Taking a softly, softly approach to food scandals in China is not an option, writes Nathan Field

When it comes to the Chinese consumer, most people don't know what they're talking about.

If there's a case study Fonterra should be studying with a magnifying glass, it's KFC. Up until late last year, Colonel Sanders was going gangbusters in China.

More than one KFC store was opening every day, and sales were on fire, to the point that parent company Yum Brands was making more than 40 per cent of its profits from China.

Yum Brands became the pin-up stock for the burgeoning spending power of the Chinese consumer.


As a result, between 2010 and early 2012, Yum's share price doubled. And if management's projections were to be believed, KFC's expansion in China was only just getting started.

Then in December last year, the dream turned sour. A Chinese TV report claimed some of KFC's suppliers were juicing their chooks with unapproved antibiotic drugs and growth hormones.

The reaction from consumers was swift, and KFC's sales began to nosedive.

The recovery effort wasn't helped when a fresh strain of bird flu emerged in March.

The panic quickly subsided, but the public perception of poultry took another hit.

Seven months after the initial scare, and KFC is still struggling in China. Same store sales plunged 13 per cent in July, much lower than the market was expecting. The worst was supposed to be over by now.

So what lessons can Fonterra learn from Yum's woes?

Firstly, when it comes to the Chinese consumer, most people don't know what they're talking about.

When news of the KFC poultry scare broke, management assured investors the problem was being dealt with, and most analysts reconfirmed their buy recommendations on the stock, claiming the strength of the brand, and deliciousness of the chicken, would prevail.

There were graphs showing internet searches on bird flu and killer chickens had declined, therefore Chinese consumers would soon be rushing back to KFC to get their fix of hot wings. This hasn't happened yet.

Maybe the immediate health risks have dissipated, but so has the consumer's appetite for KFC.

Perception is also more important than reality. Consumers were never in danger of catching bird flu from deep fried chicken. They stand far more risk of a coronary event.

And while Yum cut off 1000 dodgy farmers in response to the supply scandal, it's difficult to gauge whether these pumped-up chickens had an adverse impact on consumer health.

But it doesn't matter what the risks of death or disease are.

What matters is that Chinese consumers view certain foreign brands as a guarantee of quality.

And if food safety regulations are compromised, that guarantee is lost.

So taking a softly, softly approach to food scandals in China is not an option.

Yum was initially seen as being slow to react to the poultry scare, offering free drinks to lure customers back, and then issuing a poorly received public apology.

The marketing campaign to restore KFC's image in China has been steadily ramped up, but the money may have been better spent early on, before the successive months of sales declines.

All is not lost for KFC in China, and the resilience of Yum's share price, only 5 per cent off its highs, suggests investors believe this too shall pass.

But there's no denying the road back is going to be a lot longer, and costlier, than the company anticipated.

Arguably, Fonterra faces an even bigger PR mountain to climb, given its products are consumed by infants.

Also, many Chinese consumers blame the poultry scandal on KFC's local suppliers, and not the company. Fonterra doesn't have that same excuse.

One thing is for sure, doing business in China is as full of risks as opportunities - and the risks need to be monitored just as closely.

Yum was previously held up as an example of how a foreign company can thrive in the complex Chinese market. But like Fonterra, it took a food scare to show that management still has a lot to learn.

• Any opinions expressed in this column are Nathan Field's personal views. These opinions are general in nature and should not be construed, or relied on, as a recommendation to invest in a particular financial product or class of financial products. Readers should seek independent financial advice before making an investment decision.

Nathan Field is a portfolio manager at Gareth Morgan Investments.