Location strategies of KFC (Kentucky Fried Chicken) in China

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Location strategies of KFC (Kentucky Fried Chicken) in China

 

1.      Introduction

 

1.1    Introduction of KFC

 

Fast-food franchising was still in its infancy in 1952 when Harland Sanders began his travels across the United States to speak with prospective franchisees about his “Colonel Sanders Recipe Kentucky Fried Chicken”. By 1960, “Colonel” Sanders had granted KFC franchises to more than 200 take-home retail outlets and restaurants across the United States. Since then, the expansion of the franchise business becomes globalized. By 1971, KFC had established 2450 franchises and 600 company-owned restaurants in 48 countries (Wit & Meyer 2010, p. 916). KFC is part of Yum! Brands, Inc., the world’s largest restaurant company in terms of system restaurants, with more than 36,000 locations around the world. The company is ranked 239 on the Fortune 500 List, with revenues in excess of $11 billion in 2008 (kfc.com 2010). Though KFC is an established global brand in fast food chain restaurant, still in global view its business is behind McDonald, the most valuable brand in fast food, and it is said that KFC has been following McDonald’s strategy especially in term of location strategies. But in the Chinese market alone, the case is totally different which we will talk about right now.

 

1.2    Introduction of KFC China

 

On 12th November 1987, KFC opened its first restaurant in China in Beijing as the first joint venture company in Beijing at that time. Its expansion was rapid. KFC was the first to bring franchising to China in 1992 and the first to open a drive-through in China in 2002. KFC continues to be the number one quick-service restaurant brand and the largest and fastest growing restaurant chain in mainland China today, with nearly 3,500 restaurants in more than 700 cities (yum.com 2011). 

 

2.        Challenges

 

2.1    Challenge from competitors

 

Let’s look at KFC’s major competitive, McDonald, though globally McDonald seems to be taking the leadership, in China McDonald falls in a defending position. KFC with nearly 3,500 restaurants in more than 700 cities (yum.com 2011) compared to only about 1,100 of McDonald. Some believe that this is due to the fact that KFC China tended to introduce new products more frequently than their competitors in China. Also the fact that KFC has chicken as its core product offering is a very natural advantage that fits this context very well, since most Chinese prefer pork, followed by chicken; whereas beef and mutton lag far behind. So in that light, KFC enjoys a natural product advantage over McDonald’s (insead.edu 2010). But obviously McDonald would not surrender in such a fast growing fast food market in one of the fastest growing economies in the world. According to the news, McDonald’s Corp. plans to nearly double its presence in the world’s fastest developing economy over the next few years, senior officials from the company said after they launched the first McDonald’s Hamburger University in China. McDonald’s is capitalizing on Chinese investment fever by launching a new “Hamburger University” in Shanghai and aiming to nearly double the number of branches. McDonald’s, which has about 1,100 outlets in China expects to boost that number to a total of 2,000 by the end of 2013, said Tim Fenton, the company’s president of Asia Pacific, Middle East and Africa, in an interview (Sky.com 2010). In addition, the raising Chinese style fast food restaurants which have advantages since their food are local also post great competition to the western style fast food like what KFC provides. But according to Michael E. Porter (1998, p. 209), competition does not necessarily be bad, and the real competition is dynamic and rests on innovation and search for strategic difference. Therefore the challenges faced by KFC due to the high level of competition needs to be coped with by KFC in a more proactive way by using ways such as product differentiation.

 

2.2    Food safety accusations

 

Kentucky Fried Chicken (KFC) stores in China were alleged to have re-used cooking oil and neglected to carry out food safety tests. Quoting employees at several KFC restaurants in Beijing, the Securities Daily reported that hygiene is substandard in some KFC kitchens and frying oil is normally replaced every four days without regular pH tests being carried out, as required by food safety authorities (globaltimes.cn 2011). Because excessively used oil can be harmful, as it may contain heavy metals or other highly toxic substances that could lead to cancer, KFC was put into defensive position and obviously it can not justify. Such events have been attributed to the company’s imbalance between fast franchise expansion and adhering to decent standards.

