This is the first of several historical case studies that illustrate how important aspects of Chinese political economy have evolved over the first 40 years of the country’s Reform and Opening policies. Later this year Two Fen will publish a series of in-depth essays on China’s economic transformation to commemorate this 40th anniversary.
Just south of Tiananmen Square in Beijing is Qianmen, a stately imperial gate from the Ming dynasty. Just west of Qianmen is China’s first Kentucky Fried Chicken. The flagship restaurant, opened on November 12, 1987, stood three stories high, sat over 500 customers, and, at the time, was the largest KFC anywhere. Thousands of Beijingers braved the two-hour wait in freezing weather when it opened, and the store had to call in police to help maintain order. That day, KFC sold 2,200 buckets of chicken and made 83,000 yuan.
By 1988, the Qianmen branch was already KFC’s top-selling location among the restaurant’s 9,000-odd outlets. Average daily revenue at Qianmen exceeded 20,000 yuan, doubling to 40,000 yuan on busy days. The People’s Daily at the time quoted a KFC executive who said the company’s success “shows that China’s reform policies are good” and “Chinese people’s living standards are really improving.” Since then, KFC has become one of the most recognizable American brands in China, boasting over 5,600 restaurants in 1,200-plus cities and generating $5 billion in revenue in 2017. China is one of the few countries where KFCs outnumber McDonald’s.
Today, the first floor of that Qianmen restaurant still operates as a KFC, but much else has changed. KFC China is now owned by Yum China (Yum Brands was the parent company from 1997-2016 and PepsiCo had owned it previously) and is operated separately from other KFCs. Although Yum China is listed in New York and headquartered in Texas, it’s virtually a Chinese company.
The history of American fried chicken in China is a prism through which we can examine a key aspect of China’s reform and opening over the last 40 years—the dramatic changes in consumer markets and the services industry. That KFC was one of the first major experiments in China’s opening to the West has not been lost on the Chinese government. In commemorating the various milestones in China’s progress since reform and opening began in 1978, the official Chinese media proudly touts KFC as one of the many important “firsts.”
Indeed, KFC enjoyed significant first-mover advantage when it kickstarted China’s fast-food restaurant industry in the 1980s. It beat out local Chinese competition in the 1990s because of its increasingly sophisticated management techniques. And when faced with rising domestic competition and maturing consumer tastes in the 2000s, KFC adapted with significant localization efforts to avoid obsolescence.
1980s: First-Mover Advantage
KFC was not only the first foreign fast-food purveyor in China but, more importantly, it was also a pioneer of the fast-food restaurant experience. In the mid-1980s, most Chinese still ate at home or in the dull “socialist canteens” of their work units, where meals were either free or subsidized. Eating out was reserved for rare celebratory occasions like wedding banquets. The “American fast-food” concept was so foreign that when the Qianmen KFC opened, some Chinese customers waited for table service, asked servers for chopsticks, or brought their own pots for carry-out.
Still, the novelty and the aspirational “Western lifestyle” were highly appealing, convincing Chinese customers to dole out more than 7 yuan for a combo meal of two pieces of fried chicken, mashed potato, coleslaw, and a dinner roll—even though the average monthly wage in Beijing was just 100 yuan in 1987. Crucially, in comparison to other dining options back then, the Qianmen KFC was spotless, cheerfully decorated, air-conditioned, and had excellent customer service—much better than what the average Beijinger was used to.
This kind of quality control was embedded in KFC’s business model. It insisted on retaining ownership of most of its China restaurants rather than franchise (even today only around 10% of China’s KFCs are franchises). It’s essentially the difference between maintaining internal control versus outsourcing to others to run different restaurants—and the result was a consistency in standards that won over Chinese customers.
