2006-04-28

The billion people market dream comes true: Yum! Brands in China


It is no longer a dream. According to WSJ (see also Businessweek)
  • Yum Brands Inc., parent company of fast-food chains KFC, Taco Bell and Pizza Hut, reported an 11% rise in first-quarter earnings, helped by double-digit growth in its U.S. and China operations. Slightly higher margins and same-store-sales growth in the U.S. helped Yum offset some foreign-currency head winds overseas. The Louisville, Ky., company posted net income of $170 million, or 59 cents a share, for quarter ended March 25, compared with $153 million, or 50 cents a share, a year earlier. Revenue rose 1.5% to $2.09 billion. Same-store sales, or sales at restaurants open at least a year, rose 5% in the U.S. The company said its operating profit totaled $58 million in its China division, up 10%, while operating profit in its U.S. business was up 19% at $188 million.

Yes, that is right. $58M in operating profit (not revenue, profit) from only two brands, KFC and Pizza Hut, in China. This compares with $188M in US.

How significant is this? Considering there is no Taco Bell (unlikely in near future), we are talking about $50M(China, conservatively deducted $8M as "China division" includes Thailand, HK, Taiwan) vs $130M(US, see # stores in table below, Toco Bell/etc contributed more than $58 I deducted here)

Number, location of its stores
Source: USA Today Feb/2005

USA
Abroad
KFC
5,450
7,676
Pizza Hut
6,306
4,680
Taco Bell
5,030
193
Long John Silver's
1,200
33
A&W All-American
485
209
Total
18,471
12,791

  • China GDP: $2tn; USA GDP:13tn. So Yum! China profit is 2.5 times that of USA in terms relative to market size
  • per capita profit: China $50/1300 vs USA 130/300. i.e. $0.0385 vs $0.433. Let's factor in the fact that price level in China is lower than US, say 30-50% lower, that still gives at least a 5-7 fold growth potential for China. Scrap 2/3 of rural China, still 2-3 times that of USA.
  • Note the cost in China is also lower, and most importantly, the sales/store is a lot higher in China due to higher urban population density ($1.2M/store China vs $0.9M/store USA, see below -- this explains why McDonald's in HK is among the cheapest while also the most profitable franchise in the world
  • If you think they got lucky on KFC, let me remind you that it was bird flu year and that Chinese are not very fond of pizza
  • Another reason China has a lot of room for growth is that the $50M is mostly from KFC today, i.e. the profitable Pizza Hut has a lot of room to grow (1,378 KFC and 201 Pizza Huts at mid-2005)
In a few years, I am not surprised to see Yum profit in China exceed that of USA, by 2-3 folds.

How did they accomplish this? For an interview with Yum! CEO in February see USA Today a year ago (and older but arguably more insightful story on Times Asia Nov 2003, and of course, the always great Economist coverage).
  • Insana: Do Chinese KFCs outsell U.S. KFCs?
    Novak: Yes. Our China average unit volumes are $1.2 million, vs. around $900,000 or a little higher in the U.S. Our China business is very exciting. This year, we will make $200 million in China. That's 15% of our total profit. In 1998 we made $20 million. We have the two leading brands in China. KFC, according to the Nielsen survey, is the No. 1 consumer brand in all of China. That's ahead of Coca-Cola, Pepsi, Nike, everybody else.

    Insana: Since China's currency is not fully convertible, how do you repatriate profits?
    Novak: We are very successful taking cash out.

    Insana: In paper bags?
    Novak: Well, no. We work it through Treasury. It's a very complicated process, but we basically have no problem at all repatriating our profits. In the last quarter we brought back about $50 million from China. The great thing about China is that we're self-funding all of our growth, plus we have free cash flow that we bring back into the U.S. It's a great business.

    Insana: You're bringing Chinese food to China. How will you do that successfully? I'd be a little skeptical if a Chinese company came here and tried to sell me a hamburger.
    Novak: This is in the embryonic stages. We have a team in China that is self-sufficient and local. We told them, "You know what you love. You know what the Chinese customer loves. You develop the Chinese fast-food concept." So it's not like David Novak and a bunch of U.S. citizens going over there saying, "Here's what you need to eat as Chinese food."

Is Yum! Brands an isolated case? No. Talk to Volkswagon, P&G, Coca Cola. This is no longer an unreachable dream.

There are also miserable failures, Whirlpool, eBay, Yahoo, etc. China is THE most competitive market in the world, as the everyone comes here. However, it is also not difficult to succeed, because the large market also allows for niche opportunities. For strategists, there is no excuse for failure, as it is easy to find out what each of the failed companies has done wrong.

I will end this with a question to the economists. How does the $250M/year profit repatriation of Yum! Brands factor into the US-China trade balance? I believe Paul Krugman had the answer years ago.
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2 comments:

China Law Blog said...

Interesting post. I would think that the money that comes out of China and goes to the United States would serve to reduce our trade deficit with China. I am not positive on this, but it would certainly make sense. To the extent there are American employees who work in China and send money back, their remittances would also serve to lower the balance of trade. I think.

Sun Bin said...

Yes, this, and service industry, patent fees, etc. will change the net cash flow, hence the current account.

Unfortunately most people are pre-occupied with the narrow definition of "manufactured goods trade deficit". Inability to see the full picture might not be good for the long term competitiveness of the US itself.