Consumer

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

(Updated )

KFC's partnership with an Alibaba affiliate puts pressure on the Golden Arches in China more than ever.

By allying with a backer of the country's top food delivery website, KFC owner Yum Brands has taken a step toward solving the dilemma of slowing growth in its biggest market outside the U.S. It's a deal that McDonald's, which is also in the throes of selling its China business, will do well to match.

Yum and McDonald's are among a clutch of Western brands that have realized they need a Chinese partner to stay on top of shifting consumer tastes in the nation. The price of not getting that strategy right has meant retreat in recent years for brands from Tesco and B&Q to Best Buy.

For McDonald's and Yum, both of which have been hurt by food-safety scandals in China, the challenge is not only to improve their reputation but also to stay on top of a move toward healthier foods, capitalize on consumption growth in smaller cities where they have little presence, and most importantly, join the Chinese rush to perform ever more daily tasks online.

Yum's share of the market for fast food from major chains has dropped from close to 40 percent in 2012 to 30.2 percent last year, while McDonald's has slid from a high of 16.5 percent in 2013 to 13.8 percent, according to data from Euromonitor International. McDonald's has about 2,200 outlets in the country. Yum has 7,200 outlets in China, including Pizza Hut restaurants.

Not So Good
Yum and McDonald's have seen their share of the Chinese market for fast food from major chains decline
Source: Euromonitor

Selling a piece of the China business to private-equity firm Primavera Capital and Alibaba's Ant Financial will move Yum up the path of online relevance faster than its U.S. competitor. Ant is the owner of China's top payments platform and holds a stake in food-delivery website Eleme, key pieces of the jigsaw needed to help Yum appeal to customers who want to order and pay for food through their mobile phones.

In Primavera, Yum also gets one of the country's top dealmakers: Founder Fred Hu is the former Goldman Sachs chairman in charge of Greater China and will serve as chairman of Yum China, which will be spun off from the parent into a separate company next month.

Admittedly, Primavera and Ant will buy only a small minority stake in Yum China -- less than 6 percent initially. Still, that emphasizes the difficulty for McDonald's, which is seeking a buyer for the whole business.

Unlike Yum, McDonald's has no plans for a listing of its China operations. In common with its rival, though, the company has realized that local partners and franchising are the way forward. Most McDonald's restaurants in China, Hong Kong and South Korea are directly owned by the company. The chain aims eventually to have 95 percent of restaurants in Asia under local ownership, it said in March.

The conundrum for McDonald's is that handing over the reins to local partners may risk its brand, already dented by a 2014 food-safety scare. The company has imposed stringent deal conditions such as a three-year ban on senior management changes, Bloomberg reported in May -- though this has had the effect of deterring bidders.

McDonald's has attracted only a few Chinese suitors and none has the online heft that Ant brings. The interested parties (their private equity partners aside) aren't known for either online consumer expertise or retail exposure. The roster so far includes bad-loan manager China Cinda Asset Management and dairy producer Beijing Sanyuan Foods. Sanyuan's largest shareholder is state-owned Beijing Capital Agribusiness Group, which runs some McDonald's restaurants in Beijing. Chinese state conglomerate Citic Group, which has only a modest retail presence, is also in the running. 

There's little danger McDonald's would ever have to retreat from China. The chain has been chalking up gains in same-store sales this year, after several quarters of declines. It remains China's second-most-popular fast-food brand, according to Euromonitor. Still, both McDonald's and Yum face a mounting threat as Chinese-style fast food from brands such as Dicos, (whose fried chicken retails for a third less than KFC) and CNHLS gain market share.

China Revival
McDonald's revenue from its high-growth markets including China is picking up this year
Source: Bloomberg
Footnote: McDonald's high-growth markets include China, Russia and South Korea.

The search for a partner is key. McDonald's needs one that's nimble enough to adapt not just to changing tastes but to the rise in online shopping, especially through mobile devices. Now that Alibaba is spoken for, the list of potential Internet partners is short. A do-it-yourself e-commerce operation in China hardly looks viable. That's a lesson Wal-Mart took to heart in June when it decided to sell its Yihaodian online grocer to JD.com, China's second-largest Internet retailer after Alibaba. Yihaodian's growth had withered after Wal-Mart bought the site in 2012.

Final bids for McDonald's China business are due next week, and a new-economy partner could yet emerge. The next best option would be a group with retail expertise and a nationwide reach. Anything less, and McDonald's may start looking like leftover pickings. There's not much less appetizing than fast food that's been allowed to go cold.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Euromonitor corrects its market share data for Yum Brands, in fifth paragraph and in chart headlined Not So Good, in article originally published Sept. 5.)

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net