KFC grew quickly and attracted urban consumers—particularly women, children, and young professionals—and became a magnet for tourists and out-of-town visitors. Fried chicken became so popular that dark humor went around that KFC laced its chicken with opium to get Chinese hooked on foreign products again. The Qianmen KFC restaurant was such a sensation that every Sunday, its third floor would be booked for weddings. In his book KFC in China: Secret Recipe for Success, Warren Liu, a onetime KFC executive, believed that the company’s foresight, despite the risks, to enter the Chinese market so early continued to generate “substantial competitive advantage” for decades.
It was also important for KFC’s China management, particularly its East Asia regional manager Wang Dadong, to make a point about opening their first store in Beijing, China’s political and cultural capital. Rather than locating in the more economically and socially liberal cities in southern China, which was what McDonald’s did in 1990 in Shenzhen, Wang wanted to show that even the more conservative and staid political capital could accept Western food.
Grand opening of KFC’s Qianmen store, November 12, 1987
As an early testament to KFC’s sterling brand in China, it weathered the Tiananmen Square crackdown in June 1989. In fact, the Qianmen location served as both a gathering place for the student demonstrators to hold meetings and later as a makeshift barracks for PLA soldiers who were ordered to “clean up the square.” Soon after the upheaval, the Qianmen restaurant was one of the first Western businesses to reopen, citing “contractual obligations” (KFC had paid upfront for a ten-year lease). This came at a time when most American businesses decided China presented too much political or reputational risk. But KFC’s business appeared neutral, and both sides of a bitter political dispute were happy to appropriate its space.
KFC China bet big and early by expanding rapidly outside of major cities, whereas competitors like McDonald’s tended to focus their initial efforts on the key metropolises. This national expansion helped achieve economies of scale and locked in cheaper domestic suppliers for 97% of inputs. That the company was able to build a domestic supply chain so quickly is quite remarkable, demonstrating to other late entrants that this was possible in China.
Beyond the supply chain, KFC’s early foray into second- and third-tier cities meant that it could easily secure prime real estate for its restaurants. It was also an easy sell politically. During the heady days of reform and opening, ambitious local officials eagerly embraced the “arrival” of a Western brand to demonstrate that their province or city was connected to the global market. KFC’s national strategy paid off. As the Chinese economy grew and household incomes rose, more and more Chinese became KFC customers (see Figure 1).
Figure 1. As China’s Economy Expanded, So Did KFC Stores
Sources: Company reports; World Bank.
1990s: Outcompeting Domestic Rivals
The jovial Colonel’s spectacular early success also meant that KFC had a bullseye on its back, as homegrown imitators sprung up to cash-in on a rapidly growing fast-food market in China. This shouldn’t have been a surprise, as local competitors had their own advantages. They often could achieve lower costs and were intimately familiar with local market conditions. And because intellectual property enforcement was basically non-existent back then, local competitors could replicate KFC’s business model and branding in some respects. Moreover, the Chinese state also got behind the domestic players as it sought to bolster the domestic services sector, incorporating the fast-food industry into its economic planning in the Eighth Five-Year Plan (1991-1995) and issuing Fast Food Development Guidelines in 1996.
Ronghua Chicken, formed in 1991 and backed by a Shanghai state-owned enterprise, became KFC’s chief rival in the early “chicken wars.” It offered a cheaper, more localized menu, promising that “wherever there is a KFC, we will be there!” Ronghua recorded strong sales in the early 1990s and expanded rapidly across the country. Many Western firms faltered in the early days of reform and opening—Jeep’s ill-fated joint venture (JV) is a well-documented example—because they failed to adapt their production to local conditions, underinvested in their local labor force, or did not know the market as well as domestic firms.
Rather than KFC faltering in the face of domestic competition, it was Ronghua that folded by the early 2000s. According to the head of Ronghua at the time, it failed because of “a lack of the kind of well-developed system that KFC possesses which oversees every detail of the business, from making the product, to service, to site, to staff training and management.” This was possible in part because when foreign investment regulations relaxed further in the early 1990s, KFC decided to abandon its Chinese JV partners and struck out on its own. Meanwhile, KFC had already established a distribution network, built a cold-chain system, assembled a truck fleet, and perfected an operations structure that enabled the chain to increase turnover while opening hundreds of stores. Processes and supply chains are much harder to copy than logos and slogans.
