August 22, 2014 9:47 am

Fast food faces indigestion in China amid rapid expansion

A man reads a newspaper on a bench outside a McDonald's restaurant in Beijing, China in August 23, 2001. Faced with a saturated market in the U.S., McDonald's is accelerating expansion in emerging markets such as China, where urban incomes rose 40 percent between 1999 and 2003 and the economy grew 9.7 percent in the first half. Source: ImagineChina via Bloomberg News©Bloomberg

One month after the expired-meat scandal that dented the sales and reputation of western fast food in China, office worker Arthur Han contentedly chews his burger and proclaims that now is the best time to eat at McDonald’s in China – while the heat is still on from the food safety authorities.

Mr Han says he does not normally eat at the US burger chain, whose brand image for cleanliness and quality was shaken last month by an undercover television investigation that accused it and several other western fast-food companies including Yum Brands and Burger King of using a mainland supplier that relabelled expired meat.

In a country where food safety is one of the biggest political issues, the $200bn fast-food industry has been propelled again into the spotlight. The latest issue comes as the rapidly growing sector is grappling with a host of other issues. These include escalating competition from local players; rising rents; labour shortages – and the fundamental difficulty of procuring safe supplies in a market that is both fragmented and growing rapidly.

McDonald’s said this month that the scandal – which led Shanghai authorities to close down the affected factory of Shanghai Husi Food Co, a subsidiary of US food group OSI, and detain staff – initially had a “significant negative impact” on sales, though it could not estimate the outcome for the full year.

Yum said its brands KFC and Pizza Hut also saw sales drop initially, adding that if the decline persists it could have a “material effect” on full-year earnings per share. But analysts say that, whatever the impact on western brands, it is unlikely local players will be able to mop up the leftovers.

Food safety “is not just something that affects McDonald’s and KFC, they are just the best known”, says Torsten Stocker, partner at consulting firm AT Kearney. “If it’s a problem they are facing, why would others be any different?”

Many diners seem to realise that western brands are not the only ones with a problem: one young office worker eating lunch at a local fast-food outlet this week displayed a length of wire that he had just pulled out of his meal and told the Financial Times that the only solution was to “ignore it”.

That, say observers, speaks to the issue of suppliers. Most of China’s half a million food processors are far too small or unsophisticated to serve enormous and exacting clients such as the foreign chains.

Analysts say suppliers have failed to keep up with expansion in the sector, with companies such as Dicos increasing its restaurant numbers by 40 per cent in the first quarter of this year compared with last year, to 2,200 stores.

Hence a string of scandals have shaken the faith of China’s twenty- and thirtysomething white-collar workers. Brands such as Yum’s KFC in particular have been hit by one highly publicised supplier scandal after another; Yum sales had just begun to recover from a 2012 scare over antibiotics in chicken, when the expired-meat scandal broke last month.

A fundamental shift towards healthier Chinese-style cooking is redefining the industry, and consequently propelling domestic chains to challenge foreign evaders

- Mintel

And problems with food quality have also coincided with other trends that have challenged western fast-food brands, industry analysts say.

“Fast-food consumers in China have shifted away from their original curiosity about western fast food, and nowadays they are pickier and more focused on health,” says Shi Jun, catering industry analyst at Beijing-based Alliance PKU Management.

“Twenty years ago, a McDonald’s or a KFC might have been one of the few locations in some towns that had air conditioning and a clean bathroom, but now there are lots more alternatives; competition has greatly increased,” says Shaun Rein, of China Market Research Group in Shanghai.

KFC remains far and away the market leader with 4,600 outlets, more than double the 2,000 McDonald’s. But Dicos – a Taiwanese-owned fast-food chain strongest in lower-tier cities, with cheaper menus – recently eclipsed the US burger chain with 2,200 stores. It plans to have nearly 3,000 by the end of the year.

Private equity investors have backed a plethora of local fast-food chains, which are slowly building market share in the highly fragmented Chinese market, offering food that is closer to local tastes and marketing themselves as healthier. One such is Actis, which invested in a local hotpot chain, Xiabu Xiabu.

This is driving consumer choice in fast food, according to Mintel. The research company says: “A fundamental shift towards healthier Chinese-style cooking is redefining the fast-food industry, and consequently propelling domestic fast-food chains to challenge the foreign fast-food leaders.”

Mr Han, at the McDonald’s diner, says that if he had the time, he would definitely eat Chinese. But the fast-food industry is counting on the fact that in China – as in other markets – people will continue to be pressed for time. With a rapidly growing market that still, for all its problems, generates net margins of 15-20 per cent, fast-food operators have little intention of throwing in the towel.

Additional reporting by Zhang Yan

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