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Quick Service Restaurant Giants in the Middle Kingdom

In 2008, McDonald’s and KFC were the two largest qtack- service restaurants (QSR) in the world, with 31,999 and 15,580 outlets, respechvely1 Both chains were renowned for their broad spectrum of consumers on a global bas:s

McDonald’s appeared to be a clear winner m interna- tional expanslon It had over 17,500 international outlets and was the first corporation to set up a solid foundation for international franchising. It spearheaded global expan- sion with :ts first overseas outlet m Canada m 1967, and entered Japan m 1971 2 McDonald’s outlets had tremen- dous success in JapanIdesp:te the difference m culÿtre– with record-breaking daily sales and speed of expansion m the mÿaal stage 3

KFC also started mternahonal expans:on early, opening its hrst overseas outlet in England in 1964 However, it was g:ven a bumpy r:de when :t began to penetrate the market m Asia The Japanese outlets were far less successful than McDonald’s and only started to make a profit in 1976, SEX years after KFC entered JapanKFC outlets opened m Hong Kong m 1973 but were all closed down within two years The company would even- tually wm the confidence of Hong Kong customers ten years after :ts first entry In Ta:wan :t exper:enced rela- hvely smoother development, although KFC headquarters was to spend a huge amount of money and effort m order

Tins case was written by Gabriel Szulanska, Professor of Strategy at INSEAD, Welru Chen, Assistant Professor of Strategy, and Jennifer Lee, Research Assoc:ate It :s intended to be used as a basis for class discussion rather than to ÿustrate e:ther effechve or meffechve handling of an adnumstrattve s:tuatlon The authors gratefully acknowledge ftmdmg from INSEAD R&D

to get the ownerslup back from its joint venture partners at a later stage 4

It was a totally different picture m China In the ‘Middle Kingdom,’ KFC was not only recogmsed as the leader m foreign qmck-serv:ce restaurants but was also a sigmflcant player in the Chinese restaurant industry as a whole, alone contr:butmg 1% of the country’s total food and beverage mdusÿv revenues m 2005 s In 2005, KFC’s outlets m China recorded an average of US$1 2 mflhon m annual sales per store, compared with just US$900,000 for smnlar stores m the US 6 According to the 2008 figures, KFC had over 2,300 outlets m China, with an average profit margin of nearly 20 1%.7

In contrast, at 1,000 outlets, McDonald’s presence m China was less than half of KFC’s, with an est:mated profit margin s:gnlhcantly below that of its leading com- pehtor Many people attributed KFC’s success m China to :ts early entry–three years earher than McDonald’s–and :ts natural advantage m menu selechon wluch corre- sponded to the typ:cal consumer’s preference for chicken over beef However, were these reasons enough to explain KFC’s contmued growth and the extens:on of its lead over :ts rival? How could McDonald’s as a latecomer and the second-largest QSR player m China, capltahze upon :ts global dominance and resources to catch up w:th KFC?

Replicate or Adapt?

The Inherent Challenge for International Franchisors

Internahonal franch:smg :s frequently associated with serv:ce firms, such as hotels, retail outlets and qmck serwce restaurants These hrms often have strongly identifiable

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trademarks and try to guarantee the customer a umform and consistent level of service and product quality across different locations and over time. However, the high degree of standardlsed operations makes the replication of the format across diverse markets difficult Differences In things such as mgredlents, labour and physical space can mean slgmhcant modifications to the service formula Consequently, the basic service may be sumlar to that of the home country, but details m the delivery of the service are often altered 8

Many foreign enterprtses found China very different m culture and consumer behaviour Franchise restaurants faced several major hurdles, including a different labour force structure, dffarlculty m recrulKng technically competent and culturally sensitive managers, tough technologacal problems and a less than satasfactory legal environment and enforce- ment 9 So the challenge for international franchlsors hke McDonald’s and KFC was to decide whether to comply strictly with their ongmal models, and if adaptation was reqmred, when and how to make adaptations m order to dehver globally consistent standards while catermg to local consumer needs

Potential of China’s Restaurant Industry

Chinese consumers’ spending on eating out had increased tremendously along with the country’s economic boom In the past decade Retail revenues of the restaurant industryincreased from 5 2% m 1991 to 14% m 2007 as a portion of total retail revenues from consumer goods.1° According to annual statistics from the Mamstry of Commerce of the People’s Repubhc of China, the retail revenue of the hotel and restaurant Industry reached 1,235 2 billion RMB in 2007, rep- resenÿng 19 4% growth over the previous year, foreign fran- chises were the mare dlaver of food and beverage revenue growth as foreign direct investment m the hotel and restau- rant industry totaled US$10.4 bllhon, an increase of 25.8% on the previous year.11 China was the world’s largest consumer of meat The Economast InteIhgence Umt forecast that annual meat consumption m China would jump from 59 kg per head m 2005 to 74 kg per head m 200912 With US meat consump- taon at 128 kg a head, there seemed plenty of scope for the Western fast-food industry to expand m China 13

Foreign quick service restaurants played a significant role m Chma’s restaurant industry The share of fast food m the retail industry was expected to reach 9 3% by 2011 from 74% in 2007 Chma’s fast-food Industry was expected to grow at a CAGR of around 25% during 2008-2011.14

The first comprehensive franchising regulations, wtuch came into effect m February 2005, made it easier for foreign fast-food operators to open branches and roll out

the franchising model, which had proven to be such a sure path for fast-track growth m the US and Europe is The new Law on Franchise Regulations, passed m February 2007, helped clear up the ambiguity surrounding franchlsor’s disclosure duty 16 Thenceforth, the rights of both fran- chisors and franchisees were better protected

Quick Service Restaurant Chains: A New Experience for China

Foreign qmck service restaurants began to surface m China with the opening of KFC’s first store in 1987, followed by McDonald’s entry three years later. The tmung was propi- tious for foreign enterprises as it had been nine years since China embarked upon a pohcy of operung up and reform m 1978 and Chinese curiosity about the West was at a peak

Although GDP growth m China had averaged well over 9% per year since 1978, per capita GDP at the twne of KFC’s entry was a mere US$621 05 17 Given the 120 to 130 yuan monthly salary of Beijmg urban residents at that tune, KFC prices were unaffordable to most, but many still flocked to the store to purchase the 12-yuan KFC hamburger or 8-yuan fried chicken The most frequent customers were foreigners hying m China Despite the attractweness of fast food chains, local consumers m those early days could sel- dom afford to eat at KFC, McDonald’s or Pizza Hut. Dmmg at these estabhshments was considered such a luxury that some couples chose to hold their wedding banquets there,t8

Behind the ‘dream market’ with a vast land area and 1.3 billion people, the complexaty of Chma’s population, geography and tustory presented major challenges for for-elgn players Population density, economic development and wealth distribution varied greatly from east to west and from south to north Foreign invested enterplises usu- ally focused on the populous, more affluent eastern Ctuna The western legaons were beyond the reach of even domes- tic businesses without an effective nataonal transportation system

Chinese-style fast food had existed plaor to the entry of western quick service restaurants but represented a totally different concept and ambience compared with modern chains Most of the catering umts for Chinese fast food were small m scale, serving pre-made appetazers such as congee, buns and fritters of twisted dough (yiu-tiao). They lacked hmdmg, trained employees and a well-maintained dmmg environment 19 As restaurant staff reqmred at least five years of experience, western food chains could not fred a sufficient number of internal candidates to meet growth- driven demand and had to import skilled managers from nelghbouring markets such as Taiwan and Hong Kong, and even from headquarters m the US