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Yum! Brands' China Spin-Off: Short-Term Fix or Long-Term Solution?

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Yum! Brands announced this week that it would be spinning off its China operating segment to become a separate, publicly-traded franchisee. The new, yet-to-named company will continue to contribute revenue to Yum! Brands via royalties for the use of the KFC, Pizza Hut and Taco Bell brand names.

While in many ways this is a natural next step for the company, which has been struggling in China after a series of food safety scandals and other strategic missteps, it also serves as a significant benchmark in the industry's global growth story. Whereas Yum! Brands' China segment was the growth engine that propped up the rest of its company's profitability for many, many years, it has now fallen so far as to become a hindrance, dragging down results from better-performing emerging markets and requiring more than its fair share of energy and investment. As a result, this separation could be seen as a tangible symbol of the sea change in global fast food, in which China is officially dethroned as the singular, long-term growth opportunity. With this move, Yum! Brands has taken a definitive step toward an entirely new strategic outlook, maintaining a lower-risk stake in China while hedging its global portfolio with a more diverse range of long-term opportunities.

A mutually beneficial improvement--for now

Industry implications aside, this is a smart move for Yum! Brands, albeit one in a series of necessary steps that must be taken toward improving the company's global position. One of the key challenges for international operators in China has been that even while local conditions become more and more difficult, the long-term potential of the market remains largely unchanged. Even as growth rates have slowed from consistent, double-digit value increases to more moderate figures in the high single-digits, this change has come not as a result of any weakening in the market, but rather as a by-product of its continued strength. Further, most of the challenges facing individual brands have come as a result of changing consumer preferences rather than any macro-level economic challenges, though the latter have certainly exacerbated the effects of the former.

China’s economy has been moving rapidly through its catch-up phase in recent years, and has now emerged as a more sophisticated, more mature country with slower, steadier growth rates to match. As a result, while China’s rates suffer in comparison to its own recent history, in the context of the global foodservice industry it remains an incredibly attractive target. Combined with the sheer size of the market, accounting for 21% of global value in 2014 and as much as 42% of the global growth expected by 2019, China remains a market which simply cannot be ignored.

This has left operators in the frustrating position of needing to both lessen their focus on China while ensuring they can still benefit from the market’s massive growth over the long-term. With this separation, Yum! Brands has managed to take steps toward both goals, relieving the franchisor from the burden of daily operation while preserving a local stake in the dominant market.

This isn’t just a one-sided arrangement, however; while the new China franchisee will inherit Yum! Brands’ strategic challenges, it will also gain the ability to become a locally-operated company. If handled correctly, this could serve as one step toward mending KFC's and Pizza Hut’s relationships with Chinese consumers, while also allowing the new franchisee to benefit from local market knowledge without international oversight.

Finally, while there is still growing demand for Western-style cuisine, by far the largest long-term opportunities in China are in Asian full-service and Asian fast food. While localizing menus and incorporating Chinese dishes has long been a part of most leading international brands' strategy, many have still been struggling with how exactly to address this growing opportunity. KFC in particular has faced issues with being an American concept attempting to market a menu of Chinese dishes to Chinese consumers, especially amidst the pressure of a growing pool of locally-owned chains which are increasingly modern, clean, well-funded and much better equipped to serve this demand. This shift in structure could help to lessen this strategic disconnect, eventually allowing Yum! Brands concepts more feasible access to these growing segments.

On to the next challenge

Once the spin-off is complete, Yum! should find itself in a more stable position, but it is important to note that this will not address all of the company’s current challenges. Like many other fast food operators, Yum! Brands has also been struggling at home in the US as well as in other key emerging markets like India. In fact in the most recent quarter (Q3, 2015), Yum! Brands in India reported an 18% decline in same-store sales, while the global Pizza Hut division saw same-store sales increase just 1%. Much of this had to do with softer than expected sales in the US after a major menu rebrand at the end of 2014 that included a much more diverse range of ingredients (including sriracha-infused crusts and balsamic “drizzles”). While this menu was designed to increase appeal for millennials, it has so far failed to boost sales, and many customers have been left wondering if they can still identify with the brand's new direction. Meanwhile, Taco Bell has been the company's best-performing brand in recent years, but it is also the smallest, at less than 20% of global system-wide sales in 2014. It is also the brand with the lowest global profile , and it is still in the very early stages of international expansion. Removing the pressure of fixing China's day-to-day struggles should allow executives the time and resources to address these more fundamental issues at the company’s core, but true stability will only come once a number of other strategic knots have been untangled.

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