In 1986, Tony Wang was Vice President of the Southeast Asia division of KFC. He had an opportunity of bringing the world’s largest chicken restaurant company into the world’s largest populated country. Wang was an experienced entrepreneur and had been working for KFC for seven years. No other fast food companies were currently operating in the People’s Republic, so Wang did not have anything to go by and nothing to help him evaluate the attractiveness of the Chinese market. The main downsides of operating in China were huge demand on managerial resources and the low prospects of significant hard currency repatriation.
The first decision that Wang was faced with was where to open the location of the first KFC. Obviously there were differences from city to city but a reliable way to evaluate these differences did not exist. Wang was interested in the enormous potential of the Chinese market, but he knew that many other companies had failed in similar ventures.
Ta-Tung, (Tony) Wang was born in the Sichuan province in the People’s Republic of China in 1944. He moved to Taiwan when he was young and graduated from the Chong-Yuan University with a degree in engineering. He later moved to the United States, and in 1973 completed a masters degree in management science from the Steven’s Institute of Technology in New Jearsey. He then attended New York University where in 1975 he received his post-master’s certificate in international business management.
Wang joined KFC in 1975 at the headquarters in Louisville. Wang was convinced of the large potential for American-style fast food in China. He attended a lecture by the mayor of Tianjin(the third largest city in China), who spoke of the many opportunities for investment in his city. Wang was asked by the mayor to sit on a council to advise on improving the fast food industry in Tianjin.
KFC was currently owned by R.J. Reynolds who were very interested in getting into the Chinese market to sell their cigarettes. American smokes were in high demand in China.
Wang had the support of top management. He spoke perfect Mandarin and English and was as comfortable working in New York as he was Beijing. He also had experience negotiating with the Chinese.
As Tony Wang investigated more and more into the necessary requirements, concerns were beginning to grow. He knew that Chinese workers would have problems working under the KFC guidelines. Time-consuming, expensive training programs would be a necessary requirement. As well their large capital outlays would be needed to find and negotiate a partnership, to sign a lease and gain operating permits.
Wang began to thoroughly research the Chinese market. The first are that he began to look at was location. The reason that this was so important was because the location would have dramatic impact on the profitability, future expansion to the rest of China, and the managerial resources commitments. Four cities were selected as potential locations for the first store: Tianjin, Shanghai, Guangzhou, and Beijing.
Tianjin – The major advantages of Tianjin were the established contacts that Wang had there. As well, it was only one of three municipal governments in China that were not controlled by the Central Government in Beijing. The major problems with Tianjin were it lacked a convenient supply of grain-fed chickens. The chickens there were fed using fish meal-fed chickens. The Chinese place great emphasis on freshness and taste. They also were not a very popular tourist location. Wang expected most profits to be in Renminbi, but some foreign currency would be needed for profit repatriation and purchasing needed supplies, that can only be purchased outside of China.
Shanghai – Shanghai has over 11 million people, and is regarded as China’s most prosperous business centre. Shanghai is home to a large variety of Western hotels, business facilities and tourists, however its also is not a very popular tourist spots because of the pollution and loud noise. The investment could not be justified if it did not supply an adequate amount of foreign currency. . However it did contain several feed mills and the largest poultry supplier in China.
Gangzhou – Gangzhou is located in Southeast China only a short distance from Hong Kong. Gangzhou is recognised for it preferential treatment for foreign investment. It has greater autonomy in approving foreign investment projects, reducing tax rates, and encouraging technological development. Many tourists visit Gangzhou because of its close proximity to Hong Kong. As well any operations could be managed directly from the existing Hong Kong operations. As well Wand did not anticipate difficulty finding a supplier for chicken.
