Mcdonald's in China

McDonald’s: Is China Lovin' it?

Executive Summary
This case studies McDonald’s’ business model as it develops to achieve success in the Chinese market. Issues addressed included how to retain McDonald’s’ image of cultural Americana, yet adapt to satisfy pallets and appeal to patrons in Chinese culture.

1. What is the purpose of conducting an external environmental analysis? What are the general environmental forces that could influence or have influenced McDonald’s development in China?
The purpose of conducting an external environmental analysis is to obtain information on the forces outside of a company that will help to determine how the company will operate. A successful company cannot operate only in its internal environment and must be aware of the external factors that will further shape the business. Company strategies must take these factors into account in order to match their internal strengths and weaknesses with their external threats and opportunities.

With McDonald’s expansion in China, external environmental factors did play a key role. One major environmental force came from American company KFC. KFC entered China in 1987 and it was important for McDonald’s to analyze the factors that had been successful and unsuccessful at KFC. Another environmental force that played a large role in McDonald’s growth in China was local Chinese quick service restaurants where customers could buy local cuisines such as noodles and dumplings.

Other pertinent environmental factors that McDonald’s was forced to address in China were the effects of the growing middle class and a more affluent population. This lead to other types of local and foreign restaurants attempts to capitalize on this growing wealth, generating further competition.

The external environment has also shown force by consumers demanding higher standards in the McDonald’s restaurants as well as resistance to the restaurants’ high prices. Buyers’ desires also affected the external environment, which caused McDonald’s to increase operating hours to 24 hours, implement home delivery service and drive thrus in many location. Suppliers were integral elements of the external environment as well and McDonald’s grew to source 95% of their food from local growers and suppliers.

2. Based on the external environmental analysis, what are the opportunities and threats presented to McDonald’s operations in China?
The external environmental analysis reveals several opportunities in China on which McDonald’s can capitalize. Annual per-capita disposable income has increased an average of 22.18% for urban households and 64.62% for rural households per year over the last 20 years. The general trend during this time has been movement from rural to urban population centers where disposable incomes are higher[i]. The increase in disposable incomes has helped contribute to the fast food industry boom. These trends promise to continue as the Chines economy evolves. Tier pricing can be leveraged to help McDonald’s reach customers of different income levels in locations at different levels of development.

Additionally, as the Chinese economy continues to develop, improvements to local infrastructure may create opportunities for an improved supply chain. As of 2006, 95% of materials used by McDonald’s in China were locally sourced. McDonald’s will likely benefit as local suppliers employ more advanced technology and management processes.

There are also untapped opportunities for franchising. China created the legal structure for foreign franchisors in 2004 and, as of February 2007, only one of the 879 McDonald’s restaurants in China was franchised while KFC, their largest competitor, franchised 37 of their 1700 restaurants. Increasing the number of franchisees will allow McDonald’s to expand to new locations while minimizing risk.

In addition to expanding their franchising operations, McDonald’s has opportunities to take advantage of changing Chinese preferences by expanding store innovations and local partnerships. Drive-thrus, 24-hour restaurants, delivery, and even more upscale casual dining restaurants may help the chain improve their appeal with young people as would further partnerships like that created with Taobao.com in 2007.

Several threats were also revealed by the external analysis including intense competition in the Chinese fast food market from both foreign and local chains. McDonald’s was a relatively late entrant to the market allowing competitor KFC to enjoy first mover advantages. Because barriers to entry are relatively low several other foreign chains have expanded to China including Burger King, Subway, Pizza Hut, and Japan’s Mo’s Burgers and Ajisen Ramen. Local chains including Malan Noodles, Hong Kong’s Cafe de Coral, and Taiwan’s Dicos contribute to an intensely competitive market. The threat of new entrants remains and, as Chinese industries become more advanced and familiar with Western management and operations practices, is significant.

McDonald’s operations in China may also be threatened by new trends in the casual dining industry and rising expectations of customers who may be less willing to pay luxury prices for what they are learning many Americans consider a downscale product. Finally, increasing social criticism over health, environmental, and wage concerns will also pose a threat to McDonald’s in the future.

