Business Report

This document is authorized for use only by Prof. Gang HAO's MS6722 Advanced Case Analysis of SCM course at City University of Hong Kong, from January 2021 to July 2021.

Dr. Claudia H. L. Woo prepared this case under the supervision of Prof. Zhigang Tao for class discussion. This case is not

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Ref. 14/550C

1

ZHIGANG TAO

MCDONALD’S CHINA: THE EXPIRED MEAT SCANDAL

China is no stranger to food scares. Just when the 2012 scandal involving Kentucky Fried

Chicken (KFC) “instant chicken” had begun to fade, two years later another food safety scare

hit Chinese fast food chains. In July 2014, a Shanghai television station revealed that

Shanghai Husi, a Chinese subsidiary of a reputable US-owned food supplier, was producing

substandard meat products. McDonald’s was one of its biggest fast-food clients and had been

sourcing from the supplier for more than two decades.

The scare affected not just a large number of McDonald’s outlets in China but also in Hong

Kong and Japan, which had also sourced meat and other food items from Shanghai Husi and

other Chinese-based Husi factories. As part of their investigation, Chinese health authorities

forced Shanghai Husi to shut down. Having relied on this supplier for over two decades,

McDonald’s suddenly faced a severe shortage as well as declining stock prices and dropping

revenue in the Asia-Pacific region. What would McDonald’s do to improve its product safety

and supply chain management in China, when it seemed that even a large, foreign-owned

supplier no longer guarantees reliability?

Quality Control in Chinese Food Processing and the Fast-Food Industry

Since China’s market reforms in 1978, its fast-growing economy and rapid urbanization had

contributed to higher disposable income and increased demand for high-quality food products,

boosting the country’s agribusiness and food processing sectors. [See Exhibit 1.] The Asia-

Pacific region was the world’s biggest and fastest-growing with respect to consumption of

processed meat, accounting for 63% by volume of the growth generated from 2009 to 2014. 1

[See Exhibit 2.] China accounted for the largest share of sales within the region, with retail

sales of six billion tons in 2014. It was expected to surpass the US by 2015 to become the

biggest processed-meat market in the world. Despite being a strongly growing and profitable

industry, there was little government supervision of the industry and no regular inspections of

1 Hosafci, P (18 August 2014) “Processed Meat – What is the New Euromonitor Data Telling Us?”, Euromonitor International,

http://www.globalmeatnews.com/Industry-Markets/Processed-meat-what-is-the-new-Euromonitor-data-telling-us (accessed 23

September 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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meat-processing plants. For example, using expired meat in food-processing facilities,

according to industry insiders, was not uncommon in China.2 The industry usually relied on

the public and media for scrutiny.3 Although food producers in China were encouraged by the

Chinese government to adopt international compliance standards, this was not mandatory.

The nation’s food-safety regulations had improved since 2008, after the melamine tainted-

milk scandal hit the country, at which time the Food Safety Law was introduced to replace the

outdated Food Hygiene Act. In some respects, food safety standards in China were arguably

stricter on paper than in many developed countries.4 However, the country’s enforcement of

food safety standards was always questionable. One of the problems was a shortage of food-

safety inspectors. According to market researchers the Mintel Group, there were about

500,000 food-production and processing companies in China and only one inspector for every

420 of them.5 Of these 500,000 companies, 70% had less than 10 employees. Given their size,

they tended to be less structured in terms of quality control and lacked the capital and

technology for improvement. In contrast, most foreign-owned companies in China had more

stringent in-house food-safety control measures. Nevertheless, many of them were staffed by

local employees and run by local management, who, while familiar with the Chinese market,

might have little concern about food quality and were willing to cut corners to save costs.6

With respect to third-party inspections, industry insiders noted that it was common for

Chinese food suppliers to know about audits in advance, making inspection findings highly

biased, as plant operators could window-dress conditions on the day of the audit. 7 Even

though heavier penalties for food-safety violations had been introduced over the years in

China due to frequent food scandals, many expected still tougher punishments to be instituted.

For instance, prior to July 2014, selling expired food would be fined up to Rmb50,000

(equivalent to US$8000) if the food products’ value was less than Rmb10,000. Otherwise, the

penalty would increase to 10 times the product value. The draft of a new amendment to the

law suggested raising the penalty to 30 times the food’s value.8

Food scares implicating top foreign fast-food restaurants in China were frequent in recent

years. In 2005, KFC China had taken its chicken products from the menu after a cancer-

causing food dye, “Sudan Red,” was found in the seasoning. The chain was accused in 2007

of re-using frying oil for up to ten days by adding magnesium trisilicate to extend usage.9 In

2012, a McDonald’s outlet in Beijing had reportedly altered expiration dates on some dessert

products and used meat patties that had been dropped on the floor. At the end of the same

year, both KFC and McDonald’s were under fire as Chinese national television found that

