Location strategy analysis of McDonald China

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Location strategy analysis of McDonald China

 

1.        Introduction

This assignment will be dedicated to the research on the location strategies adopted by McDonald in the market division of China. McDonald’s Corporation is the world’s largest chain of hamburger fast food restaurants, serving around 64 million customers daily in 119 countries. Headquartered in the United States, the company began in 1940 as a barbecue restaurant operated by the eponymous Richard and Maurice McDonald; in 1948 they reorganized their business as a hamburger stand using production line principles. Businessman Ray Kroc joined the company as a franchise agent in 1955. He subsequently purchased the chain from the McDonald brothers and oversaw its worldwide growth (Oyafemi 2011). It is self proclaiming by the company that the chain of fast food restaurants represents the world’s most successful food service organization. In July 2010, McDonald’s reported global sale were up 5 percent and operating profit was up 10 percent and at the same time it was ranked the sixth most valuable brand in the world with worth in excess of $66 billion (Haig 2011, p. 93). McDonald’s is a late entrant into the foreign fast food industry in China. In 1990, McDonald opened its first restaurant in the south city Shenzhen when PepsiCo opened its first Kentucky Fried Chicken in Beijng in 1987. Despite its late entrance, it still has an advantage over its competitors with the world famous brand in the fast food industry (Luo 2011) and enjoys a fast expansion in the recent years.

2.        Challenges

Despite having a strong brand in the industry, McDonald China faces several key challenges in its operations in the China market such as the pressure from the competitors, legal and political risks, cultural differences, increased labor cost and food price and inefficiency in supply chain which will be discussed below.

2.1    Challenges from the competitors

 


In a global wide, Subway beat McDonald’s to become the top restaurant chain. At the end of 2010, Subway tallied more restaurants than McDonald’s, giving them the honor of the largest restaurant chain in the world. Subway had 33,749 restaurants around the globe at the end of 2010, said company spokesman Les Winograd. McDonald’s had 32,737 at year end of 2010 (Time.com 2011). Even in the market of China where Subway is not a major fast food brand to the people, McDonald faces strong challenges and threat from KFC and other Yum brands. It is reported earlier this year that KFC is killing McDonald’s (MCD) in China, making all the right moves in the world’s second-largest economy. KFC’s owner, Yum Brands (YUM), now has a 40% market share in China compared to only 16% for McDonald’s. Yum opens a new restaurant every 18 hours. The group is so successful by doing a better job of becoming Chinese. For instance, until June 2010, KFC has over 3,000 outlets in China, whereas McDonald’s operates 1,100, or only one third as many (Ministryoftofu.com 2011) resulting in customers’ wrong perception that KFC is a larger and better brand than McDonald globally. And even in the perspective of the inventors, the Yam group seems to be a better and choice for them. In the end of last year Yum shares were at $47.66, up 33% from a year ago (Money.msn.com 2011). Therefore we can see that the disadvantage position that McDonald has right now is not only because of the late entry into the Chinese market, there are also a number of reasons in term of the strategic decisions behind the current situation rather than just the branding issues.

Figure 1 Trademark dispute between Wonderful (left) and McDonald’s (right)

Source: WordPress.com 2011

Another kind of problems caused by the competitors is the copyright issue. As a globally known brand, McDonald has long been a brand to be imitated in the Chinese fast food industry in term of both product and logo design and even other business strategies such as location strategy. For example, McDonald’s sued the Trademark Appeal Board, China’s top trademark watchdog, over a trademark dispute with a local restaurant that used an allegedly similar logo. The two companies were entangled in a legal battle as early as in 2003 when McDonald’s lodged an appeal to the Trademark Appeal Board, demanding a revocation of the trademark registered by the restaurant, but the authorities rejected its claim. After McDonald’s ordered the trademark watchdog to review its earlier decision, the Trademark Appeal Board decided to place a block on the registration of “W” as a trademark for catering businesses in 2011 but reserved the registration for other purposes (WordPress.com 2011). Besides the trademark dispute with Wonderful, McDonald also encounters a number of similar cases involving a number of competitors, and not all of them could end up with satisfactory results from the view of McDonald.

