I’m confident that China will provide YUM with unit growth for a long time. I’m also confident that the current rate of growth is not sustainable into 2010. We also now know that MCD is getting aggressive with its discounting in China. This will not be good for industry profitability.

We all know now that SBUX was growing too aggressively in the U.S. Some of us had questioned the company’s growth trajectory when it started to experience sales cannibalization from new openings. At that time, SBUX management continued to defend its growth despite some level of cannibalization.
Analyst question and management response from SBUX’s fiscal 3Q07 earnings call:

Analyst: On your comment on slowing the U.S. store growth modestly, you mentioned cannibalization as one of the issues. Historically when you've opened new stores, you've always typically cannibalized existing stores. Is the difference now that the stores that were cannibalized, were they not ramping up as much, or is it just the new stores aren't I guess opening at the same type of volumes?

Management: If you look at the cannibalization factor today as we did several years ago, and it's more in pockets than it is across the company, but, we're seeing in these pockets certain cannibalization dependent upon where those stores are located. But we don't see this as an issue that basically overrides the opportunities that we see for continuing our growth.

As we go forward, we're going to continue to infill markets where the opportunities exist, factoring in some form of potential cannibalization in our plans, whether they are total overall revenue or 3% to 7% comps.

And again on its fiscal 4Q07 earnings call:

Analyst…just on the U.S. unit growth topic and cannibalization, I think you’ve noted in the past some pockets of likely cannibalization across the U.S. but not the driver to further slowing your unit growth. I’m just wondering if you could talk about the magnitude of potential cannibalization.

Management: On the store count, we had reduced the U.S. slightly this year, but when we look at this traffic softening, we’re looking at it from an economic environment as we see it all across the retail industry. And our perspective, the saturation comments are overblown. Our perspective hasn’t changed. We’re still opening new stores knowing that the surrounding stores will experience some level of pressure but also the understanding of the convenience that will drive the customer frequency. And we’ve said once, we’ve said quite a few times that we just need to be where the customer is, so again we’re balancing that and this little pause in ’08 will give us a chance to recalibrate, look at this, and continue to grow towards the 10,000 stores.

Only one quarter later, SBUX announced its plan to slow its U.S. growth and to close 100 underperforming stores in the U.S. in an effort to “potentially reduce cannibalization of existing stores.” And, that was just the beginning!!

Based on SBUX’s defensive comments from late 2007 and performance since then, you can understand why I am concerned by YUM management’s statements yesterday justifying its continued aggressive unit growth in China:

YUM Management’s comments on cannibalization – 4Q08 : Again, in the China division we opened up 500 units in 2008 and our plans are for high growth again in 2009 across all tier cities. The growth continued to be strong. That is one of the things we look at whether we look at the performance. We assume a sales transfer, some sales transfer will occur and despite that, we have great returns. We often do want to cannibalize ourselves so to speak in places we have a very high performing restaurant we almost need to take some of the sales off with that built into our business plan as well. As we open up new units on average, just for people who look at us, we start out at a rate that is lower than our total sales average because we do go into some smaller tier cities that have high returns but then grow quicker over time is how we have seen those markets perform and obviously as we go into a share of the city you see some sales transfer there. So far we have not seen anything unusual or different on actual sales transfer versus our projected sales transfer. So again all systems are a go on the new unit front. We are very confident about our model we get great returns. We keep going as long as we keep getting great sites and great trade zones.

Sound familiar?

I’m not saying there are no growth opportunities for YUM in China. It’s the rate of growth that I am questioning, and right now they are pushing the envelope of growth in China. YUM’s aggressive growth posture is also occurring at a time when the competition is getting more aggressive with discounting. Yesterday, McDonald's offered its biggest price discounts in China as it faces slower sales trends in a slowing economy.

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