 

2.3    Rising labor and food cost

 

One of China’s biggest attractions for investors has traditionally been its cheap labour costs and ability to provide economies of scale. However, labour costs have been rising owing to several factors. The trend has become more apparent since 2008 when the government introduced new labour legislation in a bid to protect workers through enforcing contracts, job security and minimum wage compliance. What is more, workers have also been demanding higher wages amid rising inflation, with labour disputes in 2010 resulting in pay rises and increases in minimum wages (euromonitor.com 2011). Inflation affects consumers by reducing their purchasing power and squeezing disposable incomes. China’s Consumer Price Index showed that prices rose 6.2% over the 12 months ending in August 2011, China’s National Bureau of Statistics reported. That marks a slight slowdown in China’s rapidly growing inflation rate, after CPI grew 6.5% in July — the fastest rate in three years. Last month marked the first time Chinese inflation has slowed since December. Still though, food prices – the main driver behind China’s inflation – are substantially higher than they were a year ago. And in a country where food accounts for more than a third of the average person’s expenses, rising prices can take a substantial chunk out of consumer spending (cnn.com 2011). Rising labor and food cost will impose two kinds of challenges to KFC’s business: reduced customer spending (price become decisional) and increased product cost due to increased labor and food cost. Even the group’s profitability is influenced; the Yum brands opened around 600 new restaurants in China in 2011 but profits were slightly down in the same period as a result of higher commodity and labor costs (factsanddetails.com 2011).

 

3.        Location strategies

 

The physical location of business facilities (including the fast food restaurants) can have a significant impact on the success of a company (Russell & Taylor 2009, p. 290). Based on the view of Joel D. Wisner, Keah-Choon Tan and G. Keong Leong (2008, p. 409) location decisions are extremely important for all services because they have a significant impact on customer visits and consequently the long term profit of the company. And location decisions are viewed as long term decisions because of typical high cost of construction, remodeling and relocation. Below we will analyze three levels of location strategies of KFC in the Chinese market, i.e. regional location, city location and site selection to see how KFC reacts to the challenges that it faces.

 

3.1    Regional location strategies: deciding the number of restaurants

 

As for KFC in China, with nearly 3,500 restaurants in the Chinese market KFC has restaurants in every province of China and covers the major large and medium sized cities, so the regional location strategies would not be deciding which area to be penetrate but how many outlets should be opened one particular area. Below are some factors that determinate the focus and speed of the business growth in a regional level.

 

3.1.1            Level of economy development


Chart 1 Chart of GDP for all provinces 

Chart 2 China GDP per capita by province 

When KFC makes decisions for a region, such as the Northwest part of China which include Xinjiang, Shan Xi, Qinghai, Gangsu and the adjacent provinces in the northwest, firstly it has to evaluate the level of economy development. Major economic indicators could be used to access the level of economic development in different regions (one region usually include several provinces) such as Gross Domestic Product (GDP), GDP per capita (PPP), Industrial Production, Inflation Rate, Interest Rate and so on. By adding up to a region base and evaluate them on a weighted way based on their importance to the business of KFC, the company would have a general understanding of the level of economy development in the regions and also by comparing the annual changes, the company would be able to predict the future of different areas.

 

 

 

3.1.2            Government regulation and relationship

 

Chinese government officials can have a lot of clout, especially in foreign business circles that involves the participation of foreign firms. For instance, the mayor of a good-sized city often plays a more important role in business than his or her counterpart in Europe or North America. A Chinese mayor may be able to get the authorities to speed up the investment approval process or help fix a problem that a foreign company is facing. Also the Chinese in any levels often plays multiple role such as it can be an investor and regulator at the same time, blurring the relationship between business and government (Collins & Block 2007, p. 139). Therefore, it would be advisable for the KFC to build up good relationship with the relative governments in the region before substantial strategic expansion begins. In addition, local regulation also plays an important role. Though in the perspective of legal system, China only has one single legal system which the local regulations must be obey and local regulations which are inconsistent with national law should be reported to local people’s congress for annulment (Corne 1997, p. 172), still the local regulations could be very different and also foreign companies need to be aware of the different regulations to the foreign firms in different regions and provinces.

 

3.1.3           
Infrastructure

Chart 3 The China’s Stimulus Package Pie Chart

Source: National Development and Reform Commission, 2009

The regional differences of China are mainly shown between eastern, central and western parts of China. Factors contributing to these differences in development are various. One of the important reasons is that the natural conditions of north China and northwest China are fairly poor, and especially the water resources of the two regions are quite deficient. Coordinated development between different regions is an important guarantee for realizing a long-term, stable and healthy development of China’s national economy, for consolidating the country’s comprehensive strength, and for realizing the goals of common prosperity and modernization (yeeyan.org 2011). For long and especially for the recent years, the Chinese central government and also the local governments have been largely investing in the basic infrastructure, for example as the chart illustrates,  a stimulus package estimated at 4 trillion yuan (about 570 billion U.S. dollars) was spent over the later two years to finance programs in 10 major areas, such as low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from several disasters, most notably the May 12 earthquake (xinhuanet.com 2008), among these 10 areas, infrastructure is the industry to be benefited. The large investment into the national infrastructure will bring in large changes and to KFC China, it needs to watch closely the regional changes in term of infrastructure to access the impacts and implications that such changes hint.