2.2    Political and legal factors

Though after China’s accession into the WTO in 2001, it is in accordance with the WTO’s requirement for China to have laws that are executed in a “uniform, impartial and reasonable manner”, the change to a “rule of law” system may not be fully implemented even years have passed. For example, there are legal terms such as “reasonableness”, “fair dealing” and good faith” which are not well defined in Chinese jurisprudence and thus the vagueness is particularly problematic in contract law since several provisions refer to vague concepts like principles of fairness (Lee 2004, p. 981). On the other hand there is also corruption in the political and legal systems which are common in China. According to Joseph Fewsmith (2010, p. 57), the lack of transparency in the judicial contributes to the potential corruption. Since China follows a continental or civil law system, court decisions do not have binding precedential value as civil law system like the United States, and legal options have not normally been made public, although selected decisions are published for reference by other courts and layers. Many problematic courts in China have attracted great disputes in the society. Even to the foreign companies, receiving legal and political fairness seems not to have a 100% guarantee.

Another political risk is about the land ownership as in China land is not privately owned in perpetuity but owned and allocated by the government on the people’s behalf. While private land ownership does not exist, long-term (generally 50 year) leases do and are bought and sold between both individuals and enterprises. Still the uncertainties after the 50 years bring great risk to the business operation especially the large chain restaurants like McDonald which involves a large amount of property transactions (Bergsten 2008).

 

2.3    Cultural differences

As mentioned above, until June 2010, KFC has over 3,000 outlets in China, whereas McDonald’s operates 1,100, or only one third as many (Ministryoftofu.com 2011), one of the key reasons behind such difference is the local food cultural differences which is different from the US style fast food and KFC has been adapting their products to the local needs. Kentucky Fried Chicken entered the Chinese from the beginning with the focus on the special nature of the Chinese market; they are caring about the Chinese culture and consumer habits through in-depth research and investigation, recognizing China’s market and Western European and American markets with unique features. KFC continue to meet consumer demand in the Chinese people and added a lot of product lines in consistence with the consumer habits of Chinese people, such as fritters, the old Beijing chicken roll (Hi138.com 2011). Also, after entering the Hong Kong market in 1970s, KFC found out that the Chinese people prefer to sit down and eat with Western utensils or at least chopsticks. Therefore, when KFC entered into the China market, in the first store which was located opposite the Tiananmen Square, it included a large seating area. Similar changes were also found in term of decoration and the shop layout design. In contrast, while the KFC was willing to localize, McDonald keeps staying with the tried and tested menu and process, which to a large degree contributes to the undisputed fast food leadership in the mainland (Yuann & Inch 2008). The different strategies used by the two major competitors suggest that local cultural need is a challenge to McDonald.

2.4    Inefficient supply chain

 

Efficient supply chain in of no double a key factor to the success in a low-margin industry like the fast food industry, as The Economist observed, since China is in a huge size and with enormous regional variations, many national brands would need to struggle to establish a national infrastructure, supply chain management would become difficult in this large size (Hitt, Ireland & Hoskisson 2009, p. 176). And the whole supply chain in China is unsophisticated and aboriginal. Despite of the highest population in the world, its whole food supply chain is still relying on small food processors which are inefficient and lack of technology for mass production. It also reflects there are very few large end users to support the building-up of large food processing plants (Caijing.com 2011). Though the management of McDonald’s China supply logistics has taken a step forward with the entry of The Havi Group, McDonald’s main US distribution manager and Havi has established the wholly foreign-owned Husi Food Co. Ltd. to function as the consolidator and distributor of virtually all of McDonald’s inputs in China, still the full takeover by Havi Group is not yet achieved (Chinaadopttalk.com 2008), as a result the local small and inefficient supply chain will be difficult for McDonald China in managing the supply side.

 

 

2.5    High labor cost and food price inflation

 


For a long time people will link the word “cheap labor cost” to the labor market of China and believe that China will enjoy a long term low cost advantage because of their large population, but such advantage is losing because of the government’s decisions. Its one-child policy is putting a dent in the labor pool. Banks aren’t lending as readily as they used to. And with so many jobs available, Chinese workers can be a little choosier about where they look for employment – meaning wages are getting higher. It’s more expensive these days to be a boss in China, or to own a business that manufactures there. The BCG analysis even predicts that by 2015, labor costs in China will get so high that several industries will reach a “tipping point,” and could even decide to move the bulk of their Chinese operations over to the United States (Huffingtonpost.com 2011).