2 Sina Finance (26 July 2014) “The Expired Meat Scandal; Losing Control Over Sourcing Management of Fast Food Giants”,

http://finance.sina.com.cn/chanjing/gsnews/20140726/013119824489.shtml (accessed 5 October 2014). 3 Burkitt, L (27 July 2014) “McDonald’s Meat Supplier Pulls Chinese Plant’s Products”,

http://online.wsj.com/articles/mcdonalds-meat-supplier-pulling-all-products-made-by-shanghai-husi-unit-1406445545

(accessed 20 September 2014). 4 For example, nearly a decade earlier, China banned clenbuterol and all beta-agonists in its class (i.e., growth-enhancing

chemicals), which were used to make hog grow faster and leaner. However, in the United States, certain types of beta-agonists

used in animal feed claimed to be less threatening than clenbuterol were still allowed. See Philpott, T (3 June 2013) “China

Could Actually Improve US Pork. Here’s How”, Mother Jones, http://www.motherjones.com/tom-philpott/2013/05/why-

chinas-smithfield-buy-could-slightly-clean-us-pork (accessed 23 September 2014). 5 Bloomberg News (25 July 2014) “China Meat Scare Add Foreign Suppliers to Food Worried”,

http://www.bloomberg.com/news/2014-07-24/china-meat-scare-adds-foreign-suppliers-to-food-worries.html (accessed 22

September 2014). 6 Ibid. 7 Reuters (2 September 2014) “McDonald’s to Boost China Audits After Food Safety Scandal”,

http://www.reuters.com/article/2014/09/02/mcdonalds-china-idUSL3N0R32HO20140902 (accessed 15 October 2014). 8 Global Times Published (22 July 2014) “Confidence in US Fast Food Dented After Meat Scandal”

http://www.globaltimes.cn/content/871870.shtml (accessed 24 September 2014). 9 CRIENGLISH.com (13 march 2007) “KFC Reusing Oil Could be Dangerous”,

http://english.cri.cn/4026/2007/03/13/[email protected] http://www.cbsnews.com/news/officials-say-okay-to-processed-

chicken-from-china/ (accessed 16 September 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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their local suppliers had used illegal amounts of antibiotics to boost chicken growth. Less than

a year later, both fast food giants were accused of using contaminated ice cubes that contained

considerably more bacteria than the water from local toilets. In the past, products sold by

foreign chains were perceived to be safer than those from local Chinese stores, and in many

food scandals, locally-owned suppliers were usually put on the spot. With more cases

implicating foreign companies coming to light, Chinese food-chain problems became more

alarming.

McDonald’s in China

McDonald’s, the famous American fast-food chain, entered China in 1990, during a period

when “franchising” was still a very new concept in the country. Instead of relying on the

franchise model to expand its outlets in China, McDonald’s restaurants were initially run

either under wholly foreign-owned enterprises (“WFOEs”) established in the country or joint

ventures with local firms.10 In 2004, as the nation’s regulatory and investment environment

became more developed, McDonald’s China began franchising. However, a rather slow and

cautious approach was still taken in order to maintain brand quality and management control.

Even though McDonald’s restaurants outnumbered KFCs globally, the latter was more open

to the franchising model and had many more outlets in the Chinese market. Between 1990

and 2010, McDonald’s restaurants in China expanded at an annual rate of 17% — much more

slowly than in certain other markets in the Asia-Pacific region, such as Japan.11 . By 2013,

China had become McDonald’s third-largest market in the world, although only 12% of its

restaurants in China were franchised. At the end of April 2014, McDonald’s China had

launched 2000 restaurants in the country. It expected to increase the ratio of its franchised

restaurants in China to about 25% by 2015. 12 [See Exhibit 3 for McDonald’s Consolidated

Revenues by Region and Operating Mode.]

By focusing on operating efficiency and standardization to minimize operating costs,

McDonald’s global competitive strategy was oriented towards cost leadership. However, in

China, McDonald’s was initially perceived as pursuing a differentiation approach, as it

sourced most of its raw ingredients outside China at higher costs to assure quality. Chinese

consumers also tended to regard foreign fast food as higher in quality and were willing to pay

more to multinational companies than to local eateries. McDonald’s Chinese supply chain had

a single meat-production plant in the country when it opened its first outlet. The rest of the

ingredients were imported. It was not until 1999 that it managed to serve french fries made

from Chinese-grown potatoes in all its restaurants in the country—after 14 years of joint

investment between McDonald’s and its primary US-based french-fry supplier pioneering the

development of industrial potato-farming in China.13

As market competition intensified in China, with the entry of more foreign and local fast-food

companies, cost-reduction became a must for McDonald’s China. To cut down operating

costs and leverage China’s abundant labor and agricultural resources, McDonald’s invested

heavily in creating a large supply chain in the country to furnish locally produced food to

