Yesterday, Yum Brands, operator of KFC, Pizza Hut and Taco Bell restaurant franchises and outlets, invoked business media headlines with the announcement that the firm will split-off all of its China based restaurant outlets into a separate publicly traded franchisee based company.
From our Supply Chain Matters lens, the announcement provides two important takeaways for industry supply chain communities.
The first relates to supply chain disruption and risk associated with global expansion, particularly as it relates to current conditions in China. Yum’s operations in China had accounted for nearly half of the operator’s revenues. The firm has been long cited as a fast-food and foreign brand pioneer in investing in China, having opened its first KFC restaurant in Beijing in 1987. Yum reportedly now operates 6900 restaurants across China.
In the summer of 2014 well-known global restaurant brands such as McDonald’s, Burger King and Yum Brands were each named by both Chinese media and food regulatory agencies for offering expired meat products to customers. The expired chicken and beef meat products were traced by restaurant operators to a specific China based supplier, which was affiliated with U.S. based OSI Group, a $6 billion producer of food products. OSI itself had garnered what was reported to be a solid reputation as a quality focused food supplier. Unfortunately however, wide-scale publicity across China and continued regulatory scrutiny hampered efforts to restore consumer confidence. Since that time Yum Brands has attempted to recover from other food safety scares along with the consequent damage to its respective brands within China.
In its reporting, The Wall Street Journal indicates that one of the intents of this proposed split is to insulate the company from the turbulence that has beset its China operations from food-safety scares, stronger competition and Yum’s own operating missteps along the way. However, the operator desires to maintain a stream of future revenue from what remains to be a large and growing market. Hence is the proposed split involving a franchisee and royalty-based framework.
While many details of this proposed split are lacking, the gist of current reports would indicate that current Yum owned outlets across China will be franchised with a royalty arrangement back to Yum. Whether this arrangement includes an exit from supply chain operations within the country is still an open question, but by our view, seems to be a likely possibility. That would in-effect saddle the China operation with the responsibility to maintain or modify existing sources of supply and perhaps re-negotiate existing food and other supply agreements.
The implications of a pioneer such as Yum Brands making such a move is another indication of many troubling challenges that foreign-based brands are struggling with in maintaining operations within the country.
The second takeaway relates to the continuing influence that activist investors have on strategic decisions related to value-chain operations. As the WSJ notes, this week’s news comes only five days after an activist investor who proposed such a split had assumed a Yum board position. That activist investor accumulated a five percent ownership position in May and then lobbied for both a business strategy change as well as a seat on the board.
When a recognized pathfinder elects to punt from owning value-chain operations in China, it is indeed a wake-up call, especially for companies with impatient investors. China represents a vast market potential yet a multitude of complex value-chain challenges and risks, especially in the light of a troubled economy.