Beijing – Beijing is the second largest city in China. It is the political and cultural centre and has relatively high levels of affluence and the education of its inhabitants. It is also the tourist centre of China, with many attractions located in and around Beijing. A Beijing location would also give a higher profile. This could be good and bad. If they received approval from central government they would be able to enter the rest of the Chinese market without hassle. However, because of the higher profile the government might decide that they would not fit in to the Chinese landscape, which would prevent them from ever succeeding. Outside of Beijing there were also numerous poultry farms.
Wang knew that the location was the most important and would decide whether KFC would succeed or not. There were currently no other competitors in the Chinese market so now was the time to strike and take advantage of the situation, but the risks were high and he had to weigh out these risks for a huge gain or loss.
In early February 1987, Wang decided to open operations in Beijing. This was decided because of Beijing’s high amount of tourists and its autonomous municipal government. However, he was feeling more worried about the venture. KFC just recently signed a joined venture partnership. Wang’s worries were stemming from the difficulty he had been experiencing getting things done in a city governed by a bureaucracy that seemed impossible to either understand or work with. He felt that he would never be able to find a location in the city and government approval on everything was required. Wang was also concerned whether Chinese workers would be able to meet KFC’s demands for cleanliness, quality and service.
The establishment of a joint venture was considered essential because Wang described them as, “completely impossible for us to understand. In fact, trying to do so is a complete waste of time.” Trying to understand investment regulations, winning approval for operating licenses, leases, and employment contracts could certainly prevent them from proceeding. A local partner was not required under Chinese law, however Wang felt it would in setting up operations and maintaining its continued viability.
Through ties that R.J. Reynolds had with the Ministry of Light a partnership was formed between KFC and the Beijing Corporation of Animal Production, a Beijing city government-controlled producer of chickens. After careful inspection KFC found that this would indeed work out because they already produced 3 of the approved breads of chicken required for operations.
Negotiations with the Poultry producer commenced with Mr. Jue Xia, a senior manager in the Beijing corporation. Xia felt that it would be to meet KFC’s large demand because they did not have access to more excess reserves of grain. Xia was also hesitant about KFC’s quality standards. However, they thought that a partnership with a Western firm would be beneficial for them by gaining valuable international experience, and Xia felt the Tony Wang was unlike most American managers; he was a man he could deal with.
The Beijing Corporation helped Wang find a chicken supplier but they lacked close contact with the government agencies that would be essential to setting up operations. So a third partner was needed. Both partners agreed that the Beijing Tourist Bureau would be able to meet their requirements. The Tourist Bureau was responsible for the supervision of the construction and operation of all hotels and restaurants in Beijing. They had lots of experience speeding up the construction of many Western hotels, and had many types participated in a joint venture in these operations.
During these negotiations it happened that KFC was sold the Pepsico. During this time KFC was the second largest fast food chain in the world. It was initially thought that Animal Production had only come on board because of pressure from the Ministry of Light Industry, who wanted to win points with Reynolds, so the acquisition came at a bad time. But as it turned out Pepsico’s connections with the government in Beijing were even stronger than Reynolds, so negotiations continued with a renewed interest.
To convince the partners to become part of the venture, Wang offered a guarantee of five percent return on equity, much better than they could receive domestically. This sealed the deal in winning over the partners. KFC retained 60% of ownership, The Tourist Bureau received 27%, and Beijing Animal Production took 13%. This was the actual breakdown of assets that each partner was contributing to the arrangement. This deal was privately pre-approved as acceptable in negotiations with the Foreign Economic Development and City Planning Commissions. The approval of the partnership also required on the sharing of the corporation. With one-half coming from KFC and the other half split between the other two partners. The deal also stated that the chairman would be appointed by Animal Production and the vice-chairman would be appointed by the Tourist Bureau.
This concerned Wang because of loss of control of operations. Wang countered by establishing the new store as a franchisee. With the franchiser being KFC’s head office in Singapore. This would require 3% of royalty payments to be paid to the head office, and require the store to purchase it seasoning mixes from the head office, both using hard currency. Wang also appointed a day-to-day general manager to Beijing, who would be appointed by KFC and have control.