10 Vedder, T. (19 August 2007) “Fast Food Domination”, China International Business,

http://www.cibmagazine.com.cn/Features/Industry.asp?id=85&fast_food_domination.html (accessed 9 October 2008). 11 Worldcrunch (12 March 2014) “Supersize the Franchise: McDonald’s New China Strategy”,

http://www.worldcrunch.com/business-finance/supersize-the-franchise-mcdonald-039-s-new-china-strategy/kfc-fast-food-

rivalry-catering-restaurant-franchisee/c2s15258/#.VGMl7jSUdX4 (accessed 11 November 2014). 12 ChinaRetailNews (21 April 2014) “Fast Growth Equals More Fast Food For McDonald’s in China”,

http://www.chinaretailnews.com/2014/04/21/7055-fast-growth-equals-more-fast-food-for-mcdonalds-in-china/ (accessed 21

September 2014). 13 Groom, N (10 November 2006) “McDonald’s Look to China to Supply Restaurants”, Reuters,

http://www.reuters.com/article/2006/11/10/businesspro-leisure-mcdonalds-china-dc-idUSN1047786220061110 (accessed 21

September 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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more of its restaurants in China and other parts of the world. Over the years, McDonald’s had

created a solid network of farmers, food processors, and other direct and indirect suppliers in

China. By 2006, more than 95% of the ingredients used by McDonald’s China (e.g., potatoes,

meat patties, vegetables, milk) originated from within the country.14 Meanwhile, McDonald’s

suppliers in China also exported products such as chicken, beef, lettuce and apple pies to the

chain’s other Asian markets. Much of the packaging used in McDonald’s restaurants around

the world was also produced in the country’s factories.

Globally, McDonald’s claimed to approach its supply chain through the three E’s—ethics,

environment, and economics—from raw material production through processing and

distribution. According to the company, this meant “working with suppliers to innovate and implement best practices for sustainable ingredients, requiring that McDonald’s suppliers

protect human rights in the workplace, and safeguarding food quality and safety through best

practices in animal health and welfare.” 15 With respect to food safety management, McDonald’s applied the internationally recognised Hazard Analysis and Critical Control

Point (HACCP) 16 program globally at its suppliers’ plants and its own restaurants to track

food-production safety risks and put preventive measures in place.

McDonald’s Long-Term Meat Supplier

McDonalds’s China tended to work with big-name suppliers. Its largest meat supplier was the

OSI Group (“OSI”). 17

Founded in 1909, OSI was a global food processor headquartered in

Aurora, Illinois, supplying top fast-food chains around the world.

OSI first started supplying beef patties to McDonald’s in Illinois in 1955. It entered the

Chinese market in 1991, beginning with processing chicken, beef, fish and pork. With the

growing demand for western fast food in China, OSI expanded into processing vegetables.

OSI’s decentralized business model allowed its Chinese managers great decision-making

autonomy and this strategy had helped OSI to expand quickly in China beginning in the early

1990s.18

OSI established a wholly-owned subsidiary, Shanghai Husi, in China in 1996, which built

five production lines for pork, beef, chicken, vegetables and noodles. There were other Husi

plants in China, in Hebei, Guangzhou, Kunming and Shandong. It was one of the few Chinese

poultry suppliers with nationwide recognition. Some of Shanghai Husi’s Chinese clients in

China included Burger King, Yum! Brands (owner of KFC and Pizza Hut), Dicos, Papa

John’s, Subway, Starbucks, etc. By the end of 2013, OSI had successfully established its tenth

facility in China and spent at least US$750 million on three vertically integrated poultry

processing plants.19 All three vertically integrated operations used entirely company-owned

14 Cheung, A. (11 December 2006) “An Exclusive Interview with Gary Rosen, McDonald’s Chief Marketing Officer in China”,

The China Perspective: Consumer and Retail,

http://thechinaperspective.com/articles/anexclusiveinterviewwithgaryrosenMcDonald’s039schiefmarketingofficerinchina1751/

index.html (accessed 29 August 2008). 15 McDonald’s (2013) “Our Journey Together For Good- McDonald’s Corporate Social Responsibility & Sustainability Report

2012-2014”, pg. 25, http://www.aboutmcdonalds.com/content/dam/AboutMcDonalds/2.0/pdfs/2012_2013_csr_report.pdf

(accessed 21 September 2014). 16 For more details of the HACCP Program, see the official website of Standards.Org:

http://www.standards.org/standards/listing/haccp (accessed 3 October 2014) , 17 Cendrowski, S (2 September 2014) “Why McDonald’s Supplier Failed in China”, Fortune.com,

http://fortune.com/2014/09/02/why-mcdonalds-supplier-failed-in-china/ (accessed5 October 2014). 18 Ibid. 19 Forbes (21 July 2014) “U.S. Firm at Center of Reported China Meat Scandal Had Earlier Success”,

http://www.forbes.com/sites/russellflannery/2014/07/21/u-s-firm-at-center-of-reported-china-meat-scandal-had-earlier-

success/ (accessed 13 October 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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farms, aiming to improve food-safety and traceability control throughout its supply chain.

