American Fast Food in Korea

American Fast Food in Korea International Business I. Demand Environment: Macroeconomic data (Exhibit 1) for Korea suggests that the country has favorable demand environment for the fast food industry in Asia. Although China and Singapore’s economies grew at seven and ten percent, respectively, within the last year, the former is too undeveloped for a company with no operations in Asia and the latter represents a market that has been saturated. Ranking fifth on GNI per capita is a double-edged sword. On the one hand, Korea only ranks behind the countries whose fast food industries have already matured and thus showing that Korea may hold the same potential; on the other, the country is only six spots away from having one of the lowest GNI per capita figures, which could prove beneficial since consumption of fast food has been shown to increase with lower incomes. Additionally, Korea ranks fourth in terms of urban population (the segment of its market that is serviceable) and has one of the highest people to store ratios. In Korea, there is 1 store for every 1.7 million people. Taken in comparison to Japan’s 1:200,000 ratio, this suggests that there may be unmet demand in the Korean market (Exhibit 2). II. Industry Analysis: The fast food industry in Korea is moderately unfavorable. Supplier power is strong and rivalry, intense. These two factors have the strongest impact on a company’s bottom line and are thus weighed more heavily than the threat of new entrants, substitutes, and buyer power, which are factors favorable in the industry. Rivalry within the industry is intense and is dominated by price wars led by Lotteria and McDonald’s—companies, which have the financial resources to absorb losses in promotional pricing. However, the industry has not yet reached perfect competition where competitors are numerous and relatively of the same size. As long as the firms continue to have differentiated offerings, they maintain their ability to set prices. Demand is projected to shrink due to the shift in target markets from the baby boomers (previously 29% of the population) to a new generation (only 15%). Although this reduces the size of the market, it also represents an opportunity to serve a segment that may not be currently targeted. Since the industry is still recovering from the Asian financial crises, this slowdown in growth suggests that competition will be based upon battling for market share. The high fixed costs of procuring raw materials and setting up business creates high exit barriers, meaning that franchisees are likely to compete on price as a means of staying in the game. The threat of new entrants is low. There are high capital requirements for doing business in the fast food industry since franchises are high fixed cost investments that require economies of scale in order to be profitable. There is existing brand loyalty to Lotteria, who has been in the market since 1978, while other fast food incumbents have already obtained the most favorable store locations. These existing competitors are also more likely to have stronger supplier relationships, which allow them to enjoy cost advantages that new entrants cannot. Although Korean entrants are unlikely to have the same access to financial intermediaries, they benefit from their connections to the Korean chaebol of business and supplier networks. Substitutes in the fast food industry comprise of family restaurant chains, pizza restaurants, and local Korean restaurants. The majority of these substitutes, with the exception of low-end Korean restaurants, set a price ceiling for the fast food industry. These restaurants typically charge higher prices, but are reserved for more formal, sit-down dining. These substitutes have also moved into niche markets and the suburbs. As a result, they do not compete on the same dimensions as fast food, which is perceived to be convenient and relatively cheap. Thus, substitutes compete only weakly with fast food since they do not offer the same price to performance tradeoff. The bargaining power of suppliers is unfavorable in the Korean fast food industry. Although beef and chicken are standardized products, their supply is very limited in Korea. Although the fast food industry is an important customer for suppliers, these food supplies are essential to the firm’s business—thus implying that the fast food industry needs the suppliers more than the suppliers need them. Additionally, it is difficult to find capable workers to service the franchises. These additional costs in procurement and labor significantly effect a firm’s ability to do business profitably. However, these threats are mitigated if the firm is able to internalize the supplier function and thus control costs. Buyers have moderate bargaining power in the industry. Since the price of the product only represents a small portion of the consumer’s income, he/she is less likely to shop around. Low switching costs erode customer loyalty, but since product offerings and marketing create differentiation within the industry, it mitigate the bargaining power of buyers. GDP growth will have the effect of increasing disposable income, which strengthens their purchasing power. It is unlikely that the buyers will backward integrate. III. Other CAGE factors: The cultural differences in Korean fast food create both opportunities and threats for the industry. The shortened work week will provide Korean workers with additional leisure time, which creates opportunities for fast food in the rural areas. However, anti-American sentiment has the potential to leave lasting impressions on the industry’s future target market of teenagers. This poor publicity not only erodes current market share, but also depresses future lifetime value. Additionally, firms need only to take limited menu localization efforts, since Korean youth prefer the taste of Western foods. Teenagers, however, are a fickle market and their tastes vary widely from one day to the next. Although targeting those in their 20s and 30s would be more stable, people in this age group seldom visit fast food chains. On the supply side, Asian countries typically lack customer service cultures, which may be a challenge for those multinationals with a service-oriented culture. The language barrier is also a source of concern for those companies which are just starting up. In terms of administration, Korea is in the process of transitioning from state-led development to a market-oriented economy. Although progress is being made, it is difficult to predict the effect of this transition on both the macroeconomy and fast food industry. However, since fast food does not hold strategic importance for the country (in terms of security, natural resources, etc), it is unlikely to garner government intervention. Since Korea is a small country, it poses the benefit that perishable items can be transported easily through the country’s well-developed infrastructure. However, it also poses the challenge that the country lacks many of the raw food supplies needed by the fast food industry. Its shared border with North Korea is a place of political contention and a threat to American multinationals operating in the county. In an industry where tight operations controls are crucial to profitability, it may be difficult for headquarters to monitor its global subsidiaries. For reasons discussed previously, Korea’s economic environment is favorable. IV. Strategic Implications: The fast food market in America has matured, leading top companies such as McDonald’s to report losses within the last quarter. The industry structure in the US is very similar to Korea’s, although American suppliers have weaker bargaining power. The following discussion will examine the best practices of American fast food companies who have managed to combat the unattractive features of the industry structure. The companies which are best able to reduce competition differentiate themselves via marketing and product offerings. Rather than compete on price, companies such as McDonald’s and Wendy’s have built-in value menus, which are essentially Everyday Low Prices models. These value menus allow companies to control their costs more effectively, while still psychologically providing the bang for your buck. In-N-Out has avoided the price wars altogether, by positioning themselves away from the competitor and offering a product which is both higher in quality and costs. In order to counter slow demand growth, McDonald’s has expanded its traditional market base by launching the “I’m Loving It” campaign tailored for ethnic minorities. Companies have also capitalized on America’s changing demographic by targeting niche markets and expat communities, where there may preferences for local foods. Suppliers in America are also increasingly becoming partners in the value-chain delivery network. Rather than treat suppliers as an appendage to the system, companies such as Wendy’s and Coke develop mutually beneficial relationships have ensure for more stable long-term profits. Differentiating and positioning itself away from the competitors will be a key success factor for any late entrant into the Korean fast food industry. One potential niche a fast food company could focus on would be the rural leisure segment that would not require a firm to battle for store locations and visibility in the competitive environment. Supplier partnerships rely on heavy technological infrastructures, which would need to be developed in Korea. However, this is a huge fixed-cost investment that may not be feasible until stable revenue streams are attained. Additionally, language barriers may inhibit the ability of firms to build rapport with suppliers. In order to turn this structural weakness into a competitive advantage, a multinational may want to form joint ventures with firms who already have access to distribution channels and supplier networks. Additionally, it will help in combating the anti-American sentiment. Knowledge of the local market, as provided by the partner, will allow the JV to create value for the Korean consumer, while cutting costs on the backend; and thus providing a basis for developing competitive advantage in the Korean fast food industry.