U.S. brands open 2nd phase in China expansion

HONG KONG -- American companies are increasingly finding life in China outside Shanghai and Beijing.

Companies including Starbucks and Yum Brands — which operates KFC and Pizza Hut restaurants — are aggressively expanding in smaller but rapidly growing cities such as Yiyang and Zhengzhou, where a cup of coffee or a chicken meal costs a healthy chunk of a day's wage for the average Chinese consumer.

They're doing so as China's largest cities become saturated with American names and foreign competitors. In recent years, the Chinese government has also built more roads, bridges and other infrastructure in inland areas, increasing their appeal to foreign companies.

The explosion of Internet usage has made smaller cities and towns attractive to global brands because it's given them the same exposure to products and services that the bigger cities have, says Ashok Sethi, head of consumer insights for emerging markets at TNS Global, a research firm. "They have similar aspirations, and they want to consume."

In the past, many foreign companies focused on the largest cities in China — Beijing, Shanghai, Guangzhou and Shenzhen — but only 10% of the country's urban population lives in these cities, says Andy Rothman, China macro strategist for CLSA, a research and brokerage firm in Hong Kong. In their second phase of expansion, companies are opening in midsize and small cities, because "That's where the majority of people are."

Even small cities in China are big: Outside of its four largest cities, China has 150 other cities with a population of at least 1 million, compared with 13 in the U.S., according to Rothman.

For Starbucks, expanding beyond the coastal cities and provincial capitals of China will be a "key focus" as the coffee chain aims to triple its stores in China to 1,500 by 2015, spokesman Dongwei Shi says.

Wal-Mart, the world's largest retailer, now has about 340 stores in more than 120 cities in China, 80% of them outside the largest cities, according to Wal-Mart China spokeswoman Christina Lee.

Meanwhile, KFC is building restaurants in small cities as well as large ones as it goes "where the economic growth occurs," says Steve Schmitt, Yum Brands' director of investor relations.

Of KFC's nearly 3,400 restaurants in more than 700 cities in China, about 30% are in small cities.

Salaries have risen quickly in China's small and midsize cities, meaning that a growing number of consumers can afford foreign companies' products.

Still, incomes in some of the cities "don't justify" eating at American fast-food restaurants every day, so consumers may hold special events there or give the meals as gifts, says Darlene Lee, managing director of retail and lifestyle in Greater China for Synovate, a market research firm.

Even consumers who can't afford a two-piece chicken meal with a drink for 13 yuan — about $2 — may find a company like KFC has a certain cachet.

"When a KFC comes to town, it's a big deal, because it means the city is on the map" for international companies, says Corbett Wall, managing director of +CW Associates, a Shanghai-based firm that advises companies looking to expand in small and midsize Chinese cities.