With this investment, OSI was able to process more than 300 million birds annually.20

Back in 2004 and 2010, the US Department of Agriculture (USDA) had conducted on-site

audits of the Shanghai Husi plant in an effort to clear the way for exporting Chinese poultry to

the US. The company was issued a clean bill of health. 21

However, some food-safety experts

criticized the effectiveness of the USDA’s Foreign Establishment Audit Checklist form’s one-

page format.

In 2013, a former employee of the Shanghai quality-control team brought a lawsuit against

Shanghai Husi for running an unsafe workplace and faking food-production dates. 22

However,

a local court dismissed the case due to lack of evidence and Shanghai Husi managed to

defend itself with records of health and safety procedures implemented in the plant.

The Expired Meat Scandal

On July 20, 2014, a Chinese state-owned media outlet, Dragon TV (東方衛視), broadcast an

undercover video of the Shanghai Husi operation. The video showed workers in the plant

picking up meat dropped on the floor and taking it back to the processing machine, repacking

old meat and extending expiration dates, and mixing expired with fresh meat. A worker told

the undercover reporter that each division only did what it was told to do from the top and did

not care about what upstream or downstream divisions did. Workers would be informed by

the management in advance if external inspections or audits were to be carried out so that

they would have enough time to cover up, for example, by hiding piles of blue plastic bags

filled with expired meat that were stacked around the factory floor on normal days. Such

instructions were written by the management in Chinese. In the video, the staff of Shanghai

Husi said the company kept two set of records related to food products, one of which was

doctored for auditors visiting the plant. 23

Immediately following this video broadcast, Shanghai Husi became the subject of an

investigation by Chinese authorities, which later shut the plant down. The Shanghai

Municipal Food and Drug Administration (SFDA) discovered that expired chicken and beef

items had indeed been reprocessed and repackaged with new expiration dates. Amongst the

substandard products, over 4,300 cases of smoked beef patties were found to have forged

production dates, with more than 3,000 cases already sold. 24 The SFDA officials also

confirmed that Shanghai Husi kept different sets of records to enable the resale of out-of-date meat.25

On 23 July 2014, six executives of Shanghai Husi were arrested by the Shanghai branch of

the Public Security Bureau on suspicion of producing and selling fake and inferior products.

20 The National Provisioner (13 November 2013) “OSI’s Vertically Integrated Poultry Investment in China Exceeds USD $750

Million”, http://www.provisioneronline.com/articles/99810-osis-vertically-integrated-poultry-investment-in-china-exceeds-

usd-750-million (accessed 6 November 2014). 21 China Daily (31 July 2014) “Food Inspectors Face Challenges”, http://www.chinadaily.com.cn/china/2014-

07/31/content_18220261.htm (accessed 6 October 2014). 22 Judicial Options of China (13 February 2014), “Wang Donglai v. Shanghai Husi”, Jiading District People’s Court

Decision, Case Reference no. 1074, dated 6 January 2014,

http://www.court.gov.cn/zgcpwsw/sh/shsdezjrmfy/shsjdqrmfy/ms/201402/t20140213_336719.htm (accessed 5 October 2014). 23 Takada, K. (24 July 2014) “Exclusive: China Meat Supplier Faced Claims Over Unethical Work Practices”, Reuters,

http://www.reuters.com/article/2014/07/25/us-china-food-dispute-idUSKBN0FU05Y20140725 (accessed 13 October 2014). 24 Li, Z (30 July 2014) “China Tainted Meat Scandal Explained”, CNN, http://edition.cnn.com/2014/07/29/world/asia/explainer-

china-meat-scandal/ (accessed 7 October 2014). 25 Burkitt, L. and Bunge, J. (23 July 2014) “Meat Supplier’s CEO Apologizes for China Unit”, The Wall Street Journal,

http://online.wsj.com/articles/chinese-authorities-say-shanghai-husi-food-violations-company-led-1406081978 (accessed 8

October 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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The local authorities urged several leading global fast-food companies to publish the names of

their suppliers on their Chinese websites in order to strengthen oversight. By the end of

September 2014, 214 food producers and 22 fast-food companies had been examined by local

food inspectors, who seized 18 tons of Chicken McNuggets, 78.1 tons of smoked beef patties

and 48 tons of beefsteak for investigation.26

Starbucks, Burger King and 7-Eleven convenience stores immediately halted sales of

products from Shanghai Husi. McDonald’s key competitor, Yum! Brands, also cut all ties

with Husi, which Yum! claimed was not a significant supplier. The scandal further prompted

Yum to cease all purchases from Illinois-based OSI. Shanghai Husi was licensed to export to

Japan. The Japanese government stopped all imports from its plants after FamilyMart Co.

withdrew the supplier’s products from its Japanese outlets.

