Some might call it a Chinese salute to arguably one of the most familiar Western faces in modern China.
No, we're not talking about Richard Nixon or Henry Kissinger. Rather, it's Colonel Harland Sanders, whose name may not be familiar to many Chinese, but whose familiar face graced China's 10,000th KFC when it opened on Friday in the scenic city of Hanghzou. The milestone underscored KFC's dominance as China's biggest Western fast food chain, 36 years after it also became the first foreign chain to enter the market.
KFC's road to 10,000 has been filled with twists and turns, including the many challenges brought by the pandemic between 2020 and 2022. It continued to open stores at a rapid clip even during that time, including 926 net new stores in 2022 and another 823 in the first nine months of this year. It said it will step up that pace in the coming years, with plans to open an average of 1,200 net new stores in each of the next three years, according to its announcement on opening its 10,000th store.
The chain has also set itself another type of ambitious expansion plan beyond simply opening new stores. It currently serves over one-third of China's 1.4 billion people, but is aiming to raise that to over half by 2026, said Joey Wat, CEO of Yum China (NYSE: YUMC), which operates KFC in China, as well as sister brand Pizza Hut.
Yum China is confident that there is still lots of growth potential in the market, and is monitoring over 1,100 Chinese cities where KFC does not have a presence, she added.
But while the company has emerged meaner and leaner from the pandemic, it could face newer challenges ahead from China's slowing economy, which is leading consumers to rein in their spending. KFC and Pizza Hut have responded by adding more items to their menu for value-oriented customers, and also by stepping up its delivery services to make things easier and more affordable for its customers.
Those challenges may be reflected in Yum China's stock, which currently trades at a price-to-earnings (P/E) multiple of 22. That's slightly behind the latest ratios in the 25 to 27 range for other major global restaurant operators like Yum China's former parent Yum Brands (NYSE: YUM), as well as McDonald's (NYSE: MCD) and Restaurant Brands (NASDAQ: QSR), which operate global chains that also include large China footprints.
Among those, McDonald's is KFC's closest competitor in China with over 5,000 stores and aiming to reach the 10,000 mark by 2028. By comparison, KFC would reach the 20,000-store milestone in China around 2031 if it can continue to open stores at its planned rate of 1,200 per year.
KFC has come a long way since it first entered China in 1987 with a lone store at the southern edge of Tiananmen Square, serving a basic menu to Chinese unfamiliar with Western fast food. From that single outlet, the chain has expanded to 1,900 cities across China, and now processes a staggering 1 billion transactions each year. The chain now accounts for about three-quarters of Yum China's sales, with most of the rest coming from Pizza Hut.
KFC has achieved its success in no small part by going local, a strategy that is now quite common but was once considered verboten for global fast food chains. Among other things, KFC's menus over the years have included items like rice porridge, known locally as congee, as well as other rice dishes, seafood and egg tarts - all foods that Harland Sanders probably wouldn't have put on the menu when he opened his first franchised restaurant in the U.S. state of Utah in 1952.
Two locally developed products, the company's beef burgers and whole chickens, now account for about 6% of KFC's China sales - more than total sales for its original recipe chicken.
Leaner Organization
While KFC's China menu may look quite different from other parts of the world, Yum China has also taken a wide range of other steps to update the chain over the years to make it more efficient and adapted to China's smaller cities with lower living standards and different eating habits. More than one in every three KFCs worldwide is now in China, many of those in such smaller cities.
As reported in its last quarterly earnings, the company focused on reducing fixed cost such as lowering cash investment in each store which has significantly contributed to the profitability of its operations. The company also boosted its digitization effort, with 89% of all orders for KFC and Pizza Hut coming over digital channels in the third quarter of this year. The chain has also adopted a range of store formats, including smaller stores that are less costly to operate and more suitable for smaller cities.
Such positioning has helped KFC to bounce back sharply from the pandemic. The chain's revenue rose 13% in the first nine months of the year to $6.37 billion, as its operating profit jumped 54% to about $1 billion. Its same-store sales also rose 9% year-on-year in the nine-month period, reversing a 7% decline for all of 2022, while its restaurant margin rose by 2.8 percentage points to 19.4%.
After years of operating all its stores on its own, Yum China is also stepping up its use of franchise partners, which are commonly used by fast food operators in other parts of the world, to achieve its aggressive growth targets. In its latest announcement, it said that 15% to 20% of its new KFC store openings will come from franchise partners going forward.
The organization has also built up strong relations with its suppliers over the years, including buying stakes in key partners to ensure its access to the materials it needs to supply its massive operation. In 2021 Yum China purchased 5% of Fujian Sunner Development (002299.SZ), which bills itself China's largest producer of white-feathered chickens. Two years later, it bought 40% of Shanghai Bolex Food (603170.SH), one of its top condiment suppliers.
Yum China was spun off and separately listed from Yum Brands in 2016 as the master franchisee for KFC, Pizza Hut and Taco Bell in Mainland China. Its stock has risen roughly 60% in the seven years since then, trailing the roughly doubling for former parent Yum Brands.
That probably reflects the fact that the stock was once valued well ahead of its peers due to bullishness over the China market. But as the Chinese economy finally starts to slow after three decades of breakneck growth, KFC and Yum China, as well as all major fast food operators in the market, are having to adopt to a new reality. That will test their ability to keep innovating and find new ways to operate more efficiently as they aggressively open new stores in a Chinese market that increasingly shares many characteristics with its more mature Western peers.