Yum’s 29% Sales Collapse in China Goes Beyond Avian Flu

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Last week Yum! Brands Inc., which owns KFC, reported that same-store sales in China plunged 29 percent in April as concerns about the safety of its chicken and the spread of bird flu prompted customers to steer clear of KFC restaurants.

While the company said the publicity fueling the sales collapse would be “relatively short-lived,” the perceived safety of KFC food is only one of the challenges tripping up Yum in its biggest overseas market.

KFC became the largest fast-food chain in China because locals loved its fried chicken for the taste and the foreign cachet. Now, a drive to offer such local dishes as chili black fungus is undermining KFC’s American identity even as local fast-food chains selling Chinese and Western dishes proliferate. Meanwhile, Louisville, Kentucky-based Yum’s U.S. competitors McDonald’s Corp. and Burger King Worldwide Inc. are ramping up the pressure.

Yum hasn’t kept pace with a rapidly changing China, said Mary Bergstrom, founder of the Bergstrom Group, a Shanghai-based consulting firm.

“The decor hasn’t changed, and they haven’t brought out what ‘aspiration’ looks like in China today,” Bergstrom said. “While the menu has become more traditional, it hasn’t evolved with how consumers want to eat.”

Yum also has yet to recover from revelations in December that locally sourced chicken contained unacceptably high levels of antibiotics. In April, Yum reiterated a forecast for a “mid-single digit” decline for 2013 profit excluding certain items. Net income rose 21 percent to $1.6 billion last year.

Less Valuable

Yum has become less valuable to investors, as well. The shares are trading at a 38 percent premium to the Standard & Poor’s 500 Index on a price-to-earnings basis. They traded as high as 62 percent last May.

Yum fell 2.1 percent to $68.92 at the close in New York. The shares have gained 3.8 percent this year, compared with a 15 percent increase for the S&P 500.

“We’re disappointed with our results” in China, Jonathan Blum, a company spokesman, said in an interview. “There’s no question, we’ve hit a bump in the road.”

There is no evidence that avian flu can be contracted from eating chicken, and Yum Chief Executive Officer David Novak said last month that “we continue to remind consumers that properly cooked chicken is perfectly safe to eat.”

Twenty-five years ago, KFC drew crowds to its first store in Tiananmen Square. In the coming years, Yum, which also operates Pizza Hut and Asian fast-food chain East Dawning and Little Sheep Group Hot Pot outlets in China, expanded rapidly.

China Revenue

Yum generates more than half its revenue in the Asian nation and, as of 2011, had a 39 percent share of China’s 86.9 billion yuan ($14.2 billion) fast-food industry, according to the most recent figures by researcher Euromonitor International. Its nearest rival, Oak Brook, Illinois-based McDonald’s, had 15.6 percent, according to Euromonitor.

Now KFC is in danger of losing what made it distinctive by loading up its menu with Chinese dishes. Two of three main KFC items on the dinner menu are rice based, including spicy prawn rice and beef rice. The third is a mushroom chicken burger. Patrons can also order fishball soup and sugared egg tarts.

“You want to localize but also maintain your core brand DNA,” said Shaun Rein, Shanghai-based managing director of China Market Research Group. “The name of the game 10 years ago was localizing, but at this stage consumers are already sophisticated.”

Yum’s localization strategy is working, Blum said.

Chinese Appeal

“We have core items that are consistent around the globe, but then we meet the local taste palate wherever we operate,” he said. “It’s a menu that appeals to the Chinese consumer.”

KFC will struggle to regain rapid growth as other Chinese quick-service chains offer similar dishes and replicate its store format, said Chiang Jeongwen, a Shanghai-based marketing professor at China Europe International Business School.

Chains such as Chongqing-based Country Style Cooking Restaurant Chain Co., which sells a fried-chicken-and-rice set lunch, often are cheaper and prepare food more suited to tastes in smaller cities, he said.

“Local competitors have a unique way of cooking and are taking over some of these fast-food needs,” Chiang said. “There are so many options now versus five years ago.”

Local operators are even moving in on KFC’s signature dish. Dicos, a fast-food chain owned by Taiwanese conglomerate Ting Hsin International Group, serves deep-fried chicken, chicken burgers and wraps. The company, which runs 1,517 eateries in China, aims to have 2,500 locations by 2020, according to its franchise website.

Chicken Bites

Another chain, Hua Lai Shi, sells fried chicken with fries or rice and such side dishes as corn cups and chicken bites. The company, which operates 1,500 eateries mostly in smaller cities beyond Shanghai and Beijing, plans to expand by three to five new outlets a day, according to its website.

McDonald’s and Burger King are accelerating store openings in China, too. Burger King plans to have 1,000 stores, from about 86 now, in five to seven years. McDonald’s aims to open 300 for this year and is focused on selling breakfast items and offering delivery service.

The number of Asian and Western-style fast-food chain outlets will grow by 10 percent this year after increasing 13 percent in 2012, according to Euromonitor. The researcher’s most recent numbers show about 17,000 such outlets.

Dynamite Findings

For now, getting Chinese diners excited about chicken again is Yum’s biggest challenge. In December, Shanghai’s Food and Drug Administration said tests from 2010 to 2011 found eight batches of chicken supplied to Yum contained too much antibiotics. The findings were dynamite in a nation where food-safety scandals have erupted so often in recent years that Chinese consumers have lost faith in local officials and in companies.

Yum apologized to Chinese consumers in a letter posted on KFC’s microblog on Jan. 10. A month later, the company started a marketing campaign -- dubbed Operation Thunder -- designed to rebuild diners’ confidence.

The 30-second commercials highlighting Yum’s commitment to food safety and quality may not be working, Gene Grabowski, executive vice president at Levick Strategic Communications in Washington, said in an interview.

Many Chinese see Yum’s efforts as “propaganda” because “there’s a tendency to discount public statements,” he said.

Yum should hire independent food-safety experts to reassure consumers, said Grabowski, who represented U.S. pet-food companies after it turned out that products made in China had been contaminated with the chemical melamine.

During a recent weekday lunchtime, a KFC in Shanghai’s Superbrand Mall had several empty tables while the McDonald’s across the way was almost full.

John An, a 21-year-old intern at a computer store, was eating a McDonald’s burger. He said many of his friends and family have stopped eating chicken and visiting KFC.

“People have lost trust and their faith in the brand,” he said.