After the scandal erupted, OSI recalled all products manufactured by Shanghai Husi. OSI

apologized to its customers worldwide and called the case an isolated incident, claiming that

Chinese inspectors had found no issue with its other facilities in the country.27 Media also

reported that while some former workers at Shanghai Husi criticized lax quality control at the

plant, workers at another Husi plant in northern China defended their management’s strict

safety rules.28 It was speculated that OSI had not conducted enough audits to ensure all its

Chinese plants complied with the global standards developed by OSI headquarters in the US.29

Further, documents used in the Chinese plants were reportedly written in Chinese, making it

difficult for English-speaking staff to understand data or operations.

Apart from conducting internal investigations into current and former Chinese senior

management, OSI brought a new management team, under direct US control, to lead its China

operation. It also planned to rotate global experts to examine and audit its Chinese units.

However, in early September, news circulated that OSI might withdraw from the China

market even though its executives had tried to rescue its business there. 30 This was because

OSI’s partner found it risky to continue the partnership.

Impacts on McDonald’s

McDonald’s claimed itself a victim in the scandal and its Chief Executive, Don Thompson,

said that the company felt “a bit deceived” by the Shanghai Husi audit results it had received.

It was reported that McDonald's and many other restaurant operators relied on third parties to

conduct audits of compliance with food safety rules and other regulations at their suppliers’

facilities.31

The scandal impacted McDonald’s restaurants not just in mainland China, but also in Hong

Kong, Japan and certain other Asian markets, with some outlets forced to pull suspect items

from their menus. McDonald's shares on the New York Stock Exchange dropped 4.7 percent

26 Yan, A. (23 September 2014) “Rotten-Food-Scandal-Hit Factory Shanghai Husi Sacked 340 Workers”, China Morning Post,

http://www.scmp.com/news/china/article/1598010/rotten-food-scandal-hit-factory-shanghai-husi-sacks-340-workers

(accessed7 October 2014). 27 Burkitt, L. and Bunge, J. (23 July 2014) “Meat Supplier’s CEO Apologizes for China Unit”, The Wall Street Journal,

http://online.wsj.com/articles/chinese-authorities-say-shanghai-husi-food-violations-company-led-1406081978 (accessed 8

October 2014). 28 Takada, K. (24 July 2014) “Exclusive: China Meat Supplier Faced Claims Over Unethical Work Practices”, Reuters,

http://www.reuters.com/article/2014/07/25/us-china-food-dispute-idUSKBN0FU05Y20140725 (accessed 13 October 2014). 29 Cendrowski, S (2 September 2014) “Why McDonald’s Supplier Failed in China”, Fortune.com,

http://fortune.com/2014/09/02/why-mcdonalds-supplier-failed-in-china/ (accessed5 October 2014). 30 WantChinaTimes (4 September 2014) “McDonald’s Meat Supplier Might Quit China After Scandal”,

http://www.wantchinatimes.com/news-subclass-cnt.aspx?id=20140904000140&cid=1206 (accessed 14 October 2014). 31 Baertlein, L. (23 July 2014) “Corrected-McDonald's Feels "Bit Deceived" by Audit Results from China Plant”, Reuters,

http://www.reuters.com/article/2014/07/24/china-food-mcdonalds-idUSL2N0PX13920140724 (accessed 16 October 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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following the Shanghai Husi investigation. [See Exhibit 4.] Its global sales growth

plummeted to a decade-worst low of 3.7 percent in August 2014. In the same month, sales in

its home market, the US, and in Europe had respectively dipped by 2.8 and 0.7 percent. 32 [See

Exhibits 5 and 6.] While McDonald’s does not break Chinese sales out publicly, the

company earned 23.6 percent of its revenue and 16.8 percent of its operating profit from the

Asia-Pacific, Middle East and Africa (APMEA) region in the first six months of 2014.33

McDonald’s believed the expired meat scandal had caused the company’s same-store sales in

the APMEA region to tumble 9.9% in the quarter ending September 2014.34

McDonald’s China: Standing by OSI?

McDonald’s pulled beef, pork and chicken products from its Chinese outlets after the scandal

broke. In cities like Beijing and Shanghai, fish burgers were the only sandwiches available.35

Instead of completely cutting ties with Shanghai Husi and its parent company OSI, as its

competitors did, the Golden Arches initially told the media at the end of July that it would

stand by its long-time supplier. Even though it would no longer receive supplies from the

Shanghai facility, it would continue sourcing from Husi’s other operations in China. 36

Reportedly, McDonald’s planned to shift its sourcing to OSI’s new processing plant in Henan

province, which in August 2014 became the first LEED-certified plant in China and among

the few meat-processing plants in the world to obtain a green building certification. 37

After stopping sourcing from its main supplier, McDonald’s China ran into severe shortages.

