Capitalize on China's Appetite For American Fast Food

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 |  Includes: SBUX, YUM
by: Winston Kotzan

Hungry investors are anxiously cheering on their favorite U.S. food and beverage titans as they open shop in the lucrative mainland China market. The prize is the brand loyalty of over a billion Chinese eager to get a taste of American food. Two such companies with high hopes are Yum! Brands (NYSE:YUM) and Starbucks (NASDAQ:SBUX).

On my latest visit to China, I went on a mission to check up on the progress of these two companies in Beijing and Shanghai. My objective is to bring you a view from the trenches of how well these restaurants are performing on the front lines.

Yum Brands

The inconspicuous red “KFC” and Colonel Sanders logo can easily be found on the facades of shopping centers and office buildings. When approaching such buildings, it is often easy to notice that both floors of the restaurant are packed with customers. Of all the KFCs I’ve visited in China, no matter what time of day or night, business was overflowing.

The accessibility of the KFC restaurants is unmatched by any other fast food chain in China. In nearly every place where there’s a crowd, there’s a KFC. They can be spotted just off of highways, in shopping areas, and prime tourist locations.

Yum! Brands has done an excellent job tailoring this American chain to the Chinese market. The menu is different from the United States, featuring smaller sized meals and new entrees with deserts and ingredients well liked by the locals. Better yet, according to Peking University marketing Professor Jianfeng Wu, the Chinese consider KFC to be somewhat of an upscale restaurant (in contrast to the “fast food” cliché it has in America).

Following the success of KFC, it is quite obvious that Pizza Hut is now making great strides. At some locations, particularly Shanghai, KFC real estate is now shared with a separate Pizza Hut.

The menus for Pizza Hut are substantially different from that of the states, featuring bizarre ingredients such as seafood and corn (yes, corn!). The atmosphere inside is more elegant, as if it were an expensive steakhouse. The good news is that the Chinese seem to like it, as each Pizza Hut I’ve seen was almost as busy as the adjacent KFC.

Through my on-site visits, there were nothing but good signs that China has a voracious appetite for Yum! Brands.

YUM 1-yr chart

YUM

Starbucks

In stark contrast to the bustling crowds at the YUM stores, there was a different picture at Starbucks. First of all, many of the Starbucks stores were not as easy to find. While KFC and Pizza Hut are sure to be found in all of the prime shopping and tourism locations such as The People’s Square in Shanghai, Starbucks is nowhere to be seen.

At the Starbucks locations that I was able to find, there were mixed results. Some of the stores had a decent level of business consistent with what you would find in the States, but there were quite a few where the employees outnumbered customers.

For Starbucks, the problem seems to lie in both product and price. China is a tea drinking nation, with tea being an integral part of its history and culture. It would be difficult for Starbucks to switch them to coffee overnight. Unlike YUM, which adapted their menu to the local tastes, Starbucks is serving the exact same menu as in the United States at exactly the same price.

Pricing is a problem in that the average price of 28 yuan (~$3.68 USD) for one cup of coffee is too expensive for the Chinese, considering that the average national income is less than $6,000 per year. This forces SBUX to service only the high end urban market.

In addition, I believe SBUX will face the problem of having the coffee market commoditized in China. Many locally owned coffee shops have sprung up, offering a pleasant environment and more extensive and creative menus than Starbucks. Even YUM has entered the high-end coffee market by serving cappuccinos at Pizza Hut.

I think Starbucks does have potential in China as the Chinese gradually get wealthier, but it will take a lot of work and potential losses before they build the same level of success as in the United States. The younger generations of Chinese have a strong fascination with Western culture, which includes a liking for coffee. Starbucks has a good chance for success in the long term, but that won’t be for a while.

SBUX 1-yr chart

SBUX

Full Disclosure: Author holds a long position in YUM