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990G01 KENTUCKY FRIED CHICKEN IN CHINA (A) Professor Allen J. Morrison prepared this case with assistance from Professor Paul W. Beamish solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca. Copyright © 1989, Ivey Management Services; Canadian International Development Agency Version: (A) 2003-05-29 In late September 1986, Tony Wang leaned back in his leather chair in his Singapore office and thought of the long road that lay ahead if Kentucky Fried Chicken (KFC) were ever to establish the first completely Western-style fast food joint venture in the People’s Republic of China. Wang, an experienced entrepreneur and seven-year veteran of KFC, had only two months previously accepted the position of company vice president for Southeast Asia with an option of bringing the world’s largest chicken restaurant company into the world’s most populous country. Yet, as he began exploring the opportunities facing KFC in Southeast Asia, Wang was beginning to wonder whether the company should attempt to enter the Chinese market at this time. Without any industry track record, Wang wondered how to evaluate the attractiveness of the Chinese market within the context of KFC’s Southeast Asia region. Compounding the challenge was the realization that although China was a huge, high profile market, it would demand precious managerial resources and could offer no real term prospects for significant hard currency profit repatriation — even in the medium term. Wang also realized that a decision to go into China necessitated selecting a particular investment location in the face of great uncertainty. It was equally clear that while opportunities and risks varied widely from city to city, the criteria for evaluating suitable locations remained unspecified. With limited information to go on, Wang realized that a positive decision on China would be inherently risky — both for the company and for his

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own reputation. And while Wang was intrigued by the enormous potential of the Chinese market, he also knew that many others had failed in similar ventures. HISTORY The origins of Kentucky Fried Chicken can be traced to Harland Sanders, who was born in 1890 in Henreyville, Indiana. When Sanders was a boy, he dropped out of the sixth grade and began a stream of odd jobs, concentrating eventually on cooking. In time he opened his own gas station with an adjoining restaurant. In the 1930s, Sanders developed a “secret” recipe for cooking chicken by first applying a coating containing a mixture of 11 herbs and spices and then frying the chicken under pressure. This “southern fried chicken” eventually became a hit at the gas station, and in 1956 Sanders decided to franchise his novel concept. By 1964, he had sold almost 700 franchises. Much of Sanders’ success in this pioneer industry lay in his near obsession with product quality and a commitment to maintaining a focused line of products. In 1964, at the age of 74, Harland Sanders finally agreed to sell the business in exchange for US$2 million and a promise of a lifetime salary. The sale of the business to John Brown, a 29-year old Kentucky lawyer, and his financial backer, Jack Massey, 60, was accompanied by the assurance that Sanders would maintain an active role in both product promotion and quality control of the new venture. With new, aggressive managers and a rapidly evolving American fast food industry, KFC’s growth soared. Over the next five years, sales grew by an average of 96 per cent per year, topping US$200 million by 1970. This same year almost 1,000 new stores were built, the vast majority by franchisees. A key element in this rapid growth was Brown’s ability to select a group of hard- working entrepreneurial managers. Brown’s philosophy was that every manager had the right to expect to become wealthy in the rapidly growing company. By relying heavily on franchising, the company was able to avoid the high capital costs associated with rapid expansion while maximizing returns to shareholders. Rapid sales growth provided promotion and opportunities to purchase stock for company managers as well as the opportunity for franchisees to improve margins by spreading administrative costs over a broader base of operations. This was critically important given the high fixed costs associated with each store. Volume, both at the individual store level and within a franchisee’s territory, was thus essential in determining profitability. Profitability, in turn, assured the attractiveness of KFC to potential future franchisees. In 1971, Brown and Massey sold KFC to Heublein Inc. for US$275 million. Heublein, based in Farmington, Connecticut, was a packaged goods company which marketed such products as Smirnoff vodka, Black Velvet Canadian whisky, Grey Poupon mustard, and A1 steak sauce.

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Challenges at Home and Abroad The establishment of KFC’s international operations began just prior to the company’s acquisition by Heublein. KFC opened its first store in the Far East in Osaka, Japan in 1970 as part of Expo-70. By 1973, KFC had established 64 stores in Japan, mostly in the Tokyo area. KFC also moved quickly into Hong Kong, establishing 15 stores there by 1973. Other areas of expansion included Australia, the United Kingdom, and South Africa. Shortly after the acquisition, KFC’s small international staff was merged with Heublein’s much larger international group in Connecticut. In spite of Heublein’s efforts to impose rigid operational controls, KFC country managers were frustrated by the imposition of U.S. store designs, menus, and marketing methods on culturally divergent host countries. Resistance to corporate control grew and led many stores to develop their own menus: fried fish and smoked chicken in Japan, hamburgers in South Africa, and roast chicken in Australia. In some cases, local managers seemed to know what they were doing; in other cases, they clearly did not. After heavy losses, KFC pulled out of Hong Kong entirely in 1975. In Japan, operations also began on shaky grounds with losses experienced throughout much of the 1970s. In addition to poor relations between country managers and corporate staff, the 1970s presented a much more challenging environment for KFC in the United States. The fast food industry was becoming much more competitive with the national emergence of the Church’s Fried Chicken franchise and the onset of several strong regional competitors. Important market share gains were also being made by McDonald’s hamburgers. With the Heublein acquisition, many top managers who had been hired by Brown and Massey were either fired or quit, resulting in much turmoil among the franchisees. By 1976, sales were off eight per cent and profits were decreasing by 26 per cent per year. To make matters worse, rapid expansion had led to inconsistent quality, poor cleanliness and a burgeoning group of disenchanted franchisees who represented over 80 per cent of total KFC sales. At one point, even white-haired Harland Sanders was publicly quoted admitting that many stores lacked adequate cleanliness while providing shoddy customer service and poor product quality. Turning Operations Around In the fall of 1975, with rapidly deteriorating operations both at home and abroad, Heublein tapped Michael Miles to salvage the chain. Miles was initially brought in to head up Heublein’s international group, which by this point was dominated by KFC. Miles had come to Heublein after managing KFC’s advertising account for