The chain had to turn to other existing suppliers, urging them to increase capacity. Even so,

many food items could not be sold in restaurants due to lack of ingredients.

There was a mix of responses from Chinese consumers to the scandal. Some of them

criticized the lack of oversight by McDonald’s China or even suspected that McDonald’s

China might have been aware of the situation but chose to keep silent. McDonald’s China

low-cost strategy was also blamed for squeezing supplier profits, forcing them to provide

substandard products to cut costs. On the other hand, some Chinese consumers believed that

McDonald’s was still better than local fast-food chains, which might use gutter oil in its

products.

The scandal also gave rise to conspiracy theories from the foreign media, which reported that

the Chinese government was trying to undermine foreign brands and business in the country.

38 It was speculated that the Chinese government had lately been putting the spotlight on

large multinationals like KFC, McDonald’s, Microsoft and GSK, undercutting their

reputations to help Chinese companies compete with them. At the same time, officials were

said to be trying to get public recognition for being serious in addressing significant issues

such as food safety without harming the Chinese interests. Such speculation was strongly

32 Sharma, B. (10 September 2014) “McDonald’s Sales Continue Decline After Being Hit by China Meat Scandal”, International

Business Times, http://www.ibtimes.co.in/mcdonalds-sales-continue-decline-after-being-hit-by-china-meat-scandal-608777

(accessed 11 October 2014). 33 Wahba, P (4 August 2014) “China Meat Supplier Prove Taking Big Bite Out of McDonald’s Sales”, Fortune,

http://fortune.com/2014/08/04/mcdonalds-china-meat-sales/ (accessed 14 November 2014). 34 Gu, W (6 November 2014) “China’s Economic Slowdown Reflected by Multinationals”, The Wall Street Journal,

http://online.wsj.com/articles/chinas-economic-slowdown-reflected-by-multinationals-1415304851 (accessed 14 November

2014). 35 Bloomberg News (29 July 2014) “McDonald’s Pulls Meat From China Restaurants”, http://www.bloomberg.com/news/2014-

07-28/mcdonald-s-supplier-recalls-meat-in-expired-food-scandal.html (accessed 12 October 2014). 36 Jargon, J. and Bunge, J. (24 July 2014) “McDonald’s Stands By Meat Supplier in Crisis”, The Wall Street Journal,

http://online.wsj.com/articles/mcdonalds-stands-by-meat-supplier-in-crisis-1406244870?mod=WSJ_hpp_sections_business

(accessed 6 October 2014). 37 Higgins, K. (2014) “One-Two Punch: Inspections and Audits”, Food Processing.com,

http://www.foodprocessing.com/articles/2014/one-two-punch-inspections-and-audits/ (accessed 8 October 2014). 38 Schuman, M. (23 July 2014) “The Factory in the China Food Scandal Is Foreign-Owned. That Could Have Made It a Target”,

Time, http://time.com/3021854/china-mcdonalds-kfc-pizza-hut-osi-yum-starbucks-food-safety-foreign-investment/ (accessed

11 November 2014).

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14/550C McDonald’s China: The Expired Meat Scandal

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opposed by some Chinese netizens, who urged foreign companies to be more responsible for

quality, rather than shying away from the issue.39

McDonald’s Hong Kong: Poor Crisis Management Practice

As soon as all imports from Shanghai Husi were suspended by the Hong Kong food safety

regulator, McDonald's Hong Kong stopped selling products the processor supplied. A range

of items was taken off the menu, including Chicken McNuggets, McChicken sandwiches, Big

Macs and products such as green salads, fresh corn cups and lemon tea, which were made

with items previously sourced from Husi units in Hebei and Guangzhou. It was not until early

August 2014 that McDonald's outlets in Hong Kong resumed serving burgers such as the Big

Mac and McChicken with vegetable ingredients such as onion and lettuce sourced from the

US and Taiwan.

When the scandal first went public, McDonald’s Hong Kong denied having imported any

food products from Shanghai Husi. However, the Hong Kong SAR government’s

Environmental Hygiene Department blew the lid off the denial. According to the authorities,

McDonald's Hong Kong had imported pork and chicken from Shanghai Husi. It was revealed

that all of the chicken imported by McDonald’s Hong Kong from Shanghai Husi two months

before the scandal broke had already been sold to customers. No Shanghai Husi products

remained in stock. It was also discovered that from July to December 2013, McDonald's

Hong Kong had imported 10 batches of frozen pork from Shanghai Husi.