Although it seemed like all major challenges were over, they weren’t. The approval of the partnership did not give any operating authority for KFC in the city. They needed a “Licence to Execute a Business Activity.” Approval of this required the signatures of the District government, the Commerce Department, the Taxation Department, the Health Department, and the Food Supply and Logistics Department. None of these agencies and had any coordination, so approval from each separately was required and this could take months or years. Tony Wang stated:
” We are pioneers in China, but so are the Chinese. However, whether they want to learn or not is another story. Many Westerners make the same big mistake in China: they assume that they can just pay to have the required work done or at least expedited. This just doesn’t work in China. The Chinese are not motivated by a desire to do things right simply for the sake of doing things right. They don’t want your help in speeding up the process. They just want to avoid problems. And unless we can convince them otherwise, we are their biggest problem.”
A license was necessary before a lease could be signed, but Wang was worried that a desirable location might not be found. All buildings and possible space in Beijing is occupied. As well, Chinese regulations stated that new tenants would have to guarantee the employment of any workers left jobless when a new tenant took over. This worried Wan because he would be stuck with a number of unskilled Chinese that hew would have to employ.
The first store that was to be opened Wang wanted it to be big and flashy because it would determine the future success of KFC in China. However this was strategically a good idea it ran counter to the culture in China were there was a history of hostility towards Western culture.
In February 1987, a license was issued by the city, allowing KFC to operate in Beijing. The Tourist Bureau played an integral role in speeding up the application. Under the license KFC was given a tax remission for two years; profits in three years, four and, five would be taxed at 16.5%, with profits thereafter taxed at 33%
Wang now had to select a site open the first location. But no matter where a location was chosen KFC would still require a building permit, as well as hookups for electricity, water, gas, and heating before the store could open. Wang discovered that many of these services were difficult to obtain, and it was not uncommon for applications to not be processed for months. Another concern was the company’s ability to secure import licenses needed to bring equipment into the country: pressure frying machines, cash registers, blending and cutting equipment for the kitchen. Each one required separate permits that could take months to attain.
During all these negotiations Tony Wang realized that no one had thought to test market the area. It was known that the Chinese liked chicken, and from KFC’s success in Hong it was assumed that it would be accepted here, but now one had time to find out for sure and they were forced to cross there fingers. Another problem was finding a reliable potato supplier of quality potatoes. If they were unable to they would have to use mashed potatoes, and Wang did not know how the Chinese would receive this.
But the largest concern facing Tony Wang was whether or not the Chinese employees could meet the quality, service, and cleanliness requirements. They Chinese emplyees would have little appreciation for KFC’s international standards of cleanliness or product quality. Most domestic organisations lacked any incentive programs, work was seen as something to be avoided, and service was a foreign term. The KFC organization would not allow the store to open if these levels were not met. The ironic part was that Chinese consumers would accept less then what was required. This would create conflict with the partners.
Tony Wang also wondered what KFC would do with the soft currency that the venture would generate, and wondered whether or not there would even be any profits.
Wang was face with three options: 1. Pull out. Cut the company losses and avoid negative publicity if the venture failed. This would further research and and KFC could try to re-enter in a few years when there was more complete information. 2. Go ahead slow. Take more time evaluating the situation to make sure the partnerships were secure and the market would accept KFC, however this would invite competitor response. 3. Go ahead full. The market had high potential for success of KFC and with 1.1 billion people large potential for profits.
Wang decided to go full ahead. The location was finally found. The central government approved the least because Wang sold them on the idea that the restaurant would represent a symbol and statement of the People’s Republic open policy with the West. The lease was finally approved in April of 1987. However they did not have the building permit which would allow them to make necessary renovations. They also required hookups for gas, water and heating. Applications were continually lost or just went unanswered.