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10 years with the Leo Burnett agency. At Heublein, he had risen to vice-president in charge of the Grocery Products Division. While he had little international experience, he had developed a strong reputation for strategic planning. His challenge in late 1975 was to install consistency in international operations by increasing both corporate support and control. One of his first decisions was to move KFC-International back to Louisville where it could begin to develop a degree of autonomy within the corporation. Within 18 months, Miles was asked to manage KFC’s entire worldwide turnaround, including operations in the United States. The basic thrust of Miles’ strategy was a return to back-to-basics in terms of menu selection and commitment to quality, service, and cleanliness (QSC). The back-to- basics strategy was supported by a new series of staff training programs, random inspections of company-owned and franchisee stores, and a new “we do chicken right” advertising program. The goal was to focus consumer awareness on a sleeker, more customer-oriented KFC which would make one product — chicken — better than any of its competitors. The results of the turnaround strategy were dramatic. By 1982, KFC had become Heublein’s fastest growing division, with real growth of 2.3 per cent. From 1978 to 1982, sales at company-owned stores jumped an average 73 per cent, while franchise unit sales rose by almost 45 per cent. Much of this growth came from KFC’s international operations where company units outnumbered even McDonald’s outside the United States. While chicken is eaten almost everywhere in the world, the same is not true of beef which has been poorly received in many countries. This provided KFC with a considerable advantage in penetrating foreign markets. Nowhere was this more true than in the Pacific Rim, where by 1982, KFC had nearly 400 stores in Japan. In Singapore alone, KFC had 23 franchised stores. Acquisition by R.J. Reynolds Although KFC had made dramatic progress, growth was limited by restricted expansion capital at Heublein. Most of the profits generated by KFC were being used to revive Heublein’s spirits operations, which were themselves facing flat sales and increased competition. By 1982, KFC was receiving only US$50 million per year in expansion funds compared with the US$400 million being spent by hamburger giant McDonald’s. KFC also had one of the lowest ratios of company- owned to franchisee stores in the industry. Many franchise stores were slow to upgrade facilities and it was understood that major investments would be required to assure the integrity of the overall KFC network. In the late summer of 1982, R.J. Reynolds of Winston-Salem N.C. acquired Heublein for US$1.4. billion. The acquisition was supported by Heublein directors fearful that the company might be taken over and sold in pieces. Reynolds had

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been seeking expansion possibilities in the consumer products industry where its marketing skills and huge cash flow could best be put to work. Although hugely profitable, Reynolds’ tobacco operations were being attacked by soaring taxes and consumers’ declining interest in smoking. The acquisition of Heublein was only part of a group of companies Reynolds acquired during the late 1970s and early 1980s, including Del-Monte Corp. in 1979, Canada Dry and Sunkist Soft Drinks in 1984, and Nabisco Brands in 1985. Soon after the acquisition, Mike Miles left the company to become president of Dart and Kraft. He was succeeded as CEO of KFC by Richard Mayer who had worked with Miles on the turnaround. Mayer had put in a 10-year stint at General Foods where he rose to become head of the Jell-O product group. Mayer characterized the acquisition as “marvellous.” International Expansion The heavy financial backing of Reynolds resulted in further growth for KFC. Betting that health-conscious consumers would increasingly shift consumption to chicken, Reynolds designed an ambitious worldwide expansion plan that promised US$1 billion in funds over five years. Much of this expansion would come outside the United States where markets remained largely untapped. As was the case with domestic operations, franchising played a major role in KFC’s international growth. Franchising became the mode of choice in many markets where political risk and cultural unfamiliarity encouraged the use of locals. Another advantage with franchising was that KFC could be assured a flow of revenues with little investment, thus leveraging existing equity. This was a particularly attractive option internationally where potential deviations of franchisees from KFC operating procedures could be more easily isolated. The downside of a reliance on franchisees was that it permitted an erosion of system integrity. Local franchisees typically controlled a portfolio of companies, with KFC sales representing only a portion of revenues. Local franchisees, driven by a desire to maximize profits, often cut corners or “milked” operations. While this type of strategy would generally not compromise short-term profitability, it often led to the deterioration of operations over the longer term. This problem was only exacerbated internationally where control was more difficult to maintain. Southeast Asia Operations By 1983, KFC had established 85 franchise stores in Southeast Asia, including 20 stores in Indonesia, 27 stores in Malaysia, and 23 stores in Singapore. This area was recognized as the Southeast Asia Region, one of five separate geographic

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