3. Discuss the five forces of the industry environment of McDonald’s China and comment on the competitiveness of the company in relation to each of these forces.
Michael Diamond’s Five Forces Model of Competition includes the following forces:

Existing competitive rivalry between suppliers: There are many fast food options in China. McDonald’s is the second largest fast food provider and their primary rival is Kentucky Fried Chicken (KFC). Other competitors in China in the fast food industry include noodle and dumpling stalls. Local Chinese restaurants sell light and simple food such as noodles, dumplings, wantons, and steamed bread, which are all becoming part of the fast food culture in China. Rivalry is a strong competitive force.

Threat of new market entrants: After numerous attempts in the 1990s by various local and regional Chinese fast food chains, some successful and some not so successful, many companies could not compete in this environment. In the mid-2000s, new market entrants into the Chinese fast food industry were U.S.-based Burger King, and Subway and Japan’s Mo’s Burger. Themed restaurants and Starbucks also entered the mix of new entrants. Although these new entrants offer a different experience, the growing middle class of China still wants McDonald’s to be a Western brand. The threat of new entrants is a moderate competitive force.

Bargaining power of buyers: Buyers do not have any switching costs. The buyers just simply go to a different fast food restaurant, a traditional Chinese meal served on communal plates, or cook at home. Buyers can purchase from several sellers. Buyers are a strong competitive force because they have a lot of leverage. McDonald’s has recognized this and has offered tiered pricing, altered their menu, trained their staff to ensure quality and consistency, and updated their décor.

Power of suppliers: McDonald’s set up its own internal supply network to sell to both the domestic and export markets. Chinese partners created joint ventures with McDonald’s and strengthened McDonald’s supply chain. The supply chain created by McDonald’s has created 95% of the materials needed. It would be costly for McDonald’s to switch suppliers because of the joint venture that they entered into with their Chinese partners. This makes the suppliers a strong competitive force.

Threat of Substitute Products: Many substitute products exist in the fast food arena. If you look at McDonald’s as a hamburger fast food restaurant, substitute products would be noodles, dumplings, sandwiches, chicken, and pizza. Traditional Chinese restaurants and home cooked meals are also substitutes to the McDonald’s hamburger. There is a vast array of substitute products available for the Chinese consumer. This makes substitute products a moderate competitive force.

4. What are the strategic groups in the fast-food industry in China? In which strategic group does McDonald’s China compete most in China.
A strategic group as defined by Michael Porter is “a group of firms in an industry following the same or similar strategy along strategic dimensions”. In other words, a Strategic Group (SG) is a group of businesses that function in a similar way with respect to specialization and vertical integration. The strategic groups in the fast-food industry in China all have the following characteristics in common: fast food, efficient self-service, standardized servings and systems, less reliance on utensils, clean/comfortable atmosphere, and local menu additions. McDonald’s obviously excels at all of these characteristics world-wide and took it a step further by promoting the Western traditions by marketing the “Window to the West”. This particular type of western-influenced fast-food is the primary strategic group that McDonald’s competes in even today.

Western-influenced fast food was not new when McDonald’s arrived on the scene as KFC arrived in 1987, a full five years ahead of McDonald’s. KFC did so well that their success lured McDonald’s and Pizza Hut to follow suit beginning in 1990. However, “fast-food” in China wasn’t new when KFC entered China as they had noodle and dumpling stalls. KFC, McDonald’s and Pizza Hut all wanted to capitalize on the rapidly-expanding middle-class economy in China with their new-found increasing disposable income. KFC was able to do this the best as their primary offering is chicken-based whereas both McDonald’s and Pizza Hut had to add local dishes to go along with their mostly-beef menu. All three of the western brands (KFC, McDonald’s, Pizza Hut) were considered luxury-type restaurants and as such were able to charge higher prices as well.

Fast forward to present times, according to William Mellor of the Bloomberg Markets Magazine[ii] we see that Yum! Brands now has 3,200 KFC’s and 500 Pizza Hut’s in China whereas McDonald’s is striving to get to 2,200 stores by 2013. As you can see, KFC and Pizza Hut are well ahead of McDonald’s in terms of penetrating the Chinese market but that isn’t deterring McDonald’s from moving forward.

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[i] Ko, Stephen. McDonald’s: Is China Lovin’ It? Asia Case Research Centre. The University of Hong Kong. December 2, 2008.

[ii] Mellor, William. McDonald’s No Match for KFC in China as Colonel Rules Fast Food, Bloomberg Markets Magazine. January 26, 2011. Retrieved July 16, 2011 from http://www.bloomberg.com/news/2011-01-26/mcdonald-s-no-match-for-kfc-in-china-where-colonel-sanders-rules-fast-food.html.