The well-known U.S. fast food restaurant KFC and China Mengniu Dairy signed an agreement on October 22 to form a strategic alliance. Starting from next year, nearly 2,000 KFC outlets in China will sell Mengniu's dairy products. By the time this happens, 90 percent of KFC's suppliers in the Chinese market will be local.

KFC is one brand owned by Yum! Brands, Inc. and has more than 34,000 stores and 850,000 employees globally. Mengniu Dairy, established in January 1999, has built 40-odd manufacturing bases, and provides one third of the daily milk consumed in China.

"We found through strict selection that Mengniu's dairy products meet our globally unified quality standards," said Zhu Zongyi, Vice President of Yum! Restaurants Greater China Ltd. "KFC's customers will now have another choice when dining at any of our stores in China."

According to Zhu, KFC will first sell Mengniu's liquid milk at its outlets and then use Mengniu's dairy products for their sundaes and coffee. Logos of both brands will be printed on the packages of Mengniu's products sold at KFC outlets.

Nestle had been KFC's exclusive dairy supplier in China for the past two decades. Since the new deal is not an exclusive agreement, KFC will continue its partnership with Nestle and provide customers with both Nestle and Mengniu's dairy products, explained Zhu.

The agreement with KFC came on the heels of a deal with Starbucks Coffee, which in June named Mengniu as its liquid milk supplier, again replacing Nestle. Early this year, the National Basketball Association (NBA) and Disney also concluded deals with Mengniu in a strong demonstration of faith in the quality of its products.

The cooperation with KFC helps to expand Mengniu's market and reduce pressure on its overstretched capital, said Yang Wenjun, President of Mengniu Dairy (Group) Co. Ltd. For Mengniu, they will make use of this partnership to actively explore overseas markets and enhance brand awareness there while keeping an eye on their stake of the domestic market.

Localization expands

KFC has become a familiar name among Chinese youth and teenagers over the past two decades since its entry into China.

"It took us 17 years to open 1,200 stores in China, from the first at Qianmen in Beijing in 1987 to the 1,200th store in Sanya in Hainan Province," said Su Jingshi, President of the greater China operations of Yum! Brands, Inc. "KFC is continuing to open 200-odd outlets in the country every year."

According to Su, the key to KFC's success in its market expansion is localization.

It has been KFC's global strategy to introduce products that cater to local tastes, something they have given full play to in China. Besides fried chicken and potato chips, other products KFC offers to Chinese customers are very "Chinese"-Beijing-flavor chicken wraps, spicy Sichuan chicken and all kinds of porridge, soups and rice. Su admitted that KFC was able to expand so quickly largely because of the creativity in introducing products suitable to the taste buds of Chinese customers. KFC has increased the variety of its products for Chinese customers from 15 in 2000 to 36 at present. There are 40 researchers in China devoted to developing new products.

KFC didn't merely localize its menu. Even thought it is a global fast food restaurant, KFC imports less than 10 percent of its raw materials for their local operations, according to a research by the School of Economics at Fudan University.

"KFC has used 100 percent local chicken since the first store opened," he said. "We resort to local suppliers for anything from vegetables, bread, packing boxes and equipment to construction materials, and 550-odd local raw material suppliers contribute KFC's more than 90 percent of purchasing volume in China."

New rivalry

It was not Mengniu's wish to limit its cooperation with KFC to within the Chinese market. As one of the two dairy giants in China, Mengniu has an eye on global expansion.

The partnership with a multinational will enhance its brand awareness globally, said Yang. Mengniu has also geared up for global market expansion hoping that international partnership will open more doors for China-made dairy products.

Nestle, one of the world's largest food manufacturers, owes its success to special milk and cereal food developed over 130 years ago. Nestle, coming to China in 1979, launched a milk processing factory in Eerguna, Inner Mongolia, in July 2007, with its first-phase processing capacity of 600 tons of fresh milk daily. The factory is expected to have a daily capacity of 1,500 tons by 2010. This was an important move to seize quality raw milk bases after the company acquired a local milk processing factory in 2004, in an attempt to promote the implementation of its localization strategy. According to the China National Food Industry Association, currently 99 percent of the products Nestle sells to Chinese customers on the mainland are produced locally.

Despite the obvious advantages Nestle has, Mengniu has strength in price and is able to compete with Nestle peer to peer as a supplier for KFC.

"We are not allowed to disclose the prices for Mengniu's products to be sold at KFC's outlets," said Yang. "But they will be acceptable." At present, there are two Nestle's dairy products available at KFC's outlets, hot milk served in cups and packaged milk. The packaged milk of 250 ml, which sells at 2 yuan ($ 0.27) each in supermarkets, is priced at 5 yuan ($ 0.67) at KFC outlets. For KFC, introducing local brands at its stores will save money and make customers comfortable.

The partnership won applause from a majority of KFC's customers who drink Mengniu's milk daily. Fu Yingying told Beijing Review while dining at a KFC outlet in Beijing that Mengniu's milk is not inferior to Nestle's and that she would support local brands if Mengniu's milk is served.

Supplier of choice

KFC's major rival Mcdonald's opened its first store in China in 1990, but its suppliers started investing in China as early as 1983 to build factories and farms. Currently Mcdonald's has 50-odd suppliers in China and derives all its raw materials locally, with a purchasing volume exceeding 4 billion yuan ($533 million) every year. Besides this, foreign companies such as Starbucks, Pizza Hut and Domino's have all reached agreements with local suppliers.

In January this year, Mengniu became the only dairy official partner of the NBA in China. In March, Beijing Huiyuan Beverage and Food Group Co. Ltd. signed a contract with Wal-Mart to supply U.S. supermarkets with juice products worth 100 million yuan ($13.3 million).

Besides the price advantage local suppliers have, the localization of raw material purchasing helps those foreign companies to slash operation costs and increase profits and, at the same time, enables them to introduce Chinese-style fast food catering to Chinese customers, said Bian Jiang, head of the China Cuisine Association.

Foreign fast food restaurants have strict standards regarding the quality of raw materials. If local suppliers can meet their requirements, it will speed up the localization of their menus, said Bian.

Product localization is an important strategy for foreign catering companies because fast food restaurants need to update their menus frequently, said Ren Wenzhi, head of the Marketing Department of Southwest University of Finance and Economics. It is safer for them to introduce Chinese-style food to attract more Chinese customers, said Ren.