Figure 2 Average wheat (flour) price of 50 main cities

Source: FAO.org 2011

 

In term of the food price inflation, it is also not a good new to the fast food chains operating in China. With prices rising since last autumn for many commodities like sugar and cotton, the country’s cabinet announced that it would impose price controls on food, introduce subsidies for the needy and increase the availability of fuel supplies. But Beijing faces a severe challenge in preventing higher global commodity prices from igniting broader inflation that could threaten China’s streak of powerful economic growth (Nytimes.com 2010). According to the most recent data released by FAO (Food and Agriculture Organization of the United States) as shown in the figure above, the average wheat (flour) price of 50 main cities has since the beginning of 2009 surged rapidly though it seems to be stabilizing in the recent months, but the continued high price of major foods have increased the cost of the main food industries such as the fast food market. In response to the higher food cost, McDonald is also forced to raise their menu price. Through the move of a “structural price adjustment” McDonald’s Corp. is raising the price on some menu items at restaurants all over China and it is believed that not only escalating food costs are a key factor in the consumer inflation situation, but rises in the cost of labor and material are also contributing to escalating prices (Upi.com 2011). And based on the economy theory that if price increases, there will be an expected demand drop as a result, therefore, price escalation is not a good new to McDonald China.

 

3.        Location factors in a regional scale

 

3.1    Proximity of customers and suppliers

 

As proposed by Bernard W. Taylor and Roberta S. Russel (2009, p. 292), the proximity of suppliers and markets are important location factors. Services companies like fast food restaurants, retail stores, groceries, and service stations need to be close to customers and distribution centers. In case of the fast food industry, transportation cost can be significant for both the fast food restaurants in delivery and the customers in order to get access to the far away restaurants if frequent delivers over long distances are required. And also the distances between the distribution centers and the restaurant points will directly influence the inventory that the restaurants need to have ready to prepare for accidental needs. In the case of McDonald China, it needs to locate its outlets in the regions that are close to both the individual customers as well as the nearest suppliers to control the transportation cost, attract as many customers as it can and also reduce the response time to the changing customer demand in term of changes in the volume of production required and the transportation costs incurred.

 

3.2    Infrastructure

 

 A country’s infrastructure development refers to roads, telecommunication, legislative bodies and open and free justice system and etc or is could also be defined as the collection of physical support systems of a location, including the roads, water and sewer and utilities (Taylor & Russel 2009, p. 292). Though the infrastructure development is considered as associated with economic development usually (Doole & Lowe 2008, p. 112), and speaking from the view of the fast food restaurants, the insufficiency in infrastructure will lead the increase of the transportations cost and also the convenience of getting to the restaurants for the customers. But a low level of infrastructure development in China does not necessarily suggest that the regions and cities are not preferable by the companies without any business opportunities. In the past few decades since the economic reform which started in the end of 1970s, China has been investing a large proportion of its government expenditure on the development of the basic infrastructure of the country and the local governments also do the same jobs, and with a fast improving infrastructure conditions, suitable business environment will be cultivated also in a fast speed which equals to a great amount of business opportunities. In the past two decades, McDonald has made a big management mistake: it has been very strict in selecting locations that have the developed infrastructure conditions as well as a large group of middle class in the region while KFC would have loose restrictions but focus on the future development of the areas. KFC’s strategic locations in the medium cities and even small cities together with the fast growing infrastructure conditions together explain part of the rationality behind KFC’s business success in China. To McDonald, it still needs to measure the level of infrastructure of the regions and communities in its regional level location strategy but a more developing perspective to foresee the future of the regions in term of infrastructure development should be held by the management of the company to maintain competitive in the future business environment. To McDonald in making the practical location strategies, the infrastructure development level could be measure by reviewing some of key indicator on infrastructure such as Habitations Connected by Roads, Households with Electricity Connection, Improvement in Telephone Connectivity over 5 years, Hospitality of the local regulations and government and so on.

 

3.3    Quality of people’s life

 

There are many factors that can influence the quality of life; the modern conception of quality of life is a combination of factors: environment, standard of living, mental and physical health, social position, education, etc (OLESHKEVYCH 2009). As observed in the fast food industry of China, dinning in a McDonald outlet is not considered as having a fast food but rather it is considered as part of the quality life. And as said above, McDonald’s major competitor KFC has long found out that the Chinese people prefer to sit down and eat with Western utensils or at least chopsticks rather than just having a simple fast food and get back to their work, obviously dinning even in the  fast food restaurants would have some cultural needs. What is more, as McDonald’s approached its 20th anniversary in China, the fast food giant recognized that future success in the country would depend on its response to a shifting audience. Since McDonald’s made its domestic debut, quality of life for Chinese consumers has dramatically improved, raising consumers’ expectations of food quality and restaurant service and giving a foothold to new market entrants like Starbucks. McDonald apparently has identified this problem which leads to some changes in the Chinese market. McDonald’s planned to introduce a new “Make Room for Happiness” brand positioning in China, which would include remodeled restaurants with a more contemporary and comfortable design, premium services such as free WiFi and new menu items like unlimited refills on coffee (Holmesreport.com 2011). Therefore, the quality of life in the regions could be quite influential when the company makes location decisions in the regional level. But in term of the quality of life measurement, not only the income level should be taken into considerations, more key performance index (KPI) in the field of quality of life should be monitored by the company to make a safe conclusion about the level of people’ life.

