Out of the Frying Pan: In China, KFC Tests High Tech and Healthy Options

HANGZHOU, China--When Michelle Xian wandered into one of the fast-food restaurants at a shopping mall here on a recent weekday, she didn't realize it was a KFC.

The modern décor featured an open kitchen and hanging plants, and the menu included tuna-and-pesto paninis and quinoa-and-corn salads. Customers were busy placing orders via smartphone, using QR codes printed on tables, or through a facial-recognition system that matches their images to their Alipay digital wallets.

"I don't normally go to KFC because it's not that healthy," said Ms. Xian, 30 years old, who ordered a chicken sandwich before being told where she was. "This is more aligned with new trends."

The KFC concept store, known as KPRO, is a testing ground for owner Yum China Holdings as it tries to capture a new audience and drive growth in the wake of its spinoff from U.S. parent Yum Brands Inc. a year ago last week. In a strategic break from its American counterpart, which is going back to finger-lickin' basics in the U.S., Yum China is pushing healthier offerings and technology.

Since the spinoff, China's biggest fast-food chain, with more than 7,700 KFC and Pizza Hut stores, has bought a controlling stake in an online food-delivery company, partnered with China's most-popular digital wallet service and improved its smartphone apps.

Yum China's 63-year-old chief executive, Muktesh "Micky" Pant, concedes he was skeptical of the emphasis on apps at first, telling his team they were too complicated.

"They very politely told me to just hang on, and I'm glad I didn't interfere," he said in a recent interview. "People have far more apps on their phones, and they are able to navigate them effectively."

Mobile payments at Yum China's restaurants represented 45% of sales in the quarter ended Aug. 31, up from 17% in all of 2016. Delivery orders, most of which come from online apps, were 14% of sales in the same period, up from 10% last year. Its two-year-old loyalty program, meanwhile, has become one of the largest in the world, with more than 127 million members--dwarfing industry leader Panera Bread Co. in the U.S., which has about 25 million members.

Net income in the first eight months of this year rose 19% over the same period a year earlier, while system sales, which include revenue from franchises and joint ventures, grew 10% in the latest quarter.

"To the U.S. investor, the numbers look meteoric," said Sara Senatore, an analyst at Sanford Bernstein. Shares in Yum China are up more than 65% since the company was listed on the New York Stock Exchange in November 2016.

"But Yum, broadly speaking, is holding its own," she added, keeping pace with Chinese chain restaurant sales.

One not-so-bright spot for Yum China is Pizza Hut. Sales at its stores open at least a year were flat in the most recent quarter, compared with 7% sales growth at KFC.

Yum Brands was the first major Western fast-food company to enter China, beating McDonald's Corp. by three years when it opened a KFC near Tiananmen Square in 1987. Its long success was dimmed in recent years by food-safety scares and stronger competition, leading the parent company to spin it off and instead collect a percentage of sales.

The market continues to be tough, as companies vie for a coveted market: young urban professionals. Peers such as McDonald's China, whose former Oakbrook, Ill.-based parent ceded control to Chinese and private-equity partners earlier this year, are also offering healthier menu options such as congee and apple slices as part of an effort to cater to young urban professionals. That contrasts with U.S. counterparts, who are ditching healthier fare and doubling down on traditional menu items to win back customers from competing fast-food outlets.

"Food safety and nutrition is a greater consideration for Chinese consumers, while speed of service and authenticity is more important to U.S. consumers," said Morningstar analyst R.J. Hottovy in an email. "The KPRO concept does a good job addressing the healthy and better-for-you demands of Chinese consumers, while the back-to-basics approach that YUM and MCD have been adopting [in the U.S.] is more about simplifying operations," he said, using the company's stock symbols.

Technology also figures heavily in Yum China's strategy. The company has partnered with Alibaba Group Holding Ltd. affiliate Ant Financial to offer its "smile to pay" system at the KPRO in Hangzhou, Alibaba's headquarters city, which serves as a test-bed for new technology and menu items.

Customers go to a self-serve kiosk to choose items on a video screen, then pay by looking at a camera, provided they've enabled facial-recognition on their Alipay app. For security, they must also enter their phone number.

"It's very easy," said Mei Xueling, 26, who bought a chicken panini using the technology. "If you didn't have to type in your phone number, it would be even better."

Yum China executives say the digital initiatives aren't about cutting labor costs, but about getting data that leads to improved logistics for food delivery and deeper insight into customer preferences.

"Customers still like the human touch," Joey Wat, the company's 46-year-old president and chief operating officer, said in an interview.

Ms. Wat, who was recently tapped to succeed Mr. Pant as CEO starting in March, joined Yum's China business in 2014 and was responsible for ushering it into the digital era. While head of its KFC brand, she oversaw trial programs such as a robotic order-taker in Shanghai and an artificial intelligence-enabled kiosk in Beijing that suggested menu items based on a customer's photo.

"We figured Joey was exactly the right person to lead the company," Mr. Pant said. "Could I have worked there longer? Sure, but it was just the right thing to do."

Write to Wayne Ma at wayne.ma@wsj.com

(END) Dow Jones Newswires

November 06, 2017 05:44 ET (10:44 GMT)