special currency then reserved for foreigners, I was able to cut ahead of the masses and order a chicken dinner in the summer of 1990. Having spent weeks in the country struggling to order food, and often severely regretting the outcome, I found the gleaming 12,000 square-foot KFC offered a certain security. It may not have been fine dining, but its taste was predictable, the price economical and its digestion relatively assured.

KFC parent Yum Brands would never articulate its strategy in this way. But those qualities explain the company’s extraordinary success in the nearly three decades since “the Colonel” installed its first deep fryer in China. KFC and its cousin Pizza Hut have earned respect – and lavish riches for shareholders – in the Middle Kingdom not simply by currying favor with Beijing but by doing good business, and providing innovations China’s central planners want, like a safe food chain.

Yum China boss Jing-Shyh “Sam” Su can take credit for that success, something few other companies have managed to achieve in China outside of the joint ventures through which Western companies usually do business. Su became a marketing executive in 1989. Today he sits on Yum’s board. Last year he even earned more than Yum Chief Executive David Novak.

“Sam Su is a god in China,” says John O’Loghlen, a New Zealander who is the co-founder of Gung Ho Pizza, a smaller rival to Pizza Hut in Beijing that has adopted many of the sourcing techniques for its cheese, tomatoes and flour that Yum pioneered in the country. “If it was not for his militaristic approach to food safety, China would be another 20 years behind.”

That approach comes from necessity. Yum has been working to rebuild customer trust since December 2012, when China Central Television reported two of KFC’s suppliers had purchased antibiotics-laced poultry from farmers. Though Shanghai FDA investigators never fined Yum, and the company swiftly eliminated over 1,000 small suppliers, the damage was done. Same-store sales at the China division fell 13 percent last year, slicing operating profit by 26 percent.

On top of that comes another challenge: having created the standard by which other purveyors of nutrition to China’s 1.3 billion stomachs are being judged, Yum is struggling to revitalize its recipe. The sight of a KFC in Tiananmen, or really anywhere in the country, is no longer special. There are 4,618 KFCs in China, plus another 1,100 Pizza Huts. Nor is the China division a footnote in the Louisville-based Yum’s finances. In the first quarter, during which it opened 123 new stores, its operating profit of $285 million accounted for half of its global income.

In late March, Su embarked on a move the company described as “unprecedented in KFC’s 27-year history in China.” It added 15 new products to the menu, including three rice dishes and a couple of new sandwiches, redesigned its packaging, restyled staff uniforms, began a rollout of new store designs and launched a slew of digital initiatives. In the Maoist tradition of permanent revolution, Su said the company would undertake a similar menu overhaul every year.

The taste test is still pending. Sales had already rebounded in the first quarter, in part thanks to reduced comparisons from the disaster of the previous year. But second-quarter results, to be released on July 17, will be critical to determining whether the $36 billion Yum’s existential crisis in China is coming to some resolution. The quarter will be the first to reflect Su’s total revamp of KFC in China.

Revolutions like the one Su is leading at Yum in China are a sign of both weakness and success. Other multinationals hoping to make China a significant market should take heed. As the early entrant, Yum had China’s fast-food market virtually to itself for years. Now fast food and casual dining chains – home-grown as well as from Hong Kong, the United States and Taiwan – are popping up everywhere. The fact that the country’s consumers can safely enjoy fast food owes much to Yum’s labors, but to stay on top, it needs to serve up something more exciting.

With additional reporting by Patrick Plasterer.

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