Following his recent presentation at Sanford Bernstein’s 2013 Strategic Decisions Conference in New York, McDonald’s Corporation (NYSE:MCD) CEO Donald Thompson was asked about his company’s strategy in China, given that it lags behind competitor Yum! Brands, Inc. (NYSE:YUM) in both revenue and number of outlets in the country. Thompson was suffering from a cold on the day of the conference, but his breakdown of the question was one of the more coherent and emphatic position points you’ll hear from a Fortune 500 CEO. Thompson outlined clear strategic and philosophical differences with Yum! Brands, Inc. (NYSE:YUM)’s approach to entering China’s massive consumer market, and his answer is worth reading in its entirety:
The headline I would say for us is — this is not about a race with any one competitor. Not only that, for us at McDonald’s Corporation (NYSE:MCD) the 1,500 to 1,600 restaurants that I talked about from a development perspective are spread around the world. We think that that is the best approach. It gives us diversification in our portfolio of assets around the world. We’ve got 34,000-plus restaurants, almost 35,000 restaurants around the world. When we grow and develop we will grow and develop in not only the BRICs of Brazil, Russia, India, China, we’ll also grow in the South Koreas of the world. We’re also growing in the Malaysias of the world. We’re growing and franchising even stronger in many other areas that are around the world. So our portfolio is more diverse. We think that’s the right approach. Relative to China specifically, China is a great market and it will be a great growth market for years to come.
Today it represents 3% of our operating income. Will that grow in time? Yes, it will grow in time, but we don’t have all of our eggs in one basket. So we’ll continue to grow China. We’ll grow it at a pace that allows us to franchise effectively. We’ll grow it at a pace that allows us to continue to seek out sites that we can place drive-throughs in, because that’s the best long-term returns. And we’ll do it in a way that grows along with the automotive growth in China. We’ll start to grow outside of the core cities, which we[‘ve] begun to do, and we’ll establish development licensees even stronger, which we’ve already begun to do. So our strategy in China is a solid strategy, but it is part of a broader strategy. It’s not just about China.
To understand why Thompson shaped his answer the way he did, it helps to review the impetus behind the question: Yum! Brands, Inc. (NYSE:YUM)’s success in China. Yum! Brands, Inc. (NYSE:YUM) has famously staked its future on China, and today, it derives more than 50% of its revenues and 44% of its pre-tax operating profits from the country. This reliance on a single, huge market can garner tremendous rewards, but the pendulum swings both ways: In the first quarter of 2013, operating profits in the company’s China division declined 41%, as dreadful publicity surrounding its KFC restaurants’ supply chain scared Chinese consumers away.
Yum!’s three-layer China concentration
Just how concentrated is Yum! Brands, Inc. (NYSE:YUM)’s bet? Yum! Brands, Inc. (NYSE:YUM) is “all in” in China in three ways: First, it has staked its future on an overall revenue concentration in the country, as mentioned earlier. Second, within that concentration, it is focused primarily on the Chinese appetite for fried-chicken menu items at its KFC restaurants. The company wants to exploit the Chinese appetite for its fried chicken while it is still a novelty, and hopes to gain loyal, long-term customers in the process.