The labor cost – the only “advantage” in China’s Quick Service Restaurant sector when the global economic integration plus unfavorable domestic business environment make it harder for new companies to take off in a ready market.

In China, KCF increased its revenues by 25% in 2009 and 28% in 2008 when it has already become the largest restaurant company in terms of numbers of stores and revenues for the past ten years. For KFC’s revenues in 2010, China will surely overtake the US as its biggest market in the world, and in the next 3-5 years, KFC China is very likely to double its revenues and restaurant numbers.

The success of KFC is a showcase to manifest the advantages of foreign company in China and the shortcomings of China’s overall restaurant sector. Because of the integration of global economy and unfavorable domestic environment, the weakness in China’s Quick Service Restaurant (QSR) has never been so obvious nowadays, for its lack of investment and financial resources, lack of management capability, weak supply chain, lack of innovation, inadequacies in legal system to build a meaningful franchise system, lack of domestic brand, random city planning, government regulations, overall weakness in consumption power vs. high real estate rentals and high material costs.

Simply put, China almost has no domestic quick service restaurant chain if measured on the definition of QSR. All QSR in China are foreign companies.

The following is a percentage cost chart of the KFC sales in 2009:

1.       Because of the low labor costs, KFC China not only contributes the most revenues to Yum Group but also make the highest percentage profit. Because the fast growth in labor costs is offset by the exchange rate, the labor costs will continue to benefit Yum in dollar term.

2.       Cost of Sales, including food costs and paper goods, reflects that China has no much competitive advantages under a global economy. Among all three branches (U.S., International, and China), China’s costs of sales is the highest.

(1)    For per combo meal sold in China is about $4.15 when U.S. is around $5.8, which means the costs of sales is $1.56 in China against $1.76 in U.S.

(2)    If deduct the labor costs of suppliers’ manufacturing process, it means that China may very likely have higher raw material costs than America for a similar quality.

(3)    The whole supply chain in China is unsophisticated and aboriginal. Despite of the highest population in the world, its whole food supply chain is still relying on small food processors which are inefficient and lack of technology for mass production. It also reflects there are very few large end users to support the building-up of large food processing plants.

(4)    KFC China has the buying power for good quality products at the lowest price when it still has high costs of sales. China’s domestic brands and other new comers would encounter the same problem with a less fortunate solution.

3.       In Occupancy category, China is compatible with the world average but higher than U.S. In China, take-out is still rare which means China’s KFC restaurant needs to add more seats and to be larger than their counterparts in U.S. In addition, KFC China is the most well-known brand in all restaurants, which give them the leverage to enjoy better rentals too.

4.       China is almost the only market where KFC’s company owned stores are absolutely dominated and the number of the franchisee stores is near ignorable. It is also the case for McDonalds in China. It means KFC China has difficulties to make good profits and maintain a good reputation in a franchising system. This is very likely due to the weakness in China’s legal system to protect a brand as well as its intellectual rights, and also for the weak supply chain to ensure all franchisees up to the standards of KFC and still to maintain a comfortable profit margin if there is a margin at all.

5.       KFC China opened 500 new stores to reach 3500 stores in 2009, and will keep opening new stores at this rate for the next several years. For the most well-known domestic restaurant chain such as KongFu Master (真功夫) or Ajisen (味千拉面), they spend 15 years not being able to reach 500 stores. KFC has the financing resources, management capability, brand name, business focus, and supply chain channels to support such a growth.

6.       The average combo price at KFC is over $4 in China. When the average salary in China’s major cities is below $500, KFC’s price is quiet expensive. As a matter of fact, because of overall high costs of sales and real estate as well as lack of compatible competition, Chinese customers will unlikely be the beneficiaries of QSR concept when QSR has always been the pioneers in cheaper food. It is an irony for QSR concept in China.

KFC is one of a few successful foreign QSR chains in China. It is unlikely there will be many foreign brands to repeat the success like KFC has, but so are China’s domestic brands. Burger King’s franchising endeavors in China has already hit the rock. The market is void and waiting, but under current global economic integration and somehow unfavorable China’s domestic economic system, it is about to have egg first or to have chicken first. The solution is obvious, but the process is hard to foresee.

** (All data are either derived or quoted from YUM! annual reports of years 2008 & 2009)