Yum! Ends Ties With Chinese Suppliers to Regain Reputation

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Yum! Brands (NYSE: YUM), the owner and operator of KFC, Pizza Hut, and Taco Bell, announced that it would undertake steps to monitor its poultry suppliers in China to ensure food safety in its KFC outlets. The fast food giant recently got hit by a controversy involving its chicken suppliers using inappropriate levels of antibiotics. This made Yum!’s China KFC sales tumble drastically, though a company spokesperson said that they instantly removed the chicken from the outlets the moment they learned of the antibiotics concern.

But Sam Su, Chief Executive of Yum!’s China division, isn’t surprised with the severe drop in the KFC sales. He understands that customers expect high quality service from foreign restaurant chains and news as this would adversely affect their consumption level.

Now the company is fighting to restore its reputation in its largest and most lucrative market. The quick service restaurant has undertaken steps to tighten its supply chain in order to drive away the chicken scare in its KFC restaurants.

Restoring reputation – "not something that Yum alone can do"
The company is checking the source of its chicken suppliers and severing ties with those who get chickens from small farms that are difficult to track. It has eliminated from its supply chain network over 1,000 small poultry farms from where 25 poultry suppliers source their chicken.

However the root cause remains unaddressed. The consumer concern over the safety of chicken comes from China’s meat industry, which mostly depends on these small farms for their supply. So fixing the issue gets complicated unless the main source is dealt with. In fact, even McDonald’s (NYSE: MCD) suffered the food safety allegation and has been accused of using chicken containing high antibiotic levels. Similar to what Yum! did, McDonald’s ended ties with the problematic poultry suppliers.

Yum! has found a couple of ways to deal with the problem. First, Yum! will go for rigorous supplier testing and maintain ties with only those chicken house that are directly managed. Second, it will coordinate with international poultry suppliers to ensure quality. These foreign poultry suppliers could either directly invest and set up on their own or work with domestic suppliers to improve their quality. Mr. Su did not give further information on this matter.

Nonetheless, it is extremely critical for Yum! to win back the confidence of its KFC customers, given that about half of the company’s top line is earned from this emerging market. Yum! invited and held talks with industry representative groups like the China Cuisine Association, China Chain Store & Franchise Association, and the China Animal Agriculture Association. The company drew their attention towards the lack of investment in this sector, saying that unless investment is increased it would be difficult to provide food security and safety to consumers. It has to be a joint effort as rightly pointed by Mr. Su, "It's not something that Yum alone can do."

It is essential for Yum! to bring its KFC business on track as China is a crucial market for the company’s future growth.

China – a critical market
Yum! draws about half its revenue from China. It even dominates McDonald’s presence here. Though Yum’s fourth quarter comparable store sales fell 6% due to the chicken scare, China accounted for over 40% of the company’s profits. January sales for KFC outlets open for over 12 months plunged 41% with a gloomy current year outlook. The company runs over 4,000 KFC stores and about 700 Pizza Hut stores in China, and plans to open about 700 stores this year.

Even McDonald’s has an aggressive expansion plan for China. The company proposes to open 1,500 new restaurants across the world in 2013, of which about half would be in China, where it presently has about 1,300 outlets. This would increase the total number of outlets to around 2,000 by the year end.

Burger King (NYSE: BKW) which has just about 100 stores in China, is looking to rigorously expand in the coming few years. It aims to open up approximately 1,000 new outlets in the next seven years. However, it would be hard for the player to get a good grip of the market given Yum!’s and McDonald’s strong foothold. Despite this, the company is targeting China as part of its international expansion to fuel growth.

The chicken contamination scandal has not only brought down revenue, but has also shaken Yum!’s hard earned reputation here. The fast food giant has already warned of lower earnings per share this year. However, fixing the chicken scare is very important given the growth prospects that China offers. As per a report of McKinsey Global Institute, consumer spending is set to rise as high as $30 trillion by 2025 in emerging markets, which include China, India, and Brazil. The fast food industry is one of the sectors that will be rewarded the most. With rising affluence and higher disposable income, consumers tend to increase their spending. As an effect of urbanization, people tend to eat out more, creating opportunity for the fast food sector.

Looking ahead
As of now, Yum!’s sales shall continue to fall in the first half of the year unless consumers get back their confidence. Unless the food safety issue is taken care of and the chicken scare lessened, it will be difficult to recover, especially since chicken forms an important part of Chinese cuisine. In the meantime, it is essential for Yum! to track all possible units that do not comply with normal food safety standards. Yum! has to ensure a high standard to maintain Chinese consumers' trust in the KFC brand.

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