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Why Chinese Fast Food Restaurants Struggle In Large Cities: A Case Study

Country Style Cooking Restaurant Chain Co (NYSE: CCSC), a Chinese quick service restaurant operator, had high hopes for its continued success when it became the first Chinese restaurant to list in New York in 2010. Although the franchise remains little known outside of Western China, in little more than a decade the company succeeded in building a name for itself and, with lofty plans to enter the lucrative first-tier market, seemed poised to become one of the largest fast food chains in the country.

Country Style Cooking, which started in 1996 in Chongqing, China's largest city by urban and rural population combined, has so far opened 206 restaurants in Chongqing and neighboring Sichuan province, where it has succeeded in attracting customers with its low prices and a menu focused on local cuisine.

Even after the entrance of foreign rivals such as KFC and Pizza Hut into the Chinese fast food market, Country Style Cooking has not fretted about competition because their prices are half or one-third lower than most of their established overseas peers. Its restaurants entertain 1,000 customers per day, with diners spending just 10 RMB ($1.58 USD) on average, much lower than the 20 to 30 RMB typically spent by customers at foreign fast food restaurants.

Another reason for Country Style Cooking's success in southwestern China is its location strategy. Instead of focusing on downtown areas and shopping malls, Chinese restaurant chains operating in third and fourth-tier cities tend to base themselves in communities and attract customers by word of mouth. Compared with people living in large cities, the residents of smaller cities are more likely to frequent stores and restaurants in their own neighborhoods.

But while this low-price/low-rent strategy served the company well in China's interior regions, Country Style Cooking failed in its business expansion plans in Shanghai. Originally hoping to take advantage of the city's World Expo in 2010, it wished to do as well in Shanghai as it had done in its home turf. Now it has closed both of its two money-losing restaurants in the city.

Country Style Cooking had gotten used to cheap rentals and labor, which did not apply to the first-tier cities, and this unknown brand could not distract KFC, Pizza Hut or McDonald's customers, an unnamed expert in the franchising industry argued. "Without enough customers lower prices do not make any sense."

Poorer standardization, management and marketing also hold back the growth of homegrown restaurant chains, the expert added.

Despite Country Style Cooking's failure in Shanghai, as well as allegations of improper sanitation practices at some of its locations in Chengdu, Sichuan's provincial capital, the company retains a strong regional presence in the market of its origin. According to statements made by Country Style Cooking's CFO, Roy Rong, in an interview in August of last year, that the company still has room to grow in Chongqing and Sichuan over the long term, and was also eying expansion into Northern China for the more immediate future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.