Beijing – Beijing is the second largest city in China. It is the political and cultural centre and has relatively high levels of affluence and the education of its inhabitants. It is also the tourist centre of China, with many attractions located in and around Beijing. A Beijing location would also give a higher profile. This could be both good and bad. If they received approval from the central government, they would be able to enter the rest of the Chinese market without hassle. However, because of the higher profile, the government might decide that they would not fit in to the Chinese landscape, which would prevent them from ever succeeding. Outside of Beijing there were also numerous poultry farms.
Wang knew that the location was the most important detail, and would decide whether KFC would succeed or not. There were currently no other competitors in the Chinese market, so now was the time to strike to take advantage of the situation. The risks were high, and Wang needed to weigh out these risks to estimate whether the expenses would lead to for a huge gain or a huge loss.
In early February 1987, Wang decided to open operations in Beijing. This was decided because of Beijing’s high amount of tourists and its autonomous municipal government. However, he was feeling more worried about the venture. KFC signed a joint venture partnership. Wang’s worries were stemming from the difficulty he had been experiencing getting things done in a city governed by a bureaucracy that seemed impossible to either understand or work with. He felt that he would never be able to find a location in the city and government approval was required on everything. Wang was also concerned whether Chinese workers would be able to meet KFC’s demands for cleanliness, quality and service.
The establishment of a joint venture was considered essential because Wang described the chinese, “completely impossible for us to understand. In fact, trying to do so is a complete waste of time.” Trying to understand investment regulations, winning approval for operating licenses, leases, and employment contracts could certainly prevent them from proceeding. A local partner was not required under Chinese law, however Wang felt it would be beneficial in setting up operations and maintaining continued viability.
Through ties R.J. Reynolds had with the Ministry of Light, a partnership was formed between KFC and the Beijing Corporation of Animal Production, a Beijing city government-controlled producer of chickens. After careful inspection KFC found that this would indeed work out, as Animal Production already produced three of the approved breeds of chicken required for operations.
Negotiations with the poultry producer commenced with Mr. Jue Xia, a senior manager in the Beijing corporation. Xia felt that it would not be able to meet KFC’s large demand because they did not have access to large enough reserves of grain. Xia was also hesitant about KFC’s quality standards. However, they thought that a partnership with a Western firm would be beneficial for them as they would gain international experience. Xia felt that Tony Wang was unlike most American managers; he was a man he could deal with.
The Beijing Corporation helped Wang find a chicken supplier but they lacked close contact with the government agencies that would be essential to setting up operations. So a third partner was needed. Both partners agreed that the Beijing Tourist Bureau would be able to meet their requirements. The Tourist Bureau was responsible for the supervision of the construction and operation of all hotels and restaurants in Beijing. They also had a lot of experience speeding up the construction of many Western hotels, and had many times participated in a joint venture in these operations.
During these negotiations it happened that KFC was sold to Pepsico. During this time KFC was the second largest fast food chain in the world. It was initially thought that Animal Production had only come on board because of pressure from the Ministry of Light Industry, who wanted to win points with Reynolds, so the acquisition came at a bad time. As it turned out, however, Pepsico’s connections with the government in Beijing were even stronger then Reynolds, so negotiations continued with a renewed interest.
To convince the partners to become part of the venture, Wang offered a guarantee of five percent return on equity, much better than they could receive domestically. This sealed the deal in winning over the partners. KFC retained 60% of ownership, The Tourist Bureau received 27%, and Beijing Animal Production took 13%. This was the actual breakdown of assets that each partner was contributing to the arrangement. This deal was privately pre-approved as acceptable in negotiations with the Foreign Economic Development and City Planning Commissions. The approval of the partnership also required on the sharing of the corporation. With one-half coming from KFC and the other half split between the other two partners. The deal also stated that the chairman would be appointed by Animal Production and the vice-chairman would be appointed by the Tourist Bureau.
This concerned Wang because of loss of control over operations. Wang countered by establishing the new store as a franchisee, with the franchiser being KFC’s head office in Singapore. This would require 3% royalty payments to be paid to the head office, and require the store to purchase its seasoning mixes from the head office, both using hard currency. Wang also appointed a day-to-day general manager in Beijing, who would be appointed by KFC and have control over operations.