 

3.2    City level location strategies

 

3.2.1            Location sequence: from big cities to medium and smaller cities

 

The location sequence or the decision about which market to be penetrated adopted by KFC in China is similar to that of most supermarkets. According to Barbara A. Weightman (2010, p. 136), supermarkets and fast food outlets are most visible in big cities but they are spreading rapidly to medium and small size town especially in East and Southeast Asia. Regarding the location sequence of KFC, there is a tendency to focus on the biggest cities and in order to pick the best locations. The main strategy is to create a demand in the bigger cities then extend into small and medium sized cities. KFC started out gaining notice in bustling cities such as Beijing, Guangzhou and Shanghai (Ni & Waleed 2007). And in one single province, the big city tends to be the capital city which will have a larger customer based and a higher level of economy development. There are three major advantages by adopting this strategy: firstly, because the big city tends to be the capital city which will have a larger customer based and a higher level of economy development, in another word it means that there would be less chance of failure in these big cities than doing business in the cities around the respective capital cities; secondly, setting business in the large capital cities will help the company to go into strategic partnership with the local suppliers and government officials which will help with the later market development into the smaller and medium size cities in that province; finally, the penetration into the capital cities could help the company the test the local market in term of the macro environment and market conditions of fast food industry in order to help further decisions regarding how many new franchise restaurant will be needed in that area and when will be the appropriate and mature timing to do so.

 

3.2.2            City level location factors

 

3.2.2.1       Market size

 

The market size refers to the total potential of the market for the goods and services that are offered by the organization. The size of a market depends on the purchasing power of the people within the market and also the population of them, apart from other things (Misra & Yadav 2009, p. 228). Because the nature of the products offered KFC fast food restaurants, it will need a large market size in order to have enough of customers.

 

3.2.2.2       Labor costs

 

Materials and labor costs make up the prime cost of a fast food industry such as the payroll cost.  Labor costs are key factor in any location decision, and to KFC, a fast food restaurant chain that needs to hire a great number of full time employees and part time workers.

 

3.2.2.3       Favorable labor supply

 

As a fast food franchise restaurant, there is no doubt that each KFC restaurant needs a great number of full time workers, but preferably, it is believed that KFC prefers hiring mostly students working part time shifts to evade the costs of providing regular employees with social security coverage or other benefits (wantchinatimes.com 2011), irrespective of the ethical issue, KFC does favor hiring the students as its favorable labor supply, and therefore while choosing a city, it is helpful to evaluate the labor supply especially the favorable labor supply.

 

3.2.2.4      Proximity and amount of poultry suppliers

 

From the first KFC restaurant in China, KFC has been using the domestic children. Only 2007 year alone, the company had purchased 150, 000 tons children from the over 500 poultry suppliers, though other materials to be purchase also include vegetable, bread and packaging materials, children will be the key materials demand by KFC China. As a result, proximity and amount of poultry suppliers will be a key city level location factor.

 

3.2.2.5       Transportation service

 

Maturity and current status of the transportation service in a city could be influential to the strategy of KFC because convenience transportation service and a good location could create high customer volume in the particular outlet.

 

3.3    Site selection with useful location analysis models

 

3.3.1            Location factor rating

 

Factor rating is a simple methodology to assess the attractiveness of each potential location and it is one of the simplest methods to compare alternative sites using the factors identified to be relevant is to use a factor rating method. This method involves four steps in which the relevant factor are identified, their relative importance established, the performance of each location in each factor assessed and finally all these information will be combined to rank the locations (Mahadevan 2010, p. 312). Besides the eight talked about

 

3.3.1.1     
Proximity of suppliers and proximity of poultry processing plant

Figure 1 The KFC integrated poultry system

Source: kfcholdings.com 2011

The distance between the major suppliers and the KFC restaurant possible site locations is critical because being too far away from the key suppliers such as the mentioned poultry suppliers would reduce the operating efficiency and increase the logistical costs. Another factor is the proximity of poultry processing plant which process poultry for restaurants and focus on achieving cost-efficiency while maintaining high quality standards. It is also important for the new restaurants to be set up closed to the chicken processing plant.

