Supply chain management

Yum Brands faces chicken troubles in China

May 9, 2013: 12:30 PM ET

The fast-food franchise owner has reeled from one PR disaster to another in China. How the company can bounce back.

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FORTUNE -- Chinese consumers feel a bit betrayed by Yum Brands -- the Kentucky-based quick-service king, owner of restaurants KFC, Pizza Hut, and Taco Bell. Yum is huge in China and has benefited there for its reputation as a transparent, upstanding Western food company.

But at the end of 2012, Chinese food investigators discovered that suppliers linked to Yum had fed their chicken more antibiotics than permitted. This past Monday, Yum (YUM) faced another PR disaster when reports suggested Chinese regulators started investigating a mutton supplier possibly tied to the company's hot pot franchise Little Sheep.

The fallout from the antibiotics issue was immense, and Yum has launched a supply-chain assessment program called "Operation Thunder" to address it, CEO David Novak said during the company's 2013 first-quarter earnings call. The company can't afford a string of food quality problems in China.

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"There's no getting around it, this is a market where double-digit same-store sales increases were the norm for the past decade," says Euromonitor's head of consumer foodservice research Michael Schaefer. "I don't think this is something they're going to address with window dressing."

Yum must get to the bottom of its supply chain issues, in part, because the consumer response to its chicken problems was so quick and violent. Yum's China division saw a 41% fall in operating profit in the first quarter of 2013 compared to the same time the previous year -- from $258 million to $154 million.

Chinese consumers are fed up with quality control issues, Schaefer says. "As people become wealthier, as living standards rise, you get this sense of, 'Why can't we have safe food? Why does this keep happening?'" So when consumers felt Yum had a transparency problem, he says, "It wasn't just fear, it was anger."

At the earnings call, Yum CEO Novak says he expects to get the company back to its double-digit growth rate by the end of 2014. He has his work cut out for him.

An avian bird flu scare broke out in early April, and while it doesn't affect cooked chicken or reflect on Yum's practices, it triggers an emotional response that drives customers away. And now mutton.

When you have the strength Yum does in China, these problems become part of the business. Yum needs this market, despite the risks, so what to do?

Part of the difficulty in solving the problem is that the company had a great reputation for supply-chain management for so long. "One of the reasons why Yum Brands has been doing so well in China is because, for the better part of 20 years, they've had a really strong team on the ground," Schaefer says. "No one really felt that they were playing fast and loose, and I still don't think there's that feeling."

It must somehow find a way to be even tighter and more aggressive about managing its meat supply in China, most of which is locally sourced. As part of "Operation Thunder," Novak said, his company has already identified 1,000 small, out-of-date chicken houses that it will cut from its supply chain. There will likely be additional supplier audits, or Yum could bring more production to its own facilities.

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The reaction from Chinese consumers is about more than safety; it's about trust. "I think there's a huge emotional component to it, but that doesn't make it any less of an issue," Schaefer says. To that end, a little symbolism might not hurt in the cleanup.

"They'd probably be well-advised to appoint a food safety czar," says Gene Grabowski, executive vice president at communications firm Levick. He suggests hiring someone local and making him or her responsible for food safety issues. This tactic, he says, could not only help the company prevent future problems, but it would give the public somewhere to turn should things go wrong.

Now, let's not all fall over ourselves lining up for that job.

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