McDonald’s China CEO on bringing McMuffins to the masses

May 10, 2012, 3:52 PM UTC

Kenneth Chan, who heads McDonald’s rapid expansion in China, talks about competition with KFC, dealing with slower economic growth, and food safety.

Kenneth Chan, CEO of McDonald’s China

FORTUNE — In 1992, when the world’s largest McDonald’s opened up in China’s capital city of Beijing, it seemed that the golden arches would someday replace the golden hammer and sickle as the Communist Party’s emblem. China’s second outlet, the Beijing McDonald’s was located on the city’s busy shopping street, not far from the Communist headquarters. On its first day, the restaurant served about 40,000 customers. At its peak time, more than 500 people lined up outside, waiting anxiously to try a piece of Americana, with each set meal costing about 15 yuan ($3.50) – one sixth of a worker’s monthly salary. The exotic name, han bao bao (hamburger), the elaborate packaging and the novel flavor of a Big Mac thrilled ordinary Chinese, who saw McDonald’s as a symbol of the modern and wealthy America that their own country tried to emulate.

Since then, the golden arches have spread fast — McDonald’s now owns more than 1,400 restaurants in China, which is the company’s third-largest market. In 2011, the company set a new record by opening 200 stores. It plans to open between 225 and 250 outlets in 2012.

In China, numerous scandals relating to food safety have undermined people’s confidence in restaurant food. McDonald’s has had its own safety crisis – and emerged virtually unscathed. In March, a McDonald’s store in Beijing was accused of selling food beyond its expiration date. The incident caught the public by surprise, especially since the company had just aired a new ad campaign touting the importance of food safety and quality. McDonald’s responded swiftly, launching an investigation and inviting the government media to scrutinize its food preparation process. Despite the incident, the world’s largest fast food chain reported an impressive 7% net income rise in the first quarter of 2012 and a 5.5% comparable sales increase in the Asia/Pacific region.

Kenneth Chan, McDonald’s China CEO, recently spoke with Fortune at a McDonald’s store inside a Western-style shopping mall in Shanghai. Walking into the crowded restaurant felt like stepping into a hip European-style coffee house, with abstract wall paintings on beige, green and red backgrounds. Chan, 47, is a Singaporean native who started his career at McDonald’s in 1993 and has been CEO in China since 2009.

FORTUNE: McDonald’s (MCD) is now facing a formidable competitor — KFC (YUM) has about 3,500 stores in China and has a larger market share. How do you plan to capture more of the market?

Chan: We are not looking to be the largest in terms of the number of outlets, but we want to be the best-quality, best-service restaurant. We hope to attract more and more customers to increase same store sales. In 2012, we’ll increase our overall investment by 50% — adding more drive-thrus, dessert kiosks and extended hours to help grow sales at existing stores. Not only do we invite customers to come in, we also reach out to them through our fast delivery services.  We want to be available anytime and anywhere for our customers.

Opening new restaurants is another top priority. In addition to opening our own restaurants, we have stepped up our franchise programs. After all, McDonald’s is a franchise company. At present, 80% of McDonald’s worldwide are owned by franchisees; in China, only 36 restaurants were franchised by 2011. We are working hard on this.

In addition to the conventional franchise model in mature markets like the U.S., we also implement what we call a “developmental licensee” model. In certain provinces where we don’t have the capacity to reach out for many years, we are looking for licensee partners who have strong financial backgrounds and strong business experience. China had seven conventional licensees and two developmental licensees as of 2011. It’s still a very low percentage and over a very short time that will change. The pace of franchising in China depends largely on finding the right partners.

We are now seeing slower economic growth in China. What is McDonald’s doing to cope with these challenges?

A key winning strategy has always been our focus on value and affordability. We have launched different types of value meals packages — breakfast, lunch or snacks costing from $1 to $3. We want to be affordable so Chinese consumers can come here often and not just as a treat. On the other hand, we strive to provide convenience — our stores are in the most convenient locations and we are open 24 hours. Not only do we invite more people to come to us, we also go to them through our delivery services.

Many of your restaurants here in Shanghai seem to have new looks. What’s behind the image makeover?

We are reinventing ourselves to adapt to the changing constituency. By the end of 2013, about 80% of our restaurants will undergo reimaging. The design will vary by areas. In business districts with many young professionals, we have kiosks for coffee and pastries. In areas with young families, we reserve places for kids to play or host parties. We also offer customer-friendly amenities like free Wi-Fi and McCafes. We want to stay relevant to the younger population and make them stay longer.

With the high inflation rate and rising labor costs in China, how does McDonald’s keep its prices down?

This is not just a McDonald’s issue. It’s affecting everyone. Fortunately, we are able to use our supply chain to get long-term predictability pricing. As a result, we have managed to keep our material cost lower than the market rate. We are also focusing on productivity and efficiency.

With the opening of new franchised stores, how do you guarantee the safety of your food chain?

We have spent twenty years building a wholesome supply chain system and our stringent standards covers the overall process, from the farm to the restaurant. About 95% of our ingredients are produced here under our safety protocol and standards. We try to communicate with the government and food authorities here and we are transparent to the public so they understand the kinds of effort we have made. We have extensive training and stringent standards for franchisees.

In China, a traditional breakfast includes congee, buns, or milk. How successful are you with the American-type of egg and sausage McMuffins and hash browns?

It is very successful. In China today, breakfast constitutes 8% to 10% of our sales. It could easily double in the next few years. We have two types of breakfasts. During weekdays, consumers want things easy, quick, convenient, something they can grab and go. We offer a muffin and a coffee for less than $1. We also have a warm American-style breakfast. They can eat at the restaurant or take it to work.

Obesity is rising among the Chinese population. Is McDonald’s China adding healthy items similar to what you do in the U.S.?

We have somewhat of a unique situation in China. When the kids come in, mothers normally come in to give the kids a treat. But, we want to make sure that everything we do has the right nutritional value for our kids. For adults, we are now offering corn cups as an alternative to french fries. We offer wraps that contain many vegetables, and 100% orange juice is also available. We try to add a variety of healthy food items to our happy meal menu. In our promotional materials, we try to convey the message of balance and moderation.