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McDonald's has a big appetite for China

McDonald’s has found a formula for success in China – but it hasn’t been an easy recipe.  . By CNBC's Wally Griffith.
/ Source: CNBC

Two decades ago, McDonald's was largely unknown here, except as a symbol of the decadent west. But a capitalist revolution has swept through the People's Republic. And today mainland China, still officially Communist, is home to 800 McDonald's restaurants — with 200 more in Hong Kong.

Jeff Schwartz, CEO of McDonald's China, says that’s just the beginning.

“I just look at China's 1.3 billion population,” he said. “U.S. (population) 300 million, 13,000 restaurants. China (population) 1.3 billion and 800 restaurants. Easily we're talking 10,000 to 5,000 restaurants as it continues to develop. So the opportunity is endless.”

It may be endless, but it’s not effortless. That's why Schwartz and his boss, Tim Fenton, spend so much time in China — on the road, in the air and on the move. Fenton is CEO of McDonald's for Asia, the Middle East, and Africa. There's no one at McDonald’s with more experience moving into new markets.

“Mistakes we made in the past: you don't open just one store,” he said. “You get three or four or five deals done, build them consecutively, train the crew consecutively so you save on the money. So when a truck goes out from the distribution center, it's not carrying one store, it's carrying the products for three to five."

When McDonald’s first opened in China in 1990, these streets were clogged with bicycles. But prosperity has brought an explosion in car ownership. However many headaches that may mean for Chinese drivers, McDonald’s saw an opportunity — called drive-thru. The company opened the first drive-thru outlet in November, 2005 and Schwartz says it’s been “very, very successful.”

“(It’s a first) for anywhere at all in China,” he said. “Drive through was a brand new concept anywhere in China.

In fact, drive-through was such a new concept in 2005, that many Chinese didn't know how to use it.

“We have a lot of traffic, and I’m walking around, they pick up the food, and then they went and parked their car, they brought their bag of food and they went inside,” said Schwartz. “And I watched this happened several times, and I think we might have a problem here on how the Chinese use the drive thru.”

Which meant that Chinese crews not only had to learn how to run a drive-thru but had to teach their customers how to use one. But some customers don't catch on as fast as others. On a recent visit with Fenton, one BMW driver entered the drive-thru on the exit side.

McDonald’s is up to 26 drive-thrus in China — so far. But if most Chinese drivers still aren't familiar with the idea, that's about to change — dramatically.

In 2006, McDonald’s signed an agreement with the Chinese state oil company, Sinopec, granting it the right to open McDonald’s stores at any of Sinopec’s new and existing gas stations – all 30,000 of them.

The very first one, opened in July, 2006, in a surprisingly run-down neighborhood outside Beijing.

“It's off the beaten path of Beijing, so it's a suburb coming out,” said Fenton. “It's a little grittier but it's like an oasis to me. I'm guessing we might be a little premature here, from the McDonald’s side, but with only upside potential.”

That, in a nutshell, has become a key part of McDonald’s expansion strategy in China: the willingness to bet on an area that may not be ready for a McDonald’s — yet. But with China, the world's fastest growing economy, McDonald’s is banking on neighborhoods like this being a good gamble.

“It's really not that difficult,” said Fenton. “You look at a developing area, and you see where it's going. You see the corners. You see the retail. You see the apartments and the condos coming in … we’ve done a lot of real estate. We've done it, like, 34,000 times.”

When the first of the new stores was set up, the surrounding buildings were half built with large undeveloped space behind it, said Schwartz.

“But you looked at the site layout and they said the shopping mall's going here, there's going to be 5,000 residents here, and down the street will be another 5,000 residents,” he said. “It was amazing."

For all of China's potential, the learning curve for McDonald’s here has been steep. And they've had to play catch-up. When McDonald’s opened its first mainland store in 1990, rival KFC had already been there for three years. Today, there are more than 1,900 KFC stores in China — more than twice as many as the Golden Arches.

McDonald’s has a lot of competition here in China, not all of it from big named U.S. brands like KFC. You can find Mom and Pop food stands all over the country. And although dishes like Scorpions and Seahorses on a stick may not be your idea of a meal, here they're traditional, they're convenient, and they're cheap.

A short walk through any Chinese city reveals a kaleidoscopic array of foods, tastes and textures. Adapting the McDonald’s menu to palates used to foods like these is the job of McDonald’s corporate chef Leslie Bailey.

He spends his days in a Hong Kong food lab McDonald’s calls "The Forbidden Kitchen." On a recent visit they were trying out a “value pork burger.”

"We're going to test this in 40 stores," said Bailey.

Seasoned with Szechuan pepper, the new sandwich passed a taste test by Fenton, who said it “has a good kick to it.”

Taste, convenience and price are important in China — just like in the U.S. But the issue here that trumps them all is food safety. It is a nightmarish problem in a developing country where corruption is rampant and safe food handling practices are still largely unknown.

“It's always in the back of your mind,” said Fenton. “Because of the area we live in, particularly the history that this part of the world has had with avian influenza and SARS.”

Food safety concerns are one reason all Chinese McDonald’s stores have hand washing stations and hand sanitizers right out in the main restaurant. And behind the scenes, McDonald’s says its stores, and its Chinese suppliers — like a bun factory near Beijing — meet the same standards as those in the U.S.

“We do have quality control inspections unannounced,” said Schwartz. “All of a sudden our (Quality Assurance) people will show up at your door and say, ‘Now. Tour. Let's go.’"

Food safety is one more strength McDonald’s is hoping to market in China. It's also a major sponsor of the 2008 Olympics in Beijing, where Chairman Mao still keeps watch over Tiananmen Square.

But two blocks away, Big Macs have become the latest Chinese food.

With more than half of its store in foreign countries, McDonald’s has long since given up trying to count how many burgers it’s sold. What it is counting on is a future where the Golden Arches continue to spread across the globe, generating more French fries, income, visibility and — quite possibly — controversy than founder Ray Kroc could ever have imagined.