China Consumer

Pot luck

Little Sheep has struggled after Yum’s takeover

Little Sheep w

Not so hot anymore

Legend has it that hotpot was invented when mutton was added to a soup for Genghis Khan to hasten its cooking time before a battle.

The hotpot chain Little Sheep has offered a more convincing theory: Mongolian hotpot’s history can be traced back over a thousand years, to days when Mongol horsemen began to fill their overturned helmets with water, boil it and add meat and vegetables. When the Mongols travelled throughout China, they created unique varieties by throwing in different local ingredients.

Little Sheep started out in 1999 as a small restaurant in Inner Mongolia’s Baotou city. It later became the largest hotpot chain in China (with 721 outlets at its peak). When it went public in Hong Kong in 2008, its IPO was oversubscribed more than 70 times. But the company has not been feeling too hot lately.

Since Yum Brands paid $568 million to acquire the chain in 2012 (when the US firm was enjoying stellar growth in China, see WiC105), customer traffic has dropped steadily. In the company’s 2014 annual report Yum admitted that Little Sheep had “clearly fallen well below our expectations” and wrote off $361 million to account for its decline in value.

“When I came here two years ago it was packed. But now only six tables were taken at this huge place,” one diner recently wrote on Dianping, one of China’s most popular restaurant-review sites. “I bet this outlet will shut down by next year.”

So what happened? In 2013 rumours emerged that some of Little Sheep’s restaurants may have purchased meat from unscrupulous suppliers using cuts from dead foxes and minks. Even though the company vehemently denied the allegation, diners were spooked.

That food safety scandal aside, Yum has scaled back Little Sheep’s expansion plans since 2012. The chain now has over 200 stores domestically compared with 480 in 2011. Instead of opening new outlets, the fast-food giant turned its attentions inward by upgrading operations and standardising everything from its supply chain to what’s on the menu.

Standardisation, however, is a double-edged sword for a Chinese restaurant. On the one hand, it makes it easier for Yum to improve quality and retain control over the franchisees. But on the other hand, it gives the restaurants little flexibility when it comes to accounting for regional differences and responding to market trends. For instance, people in northern China generally prefer their lamb more gamey while those in the south like their meat leaner.

“Yum needs to strike a balance between standardisation and letting the restaurants retain their own characteristics. Just because it wants to standardise the operations doesn’t mean it shouldn’t pay attention to subtle differences [between regions],” one industry observer told CBN, a newspaper.

It doesn’t help either that most of the senior management left the flock after Yum’s acquisition. “After the deal, many people in the original management team got rich; they cashed out and left the company. However, the new personnel that replaced them have little knowledge about the company. As a result, the whole integration process did not yield satisfactory results,” the insider told CBN.

Competition, in the meantime, is more intense than ever. While Little Sheep has been buying back outlets from franchisees and directly managing more restaurants, another rival hotpot chain called Little Lamb has sprung up. The chain, backed by one of the largest sheep rearing companies in Inner Mongolia, has already opened in 600 locations around the country, largely through franchising, says China Enterprise News. “After Little Sheep was acquired by Yum, we are more determined than ever to become China’s number one yang [in Mandarin the character yang encompasses sheep, lamb and goat],” according to one Little Lamb executive.

Another rival Hai Di Lao (see WiC212) is also considering an IPO that could raise as much as $300 million this year. “As the Chinese saying goes, not to advance is to fall behind. With Little Lamb and Hai Di Lao aggressively expanding their market share, the amount of time left for Little Sheep to grow is very limited,” reckons CBN.

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