McDonald’s Hong Kong later apologized to its consumers for releasing what it called

“confusing information” and explained the denial was made because the chain held no more

stock supplied by Shanghai Husi in its warehouses or restaurants. 40

It further posted

information on its website about ingredients that had been imported from all Husi facilities in

China and products that would be temporarily suspended from the menu. [See Exhibit 7].The

chain also reiterated that its products conformed to food and safety standards. Despite the

apology, McDonald’s Hong Kong was criticized by local legislators and media for attempting

to mislead the public over the scandal, given its initial denials. A Hong Kong spokesperson

also refused to take questions regarding the scandal in a press briefing. Considered a victim at

the beginning of the incident, McDonald’s mishandling of the Hong Kong situation made the

public view the company in a different light.

McDonald’s Japan: Marking the Worst Monthly Same-Store Sales Since 2002

In contrast to the controversial response of McDonald’s Hong Kong, McDonald's Japan

admitted that the company had sourced about 20 percent of its Chicken McNuggets from the

Shanghai plant and said it would stop selling product from Husi facilities. It also announced

two days after the news hit that it had found alternative chicken suppliers from Thailand to

replace Shanghai Husi.

McDonald’s shares traded in Japan fell by 2.8 percent by the end of July as a result of the

scandal. 41

[See Exhibit 8]. Its same-store sales in July dropped by 17.4 percent compared to a

39LegalDaily (2014), “US Media Being Criticised for Defending Husi Scandal”, Vol 2045-August. 法制文萃报 (2014), 美媒为

福喜丑闻喊冤遭驳斥” http://m.183read.com/magazine/article/article_id/262431 (accessed 6 November 2014). 40 Chan, K (25 July 2014) “McNuggets Taken Off McDonald’s Menu”, China Daily Asia,

http://www.chinadailyasia.com/hknews/2014-07/25/content_15151939.html (accessed 10 October 2014) 41 Yan, S (30 July 2014) “Meat Scandal Takes a Bites out of McDonald’s Sales in Japan”, CNN,

money.cnn.com/2014/07/30/news/mcdonalds-japan-meat-scandal/index.html?hpt=hp_t3 (accessed 12 October 2014)

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year earlier, making this the largest monthly fall-off since July 2002.42 Sales further plunged

25.1 percent in August, while the number of visitors to its Japanese outlets fell 16.9% that

same month [See Exhibit 9].43

Rebuilding Brand and Reassessing McDonald’s Chinese Suppliers

Amidst the scandal, McDonald’s launched an 18-month global rebranding campaign at the

end of July 2014. The fast-food operator had in fact suffered from various criticisms in recent

years regarding its service quality, dietary concerns about the food it served and employee

pay issues. The campaign was aimed to transform McDonald’s into a more trusted and

respected brand by focusing its efforts on reshaping its business value, marketing and

operations excellence.44

In early September 2014, McDonald’s China officially terminated its relationship with Husi

and confirmed a new list of five meat suppliers in China, including foreign-owned McKey,

Cargill, Hormel and Trident, and a large local chicken supplier, Sunner, which owned some

of the largest vertically integrated chicken farms, feed mills and processing plants in China.

McDonald’s China sought new vegetable, as well as meat, suppliers within China, including a

European-owned vegetable producer, The Creative Food Group. It also assessed another US-

owned vegetable and fruit vendor in China, Golden State Food, one of the world’s largest

diversified fast-food suppliers.

McDonald's announced it would strengthen its Chinese supplier-assessment process by

increasing the number of its China-based supplier audits, including ad-hoc plant visits by both

internal and external parties. 45 As part of its preventive measures, the company would

enhance video monitoring of its Chinese supply facilities and create a whistle-blower hotline

enabling its office and restaurant employees to report misconduct. A new position of “food

safety governance head” would also be created, reporting directly to the country’s chief

executive.46

The food scare had disrupted the general belief that food produced by foreign brands was

better than Chinese counterparts’. When large, foreign-owned suppliers in China, like OSI,

could not be trusted, would McDonald’s China’s new preventive measures be adequate and

what more could McDonald’s China do to strengthen its supply-chain management and

facilitate its rebranding campaign? In view of the ever-increasing competition in the fast-food

industry, would it be better for McDonald’s China to run its own food processing plants in

China and to change its positioning strategy to one of differentiation?

42 The Japan Times (5 August 2014) “China Meat Supplier Probe Hurting McDonald’s Sales”, Bloomberg,

http://www.japantimes.co.jp/news/2014/08/05/business/china-meat-supplier-probe-hurting-sales-mcdonalds/#.VDka2GeSxX4

(accessed 12 October 2014). 43 Fujikawa, M. (10 September 2014) “McDonald’s Japan Gets Burned by Chicken Scandal”, The Wall Street Journal, Japan,

http://blogs.wsj.com/japanrealtime/2014/09/10/mcdonalds-japan-gets-burned-by-chicken-scandal/ (accessed 10 October 2014). 44 Lam, A. and Chan, J. (28 July 2014) “Will McDonald’s Rebranding Plan be Good Enough?”, Marketing Interactive,

http://www.marketing-interactive.com/mcdonalds-rebranding-plan-good-enough/ (accessed 10 October 2014). 45 Reuters (2 September 2014) “McDonald’s to Boost China Supplier Audits After Food Safety Scandal,

http://www.reuters.com/article/2014/09/02/mcdonalds-china-idUSL3N0R32HO20140902 (accessed 13 October 2014). 46 BIDNESSETC (2 September 2014) “McDonald’s To Improve Food-Safety Control in China”,

http://www.bidnessetc.com/24956-mcdonalds-to-improve-foodsafety-controls-in-china/1/ (accessed 18 October 2014).

