Yum! brands plans aggressive expansion in China

by Keith Nunes
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NEW YORK – With a hat tip to the success McDonald’s Corp. has achieved in the United States, David Novak, Yum! Brands, Inc.’s chairman and chief executive officer, said the goal for his company is to replicate McDonald’s US success in China.

“We have an enormous KFC opportunity in China,” he said during a presentation at the Bank of America Merrill Lynch Consumer & Retail Conference. “I always like to compare the opportunity we have in China with that of McDonald’s in the United States, where you know McDonald’s has 14,000 restaurants in the United States.

“If you go to Hutchison, Kan., or any small town across the United States, you’ll see a McDonald’s on the corner location, the best location, and prime real estate, and you’ll see them literally everywhere. That’s exactly what we are doing with KFC in China as we expand into all these lower tier cities. We have first-in advantage. We are getting the prime location, and we are becoming — we definitely are going to be the McDonald’s of China — but this time it’s KFC.”

Achievement of Novak’s goal has not come without some recent headwinds. A slowdown in the Chinese economy affected Yum!’s fourth-quarter results and a controversy over poultry suppliers using excessive amounts of antibiotics has prompted the company to initiate “Operation Thunder” in an effort to reassure consumers regarding the safety and quality of Yum!’s products.

“I’m sure you might have read about what’s happened to us in China,” Novak said. “We had some adverse publicity that resulted from a poultry supply situation that we had. This resulted in a really strong media blast that lasted over six weeks. It’s impacted consumer confidence; it’s had significant sales impact in China; and as a result, as we look to 2013, we will have mid-single digit EPS decline in 2013 versus the prior year.

“But we obviously expect a very tough year in 2013, but we expect to fully recover and come back in 2014 and get back on the kind of growth rate that we have been at on a historical basis.”

Novak described Operation Thunder as doing “everything we can to ensure that we have rigid quality standards for our chicken supply.”

As a result of the program, Yum! Brands has eliminated more than 1,000 small chicken farmers from its supply chain and implemented more testing at the supplier level to ensure the company’s product specifications are met.

“We’ve seen some improvement versus what we had originally predicted,” Novak said. “The one thing I would say is please don’t get ahead of yourselves on the improvement that you’ve seen in terms of estimating our ability to bounce back immediately. It’s still early days. We think it will take us about six months or so to really begin to get the business where we want it.”

Despite the setback Yum! Brands is moving ahead aggressively to expand its business in China. Initiatives under way include building a breakfast business that is currently only about 8 percent of the company’s sales mix, adding a home delivery component, adding 24-hour service in some markets, and researching ways to grow share and create opportunities in under leveraged day-parts.

Yum! Brands is also in the process of growing its East Dawning fast-food concept in China. Sales for the business unit are about 80 percent to 85 percent of those for the KFC business in China, but Novak sees room for growth.

“So far, we’ve been in tier 1 and 2 cities,” he said. “What we're going to be doing this year is testing the impact of East Dawning in tiers 4, 5 and 6 cities.”

In 2011, Yum! Brands acquired the Little Sheep hot pot chain in China and has been working to expand its presence in the country.

“We’ve made a lot of progress on Little Sheep,” Novak said. “We think next year we will be able to begin expanding Little Sheep as we go forward. But we bought Little Sheep because we think it can be the Applebee’s or whatever the No. 1 casual dining chain is in China.”

The economy in China is an issue, Novak said, but he is optimistic Yum!’s value proposition across its business platforms will continue to grow.

“There’s no question that the economy slowed down, but as we look at it, we really believe that when our performance drops off versus a year ago, we believe it happens typically when we don’t have more innovation or more value than we had the previous year,” he said. “That’s just the philosophy that we had.”

Looking ahead, Novak cited two risks facing his company in China — food safety and social media.
“We’ve got to do everything we can to have the best processes in place in-store and with our suppliers,” he said. “And the other is social media where you might have an issue that gets blown out of proportion (and) takes on a dimension that you couldn’t otherwise deal with.”

In the case of the antibiotics in poultry story, Novak said consumer response via social media was so overwhelming Yum! Brands’ staff in China was unable to counter it.

“It stayed in the news for about six weeks,” he said. “And we never had that much press stay in the news that way for six weeks.”

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