This management and systems advantage helped KFC establish a leading position in the China market (see Figure 2). According to CCTV, the introduction of KFC to China not only “popularized the idea of ‘fast food,’ it also transformed thinking about dining concepts, management methods, and more.” Last year, the People’s Daily credited Western fast-food chains with the introduction of “standardized management” to the Chinese restaurant industry and celebrated how reform and opening allowed Chinese chains to “draw lessons” from foreign brands.
Figure 2. KFC’s Share of High-Revenue Commercial Fast-Food Stores in China Peaked at 46.4% in 2004
*Includes stores with at least RMB 2m in annual revenue
Note: Data before 2003 are unavailable.
Sources: Company reports; Wind.
That KFC stood victorious was a validation of its model of internal control and imposing strict standards across all of its operations, from the supply chain to the brick and mortar stores. It was a system perfected in the United States and successfully transplanted to the China market. While not exactly technology transfer in the pure sense, this kind of knowledge transfer is of equal importance in building successful operations in new markets. Moreover, KFC showed that low cost alone does not necessarily win the market—Chinese customers were willing to pay a premium for a superior product and a unique experience.
2000s: Deeper Localization
KFC couldn’t keep its business model under wraps for too long, however. Once the basic ingredients of an operational model have been figured out, they can be applied by any number of fast-food enterprises. And that is exactly what happened in the mid-2000s, when local upstarts like Lihua and Zhen Gongfu that made quick Chinese meals, as well as foreign entrants like the Taiwanese fried chicken brand Dicos and the Japanese noodle chain Ajisen, began to develop their own supply chains and efficient operating systems in China. Slowly but surely, KFC’s first-mover advantage faded as domestic firms figured out the secret sauce of their operations system and restaurant experience. Competitive threats began to multiply.
Few competed with KFC head-on in fried chicken, but China’s fast-food market was fast maturing, leading to a plethora of choices that would eat away at KFC’s market share. The company also faced another challenge in shifting consumer perceptions: As Chinese consumers became wealthier and worldlier, their perception of KFC moved closer to that of Americans. The novelty was wearing off.
The American brand had lost some of its luster, which meant that KFC had to further localize to adapt to these new dynamics. Localization wasn’t new to KFC, given that it already relied on a predominantly domestic supply chain and hired local labor. But localization is more than simply understanding Chinese consumer preference for dark thigh-meat over white breast-meat, for example. In this new environment, deeper changes were needed. Sam Su, a KFC China executive from 1989-2015, described the strategy as KFC “would not be seen as a foreign presence but as part of the local community…Our opportunity was to take the best ideas from the US fast-food model and adapt them to serve the needs of the Chinese consumer.”
As part of that strategy, KFC went through several iterations of its slogan to establish a different identity. For instance, in 2004, the brand said it was “based in China, integrated into life,” and in 2008, it said it would “make new fast-food, change for China.” Breakfast is an important part of Chinese daily life, so in the early 2000s, KFC began introducing a wide variety of breakfast products tailored specifically to Chinese customers: soymilk drinks, savory fried dough (youtiao), and congee. Later the company also introduced rice-based meals to its lunch and dinner menus. The company also experimented with “micro” localization to account for specific regional palates and taste preferences. For example, KFC spicy chicken is a touch spicier in chili-loving provinces like Sichuan and Hunan. Chinese KFCs were also early adopters of now-ubiquitous offerings like home-delivery and 24-hour service.
