3 Scandals in China for Starbucks and YUM!

Starbucks and YUM! must learn from three recent scandals in China's market.

Feb 22, 2014 at 7:00AM

China has 1.35 billion mouths to feed. At four times the United States' population and with a GDP set to outpace that of Uncle Sam's by 2020, China presents a Great Wall-sized market in which American food companies can profit. Starbucks (NASDAQ:SBUX) and YUM! Brands (NYSE:YUM) are leading food conglomerates competing in the race for China's stomachs. The coffee and fast food vendors' future expansion and stock values hinge greatly on China.

Yet both companies have faced three scandals in China that threaten brand growth. Counterfeit products, chemical contamination, and price scandals will force these food giants to play China smarter.

Knockoffs: SunBucks Coffee and Obama's Fried Chicken
Starbucks and YUM's KFC brand face intellectual property threats in China: 70% of all counterfeit goods between 2008 and 2010 were Chinese. Stores such as SunBucks Coffee, StarsBuck, KFG, and Obama's Fried Chicken are perennially popping up in big Chinese cities.

Brand reputation is a vital advantage held by U.S. food companies that sell to China. More development will bring better government regulation and patent laws, but in the short term these counterfeiting scandals are diluting the brand power of Starbucks and YUM!.

Carcinogens: Shoe pastries and antibiotic-ridden chicken
Urban Chinese flock to American food products for their safety. Eschewing domestic food products in the wake of China's 2008 melamine-tainted baby formula scandal, Chinese consumers are coughing up Yuan for quality-guaranteed American foodstuffs.

When American food companies in China suffer their own safety scandals, their competitive advantage over domestic brands erodes. That's why last week's news that Starbucks bakes its Chinese pastries with a carcinogenic shoe chemical was not ideal. While the chemical is legal in China, Starbucks may be watering down its reputation for quality.

KFC knows all too well how a food safety scandal in China can dent profit by 41%: that's exactly what happened to the fried chicken slinger in 2013 when the Colonel was exposed for serving poultry which had been over-dosed with antibiotics. If Starbucks and KFC persist in serving dubious meals to the Chinese, StarsBuck and KFG may start to sound appetizing.

Price Scandals: Starbucks costs even more in China, KFC's half bucket
Chinese consumers are becoming savvier thanks to smartphone-enabled price-comparison shopping. In plainer words, they know when they're getting ripped off. That's bad news for American companies that depend on artificially high prices for their Chinese profits.

Even more unsavory than raising prices in China to U.S. prices, though, is when American companies are exposed for charging higher prices to Chinese consumers. Recently Starbucks was accused by China Central Television of bean price-fixing: a segment called "Starbucks: Expensive in China" claimed that a cup-of-joe in China costs 50% more dough than it does in the U.S. Such behavior will discourage brand goodwill among the Chinese.

YUM!'s KFC has also been there, done that when it comes to a China pricing scandal. Last October, the company launched a "Half-Price Bucket" deal that went viral for the wrong reason: Weibo, China's Twitter twin, was ablaze with customer complaints about buckets that were indeed half price -- but also appeared to contain less chicken wings than normal. Once again, the incident made it to the Chinese press and it was decried as business trickery.

After these three recent scandals, Starbucks and YUM! could be drawing their last straws with Chinese consumers. The companies' future profits depend on appeasing China.

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Glenn Singewald has no position in any stocks mentioned. The Motley Fool recommends Starbucks and Twitter. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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