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EXHIBIT 1: ANNUAL PER CAPITA SPENDING OF CHINESE URBAN HOUSEHOLDS ON MEAT AND VEGETABLE PRODUCTS

Note: CNY1 equivalent to USD0.16, as at 12 November 2014

Source: Adapted from China City Statistical Yearbook 2013, 2011, and China Urban Life and

Price Yearbook 2012, China Statistics Press

EXHIBIT 2: PROCESSED MEAT RETAIL VOLUME SALES BY REGION

Source: Hosafci, P (18 August 2014) “Processed Meat – What is the New Euromonitor Data

Telling Us?”, Euromonitor International, http://www.globalmeatnews.com/Industry-

Markets/Processed-meat-what-is-the-new-Euromonitor-data-telling-us (accessed 23 September

2014)

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EXHIBIT 3: MCDONALD’S CONSOLIDATED REVENUES BY REGION AND OPERATING MODE, 2005-2013

*APMEA= Asia Pacific, Middle East and Africa region (Note: McDonald’s did not break out China revenue separately, but included it in total APMEA revenue)

Source: Adapted from McDonald’s Annual Reports, 2013, 2010, 2007

Franchised revenues (Dollars in millions)

Company-operated revenues (Dollars in millions)

Total revenue (Dollars in millions)

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EXHIBIT 4: MCDONALD’S NEW YORK STOCK EXCHANGE PERFORMANCE BETWEEN JUNE 2014-NOVEMBER 2014

Source: Reuters Finance, as at 6 November 2014

http://www.reuters.com/finance/stocks/chart?symbol=MCD.N (accessed 6 November 2014)

USD

Month, 2014

The expose of expired meat scandal

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EXHIBIT 5: MCDONALD’S GLOBAL COMPARABLE SALES BY MONTH AND YEAR ENDING JULY 31, 2013 AND 2014

Notes:

 APMEA= Asia Pacific, Middle East and Africa region

 Comparable Sales represents sales at all restaurants, whether operated by McDonald’s or by franchisees, in operation for at least 13 months, including those temporarily closed. Comparable sales exclude the impact of currency translation.

 Systemwide Sales includes sales at all restaurants, whether operated by McDonald’s or by franchisees.

 Information in constant currency was calculated by translating current year results at prior year average exchange rates.

Source: McDonald’s Newsroom (8 August 2014) “McDonald's Reports Global Comparable Sales

for July”

http://news.mcdonalds.com/Corporate/Press-Releases/Financial-Release?xmlreleaseid=123054

(accessed 6 November 2014)

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EXHIBIT 6: MCDONALD’S GLOBAL COMPARABLE SALES BY MONTH AND YEAR ENDING AUGUST 31, 2014 AND 2013

Refer to notes in Exhibit 5.

Source: McDonald’s Newsroom (9 September 2014) “McDonald's Reports Global Comparable

Sales for August”

http://news.mcdonalds.com/Corporate/Press-Releases/Financial-Release?xmlreleaseid=123055

(accessed 6 November 2014)

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EXHIBIT 7: MCDONALD’S HONG KONG WEBSITE

Source: Extracted from Lam, A. and Chan, J. (28 July 2014) “Will McDonald’s Rebranding Plan

be Good Enough?”, Marketing Interactive, http://www.marketing-interactive.com/mcdonalds-

rebranding-plan-good-enough/ (accessed10 October 2014)

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EXHIBIT 8: MCDONALD’S TOKYO STOCK EXCHANGE PERFORMANCE BETWEEN JUNE 2014 AND NOVEMBER 2014

Source: Reuters Finance, as at 6 November 2014

http://www.reuters.com/finance/stocks/chart?symbol=2702.T (accessed 6 November 2014)

EXHIBIT 9: MCDONALD’S JAPAN SAME-STORE SALES AND NUMBER OF VISITORS

BETWEEN AUGUST 2013 AND AUGUST 2014

Source: Extracted from Fujikawa, M. (10 September 2014) “McDonald’s Japan Gets Burned by

Chicken Scandal”, The Wall Street Journal, Japan,

http://blogs.wsj.com/japanrealtime/2014/09/10/mcdonalds-japan-gets-burned-by-chicken-scandal/

(accessed 10 October 2014).

Japanese Yen

Month, 2014

The expose of expired meat scandal