KFC Servers and Mascot in 1987
Another benefit of KFC’s localization strategy was the ability to mitigate political risk. Western brands are susceptible to boycott and slander during surges of economic nationalism, which tends to be inflamed by uncontrollable events. When the Chinese embassy in Belgrade was bombed by the United States in 1999, anti-American protests spread across China, and mobs trashed two KFCs in the city of Changsha. An executive at the time said local managers at KFC’s other outlets defused further retaliation by arguing that they were basically a Chinese company, using local suppliers and labor. Again in 2016, following the ruling by the International Court of Arbitration against China’s territorial claims in the South China Sea, groups of “patriotic” Chinese unfurled banners outside a dozen KFC outlets urging a boycott. But both state and commercial media tamped down these protests and urged nationalists to redirect their anger. In both cases, KFC’s sales picked up after only a blip.
Localization also helped KFC overcome more serious business-related issues. In 2005, KFC’s China operations suffered two unprecedented negative events—the discovery of a carcinogenic dye in two of its chicken products and a dip in poultry consumption resulting from an avian flu outbreak. Yet KFC still managed to increase its profit while opening hundreds of new stores in China that year, a positive outcome that its parent Yum Brands attributed to not only KFC’s operational and supply chain expertise in China, but also to its China-specific advertising spend.
Challenges of a Maturing Market in the 2010s
Localization has certainly helped KFC fare better in China than it otherwise would have. But KFC China has lately experienced a difficult few years of uneven growth due to intensifying competition, rising labor costs, and growing health-consciousness among Chinese consumers. Figure 2 above shows how KFC gradually lost market share over the late-2000s and 2010s. The increasingly mature Chinese fast-food market meant that, compared to 2005, KFC experienced more fallout and took longer to recover from major food safety scares regarding chicken-growth hormones in late 2012, another avian flu outbreak in mid-2013, and suppliers that delivered expired meat in late 2014.
As a result, same-store sales for Yum Brands’ China Division (of which KFC represented around 75% of the operating profit) declined 13% in 2013, 5% in 2014, and 4% in 2015. Yum attributed this dip to short-term consumer concerns, and demonstrated its long-term commitment to the China market by continuing to open hundreds of new stores each year.
KFC China’s fortunes began to turn around in 2016, when Yum China spun off from Yum Brands to focus entirely on the continued expansion of KFC and other restaurant concepts in the China market. Its current strategy is to aggressively expand into fourth-tier or even smaller cities with populations of around 2.5 million people or fewer—where costs are low, incomes are rising fast, and its brand retains greater consumer appeal because it’s still considered novel.
This focused approach to China reaped dividends. KFC China’s same-store sales stopped declining and instead grew 3% in 2016 and 5% in 2017. In 2017, Yum China recorded revenue growth from $4.7 billion to $5 billion on the back of 408 new store openings (with a 9% increase in system sales). Last year, KFC also decided to go more upscale and opened KPRO in Hangzhou, a restaurant that offers healthy premium food aimed at affluent young professionals and hipsters rather than families with children.
But gone are the halcyon days when KFC sat atop the Chinese fast-food chain. Figure 3 below compares the last three years of KFC China revenues. It’s clear that KFC’s revenue as a proportion of total industry revenue has declined but looks to be stabilizing. So, while KFC will likely continue to record absolute year-on-year growth, a mature market and new entrants mean that it is unlikely to experience much improvement in its market share.
Figure 3. KFC’s Market Share in China Is Likely Stabilizing
Note: China industry revenues have been converted from RMB at annual average exchange rates.
Sources: Company reports; Wind.
Seen in the context of 40 years of reform and opening—during which KFC transformed from an expensive novelty to a market trailblazer to a localization pioneer to a first-among-many-equals in an intensely competitive industry—the latest spin-off of Yum China seems to simply signify the increasing, and perhaps inevitable, convergence of Chinese and American business.
KFC’s success in China must also be couched in the successful policies associated with reform and opening. China’s fast-food market would not be as developed without opening to KFC, and KFC’s business would not be as profitable without entering China. Trailblazers like KFC imported to China best practices on how to manage a restaurant chain, build a nationwide supply chain, and maintain high levels of customer service and dining experience. KFC also showed other American restaurants—like McDonald’s—that China’s market was possible to crack.