When KFC announced that it would be hiring it was flooded with applications. Management decided to treat all applicants equally. Referrals would not be accepted. This was a unique move in China where family contacts are usually used to land highly sought after jobs. This move created conflict with the partners. Most people were attracted to working for a foreign joint venture because they paid considerably higher than domestic firms. Control over workers was mainly attained through three primary moves: hiring, training, and incentive pay. Under Chinese foreign venture law KFC was given control over hiring and firing with their own criteria. KFC hired on five key qualifications: acceptable applicants must be high school graduates, must speak some English, must be presentable in grooming and dress, must demonstrate a willingness to work hard, and cannot have had previous work experience. Once employees were hired extensive training began. The equipment was received and hands-on training was given. Incentive pay played a large role in improving employee attitudes towards quality, service, cleanliness. To give employees a slow introduction to the work, the store opened for four hours in the morning and four in the afternoon, and between times they reviewed what had happened and what needs to be improved.
Water and electricity and heat were finally obtained. Adequate potatoes for fries were never found so they decided to offer mashed potatoes and gravy instead. The store finally opened on November 12, 1987. It opened with a gala affair, speeches were made by the U.S. ambassador, the mayor, and the chairman. There was also members from the local and international media.
March 1988, Wang was staring out of the third storey window of the KFC’s Beijing restaurant at the crowd’s gathering below. However things were not running smoothly, although after four months the Beijing KFC was the number one selling branch in the world. Conflict was arising with the partners and KFC’s management style. The partner’s felt that KFC was too strict and pushed as to whether lower standards would be equally acceptable to consumers. The store manager indicated that the employees required constant supervision and problems still arose. In one instance he noted:
“There are major differences which separate American management practises from the Chinese perspective. In America, managers try to be objective. They assess peoples’ performance. In China, they judge employees by other criteria. What is their personality like? Are they friendly? How well can they talk? Let me give you an example. I recently asked one of our employees to mop the floor. He told me that it had just been mopped. When I pushed him on this he admitted that he really didn’t know when it had been mopped. Finally, after some arguing he agreed to mop it “again.” However, when I returned later I saw the job had not been done. Again, he used the same argument that “it was mopped earlier”. What can you do?”
They need to supervise employees was a constant strain on local management. Most of them only wanted to be posted here temporarily, they saw this as an undesirable position. This required the need to be continually searching for competent managers. When disputes arose between management and staff the employees ran to the partners for help which put more pressure on their relationships. The partners felt that it was their duty to advise and direct on daily operations but as far as KFC was concerned there usefulness was running out. They were integral in the start-up of operations but not were becoming more of a nuisance. Another pressing matter was there supply of chicken was already at its maximum and if KFC wanted to expand it would have to find another supplier if they wanted to expand.
In April 1988 the decision was made to open to second location in Beijing. The building that was selected had 60 employees, but only 17 met KFC’s hiring requirements. Then in an unprecedented move the Chinese government found positions for the remaining 43 workers. KFC partnered with the Bank of China in the summer of 1988. This new partner brought new opportunities to access further hard currency. They also helped them for alliances with other poultry suppliers.
In the summer of 1993, KFC operated 16 restaurants in China. KFC continued to receive invitations from other cities. Among their KFC stores their was only one Chinese owner. All the other were joint ventures. This was a very important measure to ensure a high standard of quality.
· Make sure you read your company’s wishes before proceeding with a venture. Among other things, this includes understanding the parent’s level of commitment to the project, preferences regarding operating mode, and performance expectations.
· Make sure that you have a commercial way to retain control of the venture. This can be achieved by introducing technology, expanding the operation, moving locals abroad, etc. Maintain the option to establish Joint Ventures with other partners elsewhere in China
· Take care in calculating foreign exchange earnings
· Recognize the managerial commitments/opportunity costs associated with the investment. Would other options provide higher returns?
· Discounted cash flow analyses do not help much in situations of this kind. There are simply too many variables to make an accurate assessment. Be willing to take a “leap of faith”