China's quick-serve restaurants (QSR) chains like Yum China's (YUMC -1.97%) fast but casual dining restaurant brands, KFC and Pizza Hut are a small percentage of the entire restaurant industry, and represent an enormous opportunity for chains to penetrate the market. But there are immense barriers to building a full-scale QSR chain in the country. Yum China has overcome those challenges, and is just now beginning to reap the rewards of its long-term growth trajectory. Here's how it's doing it.

Tip of the iceberg

Historically, the Chinese restaurant industry has been highly fragmented compared to other countries like the U.S. The fragmented nature of the industry means there is a significantly higher percentage of local mom-and-pop restaurants throughout the sprawling country. Likewise, the industry's supply chain feeding the local restaurants is also fragmented.

A person sipping soda in a food court.

Image source: Getty Images.

This dynamic has made it difficult for full-scale QSR chains to penetrate the country's massive population. For instance, fast food and QSR chains represent only 17% of restaurant spending in China. Now compare that to 61% in the U.S. and 34% worldwide, and you can see the opportunity that lies ahead. 

The challenge is that QSRs thrive on having consistent products and a reliable source of food and supplies. Sourcing a large amount of food and supplies from a vast number of geographically disbursed suppliers would be a monumental undertaking, especially considering the risk of food spoilage over such long hauls. But that is precisely what Yum China did.

Yum China's distribution network has grown to 33 logistics centers across China. Each one is equipped with state-of-the-art technologies to handle raw materials in real time safely. The network handles distribution to 11,788 restaurants in China.

Most international QSR chains passed on the challenge, but Yum China saw it as a game-changing opportunity. The company has a point. China has a population of over 1.4 billion people, which is more than four times the population of the U.S. So not only has Yum China's investment in building out its Chinese supply chain given it access to the world's largest market, but the same barriers still exist for QSRs looking to join the party.

Is Yum China a buy right now?

China's low adoption of QSR chains may seem like another challenge for Yum China. But the company forged ahead. Yum China has watched its revenue grow yearly from $6.9 billion in 2013 to $9.8 billion in 2021. The company should be a catalyst to grow China's QSR industry inline with the rest of the world. But it has a long way to go. Yum China's stock could earn handsome returns as the company executes it long-term growth strategy.

So the company has a strong start, and the company may have a very long growth runaway as China's QSR industry catches up to the rest of the world.

Yum China has also overcome cultural barriers in its pursuit of growth. For instance, Yum China's KFC brand has changed its menu over the years to adapt to Chinese customers' tastes. It recently introduced its Chicken Bucket, which consists of chicken feet, wing tips, and necks. Now KFC commands an eye-popping 11% of the Chinese fast-food market. That's more than double McDonald's 5%.

China has faced on-again-off-again COVID-related lockdowns over the last few years, but home delivery app usage has been on the rise in China for several years. So the company already had delivery and memberships incorporated into its mobile apps and online platform, and Yum China was able to respond to the lockdowns quickly. Deliveries in 2021 were up 70% from 2019 at its KFC stores, and 37% at Pizza Hut.

As Yum China's QSR stores continue to penetrate the restaurant industry in China, the company stands ready to continue its market domination. Yum China plans to open between 1,000 and 1,200 net new stores this year, and the trend will likely continue in the long run. There is a long runway for growth ahead of Yum China, and investors should be aware that the wheels are already firmly in motion. Shares are down a modest 6% this year, which might be an opportunity to add the stock to your portfolio.