China's Fast Food Battleground - TheStreet

China's Fast Food Battleground

Here's a traveler's view of how Yum! Brands, Starbucks and the Golden Arches are faring on the mainland.
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Editor's note: This column was submitted by Stockpickr member Winston Kotzan.

For those domestic food and beverage giants in pursuit of further profit growth outside the U.S., the biggest prize is China. The potential to build brand loyalty with more than a billion Chinese people has prompted some hopeful companies to aggressively open shop on the mainland.

Three companies with such high hopes are

Yum! Brands

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On my latest visit to China, I made it my mission to check on the progress of these companies in the Beijing and Shanghai markets. The objective of my restaurant tour was to get a view from the trenches of how these chains are fairing on the front lines.

Yum! Brands, owner of the Taco Bell, Pizza Hut and KFC chains, recently reported better-than-expected second-quarter results and raised its guidance. While its same-store sales were flat in the U.S., Yum! saw same-store sales rise 7% in China.

The company's KFC and Colonel Sanders logo is easy to spot. Yum! makes a point of making its restaurants easily accessible, and that strategy seems to be paying off. Everyplace there's a crowd, there also seems to be a KFC -- off major thoroughfares and in shopping and tourist areas. Yum!'s KFC restaurants are packed with customers day and night.

Part of the reason behind Yum!'s success is that the chain has tailored its American restaurants to fit the Chinese market. Its menus in China are different from the ones it features in its U.S. stores. In China, the meal sizes are smaller and the ingredients reflect the likes of the populace. As a result, KFC is considered by the Chinese to be somewhat of an upscale restaurant, according to Peking University marketing Professor Jianfeng Wu, rather than a fast food chain, as it's identified in the U.S.

With the popularity of KFC, it's little wonder that Pizza Hut is also making great strides in China. At some locations, particularly in Shanghai, KFC shares its space with Pizza Hut.

The menus for Pizza Hut are substantially different in China from those in the States, featuring pie toppings such as seafood and even corn. The restaurant interiors are designed more elegantly than they are in the U.S.; in China they resemble an upscale steakhouse. These menu and design decisions too are paying off for Yum!. Each Pizza Hut I visited was almost as busy as the adjacent KFC.

My onsite visits suggest that China has a voracious appetite for Yum! Brands.

In stark contrast to the booming business and bustling crowds at Yum!'s chains, a different picture emerged at each of the Starbucks I visited. The first and most immediate problem was that its branches were not always easy to locate. While KFC and Pizza Hut seem to be found in every prime shopping and tourism location, such as The People's Square in Shanghai, Starbucks is nowhere to be seen.

At the Starbucks locations I was able to locate during my walks around the cities, there were mixed results. Some of the stores seemed to be generating the same type of customer traffic you'd find in a U.S. store, but there were quite a few at which the employees outnumbered customers.

Starbucks' problems in China seem to lie in both its product and its prices. Because China is a tea-drinking nation, the coffee purveyor has a tough sell to make. Tea is a part of the nation's history and culture, so its customer base must first be converted. Adding to the slow sell is the fact that Starbucks has not modified its products to fit the market. Whereas Yum! has adapted its menus to the local tastes, Starbucks taps the same menu in China as in the U.S. at exactly the same prices.

Price is definitely an issue. Consider this: The average price for a cup of coffee is 28 yuan (roughly $3.68), but the country's average income is less than $6,000 a year. As a result, Starbucks' demographic is only the high-end urban market.

Another issue that Starbucks could eventually face is China's own coffee market. Many locally-owned coffee shops have sprung up, offering a pleasant environment and more extensive and creative menus than Starbucks. Even Yum! Brands has started serving cappuccinos at its Pizza Hut locations.

Starbucks made headlines in China earlier this month when it closed its store in the Forbidden City, China's former imperial palace in Beijing. According to an

Associated Press

report, the chain bowed to pressure from critics who claimed the store marred the 587-year-old historical site.

Meanwhile, Starbucks' stock continues to lag over concerns of moderating growth and increasing competition in the U.S. from McDonald's and Dunkin' Donuts. Management recognizes that they have a growth problem and are reformulating their strategy. Almost immediately after the closing of the high-profile Forbidden City store, the company named a new chief operating officer to build international focus. Starbucks Chairman Howard Schultz has said repeatedly that he expects China to become the biggest market outside North America for the Seattle-based coffee chain.

As wealth builds among the people of China, Starbucks could see success there, but before then I believe it will take a lot of work and potential losses before it builds the same level of success as in the U.S. The younger generations of Chinese have a strong fascination with Western culture, which includes an interest in coffee. Starbucks has the potential for success in the long term, but in the short term it faces a lot of issues.

Finally, it's hard to talk about fast food without talking McDonald's -- and there are plenty to be found in China. With nearly as many citywide locations as KFC, McDonald's also has a strong presence.

While the stores were very similar in appearance, the menu was not quite as elaborate as it is in the United States -- they lacked some of the newer chicken sandwiches. I was also somewhat disappointed in the coffee, which was not the same premium roast quality as at home. The prices were relatively the same, but still appeared to be affordable to many of the locals.

One thing is for certain, the McDonald's formula is enjoying similar success as Yum! Brands in China. Although not quite having the "standing-room-only" atmosphere of a KFC, the Golden Arches still seem to draw a sizeable crowd.

At time of publication, Kotzan was long Yum! Brands.

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