Although it seemed like all major challenges were over, they weren’t. The approval of the partnership did not give any operating authority for KFC in the city. They needed a “Licence to Execute a Business Activity.” Approval of this required the signatures of the District government, the Commerce Department, the Taxation Department, the Health Department, and the Food Supply and Logistics Department. None of these agencies had any coordination, so approval from each separately was required and this could take months or years. Tony Wang stated:
” We are pioneers in China, but so are the Chinese. However, whether they want to learn or not is another story. Many Westerners make the same big mistake in China: they assume that they can just pay to have the required work done or at least expedited. This just doesn’t work in China. The Chinese are not motivated by a desire to do things right simply for the sake of doing things right. They don’t want your help in speeding up the process. They just want to avoid problems. And unless we can convince them otherwise, we are their biggest problem.”
A license was necessary before a lease could be signed, but Wang was worried that a desirable location might not be found. All buildings and possible space in Beijing is occupied. As well, Chinese regulations stated that new tenants would have to guarantee the employment of any workers left jobless when a new tenant took over. This worried Wang because he would be stuck with a number of unskilled Chinese that he would have to employ.
Wang wanted the first store that was to be opened to be big and flashy because it would determine the future success of KFC in China. This was strategically a good idea but it ran counter to the culture in China where there was a history of hostility towards Western culture.
In February 1987, a license was issued by the city, allowing KFC to operate in Beijing. The Tourist Bureau played an integral role in speeding up the application. Under the license KFC was given a tax remission for two years; profits in three years, four and five would be taxed at 16.5%, with profits thereafter taxed at 33%
Wang now had to select a site to open the first location. But no matter where a location was chosen KFC would still require a building permit, as well as hookups for electricity, water, gas, and heating before the store could open. Wang discovered that many of these services were difficult to obtain, and it was not uncommon for applications to not be processed for months. Another concern was the company’s need to secure import licenses needed to bring equipment into the country: pressure frying machines, cash registers, blending and cutting equipment for the kitchen. Each item required a separate permit that could take months to attain.
During all these negotiations Tony Wang realized that no one had thought to test market the area. It was known that the Chinese liked chicken. From KFC’s success in Hong Kong, it was assumed that it would be accepted, but no one had had time to find out for sure and they were forced to cross their fingers. Another problem was finding a reliable supplier of quality potatoes. If they were unable to do this they would have to use mashed potatoes, and Wang did not know how the Chinese would receive this.
The largest concern facing Tony Wang was whether or not the Chinese employees could meet the quality, service, and cleanliness requirements. The Chinese employees would have little appreciation for KFC’s international standards of cleanliness or product quality. Most domestic organisations lacked any incentive programs, work was seen as something to be avoided, and service was a foreign term.
The KFC organization would not allow the store to open if these levels were not met. The ironic part was that Chinese consumers would accept less then what was required. This would create conflict with the partners. Tony Wang also wondered what KFC would do with the soft currency that the venture would generate, and wondered whether or not there would even be any profits.
Wang was faced with three options: 1. Pull out – cut the company losses and avoid negative publicity if the venture failed. This would allow for further research and KFC could try to re-enter in a few years when there was more complete information. 2. Go ahead slowly – taking more time evaluating the situation to make sure the partnerships were secure and the market would accept KFC, however this would invite competitor response. 3. Go ahead full – the market had high potential for success for KFC, and, with 1.1 billion people, large potential for profits.
Wang decided to go full ahead. The location was finally found. The central government approved the lease because Wang sold them on the idea that the restaurant would represent a symbol and statement of the People’s Republic open policy with the West. The lease was finally approved in April of 1987, however they did not have the building permit, which would allow them to make necessary renovations. They also required hookups for gas, water and heating. Applications were continually lost or just went unanswered.
When KFC announced that it would be hiring it was flooded with applications. Management decided to treat all applicants equally. Referrals would not be accepted. This was a unique move in China where family contacts are usually used to land highly sought after jobs. This move created conflict with the partners.