 

3.3.1.2      Proximity to customers

Figure 2
 Restaurant locations of KFC in Beijing

 

In service organizations such a fast-food restaurant, proximity to customers is often the primary location factor to be considered because customers must usually interact directly with the restaurants, convenient locations are crucial (Lewis, Goodman, Fandt & Michlitsch 2007, p. 441). From the restaurant locations as shown in the figure above and also by reviewing the detailed address of part of the KFC restaurants, we find out that locations are usually near to the supermarkets, gasoline service station, shopping malls and other places with large traffic and pedestrian volume.

 

3.3.1.3      Competition, Income level, Traffic volume and Residential population density

 

Other factors that also need to be taken into consideration when the company comes to the decision of the location strategy for a new restaurant site include: Competition, Income level, Traffic volume and Residential population density. And also these factors are not equally weight in term of importance. The weighting are shown in the figure in a Sample of City Location Factor Rating.

Level of economy development Weight A City B City C City
Government regulation and relationship 0.05      
Infrastructure 0.05      
Market size 0.10      
Labor costs 0.05      
Favorable labor supply 0.10      
Proximity and amount of poultry suppliers 0.10      
Proximity of suppliers and proximity of poultry processing plant 0.10      
Transportation service 0.10      
Competition 0.10      
Income level 0.05      
Traffic volume 0.05      
Residential population density 0.05      
Proximity of customers 0.10      

Table 1 Sample of City Location Factor Rating

3.3.2            Break-even analysis

 

Locational break even analysis happens to be an important management tool, it shows the point where the business has met all its expenses and has now began to show profit for the organization. Locational break even analysis is done by breaking down costs as variable cost and fixed cost and comparing these costs to a certain level of sales. Where variable cost is the happens to be directly related to the production process or those necessary in providing the services, and fixed cost is where the cost remains the same and is not affected by the change in the output (classof1.com 2010). The break-even analysis would be helpful for KFC to identify the desired sale to be achieved in order for the new restaurant in that particular location to be profitable. This analytical tool provides the company with a perspective of cost behind the location strategies.

 

3.4    Product strategy: Integration of the inherent qualities of the Chinese markets

 

One successful product strategy that KFC adopts not only in China but also in other parts of the world is the strategy to adapt its products design and formula to the needs of the local market. According to Edward Tse (2010, p. 51), in China KFC deliberately adopted products and practices that would mesh well with the inherent qualities of the Chinese markets that it was trying to reach. This strategy is successful while far too many companies start with the false perception of China as an undeveloped but fast-growing market; they conclude that products and system that have proved successful elsewhere should have a high chance of succeeding in China which pts their thinking into a box from which it can be hard to escape. For example, KFC continue to meet consumer demand in the Chinese people, this development and added a lot of line with consumer habits of Chinese products, such as fritters, chicken roll of old Beijing, Shi Quan wishful salad, corn salad, tender shoots of spring double salad, and wind beans salad, fresh vegetable soup hibiscus, tomato egg soup, Sichuan Spicy chicken, nutritious breakfast (mushroom chicken soup, seafood Danhua porridge, pumpkin porridge wolfberry, dried meat floss egg roll, egg Fort Pork, etc., and now dinner, and in a big way in selling the rice (Hi138.com 2011).

 

4.        Discussion on the overall findings and conclusions

 

From the case study of KFC’s location strategy in China, we find out that: first of all, though KFC has been leading the fast food industry in China and seems to be beating the global competitor the McDonald in the Chinese market, it still face challenges from the competitors, also food safety accusations due to the too fast expansion and threat from the rising labor and food costs; secondly, the KFC’s location strategies in China have been successful in helping the chain fast food to growth rapidly while at the same time assist to control the cost and maintain the product quality, the location strategies are in three levels which include regional location strategy, city level location strategy and site selection with the help of various analysis models such as the location factor rating and the break-even analysis. Besides this, the product strategy also helps the company to bringing uniqueness to the brand and avoids competition by integrating the inherent qualities of the Chinese markets.

 

To conclude the effectiveness of the location strategies applied by KFC, they seem to be working fine and effective. But these strategies also come with two major issues that the company could be facing: on one hand, though KFC have more outlets than McDonald and enjoys a large market share and branding reputation in the Chinese market, this fast rapid growth has been based on the company’s strategic move to largely reduce the franchise fee to attract more investors compared to McDonald’s maintaining of ownership of most restaurants in China, this means that McDonald earns more from one single outlets than McDonald; on the other hand, the rapid business growth through franchising restaurants building in different sized cities and towns, large, medium or small, it will increase the difficulty for the company to maintain high standard product quality in all the outlets which explains why the food safety issues have not really stop for KFC in China and obviously the location strategies have not helped the company to resolve this issue.

 

 

 

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