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Why China Loves Yum Brands

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"Indigenous innovation" may worry Microsoft, Boeing, and Caterpillar, but for KFC's parent, it's a non-issue.

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China can't get enough of its KFC.

One woman celebrated the Chinese New Year with her husband's nephews at a KFC in Chuzhou, after waiting in line for 30 minutes just to get in the door.

KFC parent company Yum Brands Inc. (YUM) opened more than 500 new KFC outlets in China last year, reporting a 23% increase in operating profits in the region. Revenues were up 18% year-over-year, to $3.68 billion.

There are more than three times as many KFC locations in China than there are McDonald's (MCD), and Yum is betting heavily on China as part of its growth strategy.

Yum seems to be managing this expansion well. The company is quite savvy in the way it handles its operations there.

Pei Liang, Secretary of the China Chain Store and Franchise Association, said that, in the fast food space, the company outpaces competitors because it "pays more attention to Chinese customs and consumption trends than others."

KFC has, in fact, augmented its menu with items that cater to local tastes, like egg cakes and rice porridge. It also hires 99.9% of its staff locally, and sources 90% of its ingredients from Chinese suppliers.

However, trouble seems to be brewing in the worker's paradise.

"People feel that foreign brands have taken too much market share," Wang Yong, director of the Center for International Political Economy at Peking University, told a reporter.

According to reports, China's "indigenous innovation" policy, an official set of rules favoring domestic companies -- especially state-owned ones -- has many non-Chinese firms concerned about their future fortunes in the world's largest market.

Joerg Wuttke, director of the European Union Chamber of Commerce in China told BusinessWeek, "[Indigenous innovation] could block sales worth billions of dollars a year. They have moved away from a level playing field to benefit their own companies."

But John Frisbie, president of the US-China Business Council, a private, nonpartisan, nonprofit organization whose mission is to "expand the US-China commercial relationship to the benefit of its membership and, more broadly, the US economy" tells Minyanville that Yum is "very unlikely to be touched by the recent policy concerns other US companies have had."

This is because Yum doesn't rely on exports, like many large US corporations that could -- and likely will -- get hit hard by indigenous innovation regulations.

"By and large, the indigenous innovation rules will affect Yum less than it will companies like Microsoft (MSFT), Boeing (BA), Caterpillar (CAT), and Motorola (MOT) -- companies based in the US that export to China, which is trying to incentivize domestic innovation using methods that don't conform to worldwide best practices, like tax incentives and R&D programs," he says.

Frisbie does make an effort to stress that it's "crucial we don't forget about the positives as we talk about the problems."

One of those positives, as shown in the USCBC's research, is that while US exports to China were flat in 2009, coming in at about $70 billion, US exports to the rest of the world fell 19%, meaning China actually outperformed in a down year.

Hurdles still remain for American businesses in general. In a recent speech, Commerce Secretary Gary Locke said:

This indigenous innovation issue is one that the Obama administration takes very seriously. The Commerce Department is working with the State Department and the United States Trade Representative's office to press this issue with our Chinese counterparts. Moreover, we recognize that this issue is just one facet of a broader Chinese approach to industrial policy that is creating headaches for U.S. companies operating in and trying to export to China.


Another issue is the counterfeiting problem in China -- the Business Software Alliance estimates that 80% of Chinese computers run on pirated software.

So, while it may be simple to copy and distribute a computer program a million times over, ripping off an entire fast-food concept seems a ridiculous worry that a company like Yum would never have to concern itself with, right?



Oh. Wait, um…

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