 

3.4    Business climate

 

Business climate or business environment refers to those aspects of the surroundings of business enterprise which have influence on the functioning of business. An organisation can survive and grow only when it continuously and quickly adapts to the changing environment because we are living in the dynamic world which is undergoing a rapid change due to the coming up of new ideas, economic changes, political changes and new technology (Jain, Trehan & Trehan 2009, p. 5). The business climate and environment in China could be quite different from area to area due to two factors: firstly, the reform of economy was previously limited to certain districts and regions only resulting in regional variants which last to date; secondly, the governments also tend to plan certain areas for particular purpose such as industrial use or residential use. As a result, it would be necessary for McDonald to monitor the business climate in the region when making regional decisions.

 

3.5    Labor cost and quality

 

Labor cost has always been considered as one of the most important elements of total cost calculation to any business and industries (Huang 1997, p. 18). As mentioned above it is believed that not only escalating food costs are a key factor in the consumer inflation situation, but rises in the cost of labor and material are also contributing to McDonald’s forced price increase and because of the fact that McDonald could not influence the food price, it would need to better address the high labor cost problem. For the case of McDonald China, in enacting the regional location strategy and evaluating the labor cost of the region, it can use a region’s prevailing wage rates which are an important indicator of the labor costs. They represent the wage of a typical worker in a given job category as an area has many prevailing wage rates and many different categories of labor (Blair 1995, p. 49). And McDonald unlike other industries or even other restaurants are actually looking at the prevailing wage rate of the unskilled workers because of its highly standardized production and service procedures which do not request for the creative works from the staffs and also the company provides systematic and standardized training before the employees touch the floor. This probably best explains why McDonald and KFC could hire university or high school students as a large proportion of their daily labor forces.

 

4.        Evaluations and critical discussion

 

According to the above analysis of the challenges faced by McDonald’s and location strategies applied by the company, we could now rationalize the slower development and expansion of McDonald’s in the China market than its major competitor, the Yum Group (especially the KFC): firstly, in term of measuring the infrastructure requirement of setting up a new outlet, McDonald had been keeping the strictly high requirement of the infrastructure and market maturity of the candidate regions and locations while the KFC takes into consideration of the speed of basic infrastructure development and thus looks into the future market conditions. This could be seen from McDonald’s strategic decision in the recent years to ask interested parties (potential franchisees) to prepare at least 2 million yuan ($293,000) to cover equipment purchases, joining fee and other expenses (Chinadaily.com.cn 2010) compared to the previous 8 million yuan; secondly, in face of the cultural differences in the local Chinese market as mentioned, McDonald long keeps its international standard in term of US style product lines and layout of the restaurants. And with the cultural challenges, McDonald needs more changes and adaptations to local market demand. After identifying these two major issues, the direction of the solutions would be self evident: the company should use a more developing perspective in selecting locations for the new outlets and at the same time target at a more ambitious target in term of the number of restaurants to be achieved in the future and on the other hand, more customization in both the product design and restaurant layout design should be applied.

 

5.        Location analysis techniques: location factor rating

 

After the identification of the regional location factors, technique of location factor rating could be applied to help select the good regions to expand the McDonald business strategically.

 

Location factorWeightRegion ARegion BRegion C
Proximity of customers and suppliers0.20   
Infrastructure0.10   
Quality of people’s life0.30   
Business climate0.20   
Labor cost and quality0.20   

Table 1 Location factor rating (example)

 

A region with a higher score should be considered as more suitable for the company to develop in the future business plan.

 

6.        Conclusions

 

To conclude the above study, we start from the challenges. Since McDonald’s opening its first restaurant in China, challenges never stop. The key challenges currently faced by the company that have been identified include challenges from the competitors, political and legal factors, cultural differences, inefficient supply chain and high labor cost and food price inflation. And among these challenges, the competition from the competitors and cultural difference in the China market in my understanding should be considered as the most powerful two factors by reviewing the industrial environment and the different strategies used by McDonald and KFC. And regarding the location strategy adopted by McDonald, the company would take into account of a number of regional or site location factors such as the proximity of customers, infrastructure, and quality of life. And McDonald with a strong brand should be able to compete with KFC in China with some changes in the strategies which include the location strategy.

Reference

 

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