Bird flu has broken out in China once again. Last time, it was a disaster for the country's chicken business. But, Shu Cong Xuan, chairman of Home Original Chicken, the biggest fast-food chain restaurant in Anhui province, weathered the storm in 2004. He is confident he will ride it out again this time. Shu, who started with a chicken-breeding farm in 1982, has seen his business blossom over the past 30 years. His company’s compound annual growth rate has been more than 80% since 2004 and its revenue touched 480 million yuan last year. The majority of its 220 restaurants are located in Anhui province, where Shu has his roots.
Shu ascribes his success to differentiation and quality. While most of his fast-food contemporaries are selling fast-growing, 40-day-old chicken, Shu serves 180-day birds. These were more expensive and difficult to sustain in the beginning. But persistence paid.
Shu has seen a lot of entrepreneurs like him rise and fall. One reason for that, he feels, is that they diversified into anything that came their way. The secret of his own success, he tells China Knowledge at Wharton, is staying focused.
Below is an edited version of the interview.
China Knowledge at Wharton: When you started off, you must have had a lot of choices? Why did you choose to raise chickens?
Shu Cong Xuan: When I was demobilized from the army in 1982, China’s “rural household output quota” policy had achieved its initial success. The grain harvest target had been achieved every year. I thought ahead: what will we do with so much grain? It could be used for food processing, wine making or poultry farming. I was not rich at that time. Chicken farms need very little investment — only a few hundred yuan. So that was my choice.
China Knowledge at Wharton: How is the profitability of the business?
Shu: It was not bad in the beginning. One could earn 4-5 yuan (around US$0.70 at today's exchange rate) per chicken. It rose to more than 10 yuan (US$1.6) at its peak. But the margins declined gradually. After 2000, the returns were only one yuan per chicken. At times, there was even a loss. The margins for the industry have declined significantly.
The main reason [for the decline in margins] is the low entry barrier. This makes it a buyers’ market and prices have been stagnant for a long time. On the other hand, the cost of breeding is growing rapidly. For instance, the selling price of fast-growing, white-feather chicken was 8 yuan/kg in 1994. It is now only 10-12 yuan/kg. However, the price of corn – the main poultry feed — has tripled. Fishmeal, another major feed, is now more than 6,000 yuan per ton; it was only 1,000 yuan per ton in 1994. Labor cost has grown from 300-400 yuan/man-month in the mid-nineties to more than 2,000 yuan today. The whole chicken farming business is now operating on razor-thin margins.
China Knowledge at Wharton: So why have continued in such a difficult industry for 30 years?
Shu: My business has made money every year; the difference is how much. I think the key has been my insistence on differentiation.
In the early nineties, China introduced fast-growing, white-feather chicken, with a lifecycle of only 40 days and a very low price. It quickly captured the traditional chicken market. In the wholesale market of most cities, the share of fast-growing chicken has grown to 70%-80% and the high-cost local chicken industry has been hit.
But when most of my peers were changing their business to raise white-feather chickens, it created an opportunity for me. I continued to raise high-quality, local chickens. Then tastes changed. After 2000, when the quality of life improved in China, people moved back to local chicken. We raised 2.7 million chickens in 2012 and every bird was been bred for 180-200 days. We sell one chicken (around 1.5 kg) for 63-88 yuan, more than 40 yuan per kg. Among high-quality chicken, our pricing is not too expensive. On the other hand, because we started early, we have a reputed brand, especially in Anhui province, and Shanghai and Nanjing.
China Knowledge at Wharton: Fast-growing chickens are packed into feedlots or high-density enclosures. Traditional local chickens are free-range and are raised in pastures. Don't you have a disadvantage as regards economies of scale?
Shu: Initially, we provided breeding hens to farmers and the whole breeding process was finished by the farmer. Since 2004, we have moved to a two-stage process. Our company does the egg hatching. The farmers breed the chicken for the first 100 days of the 180-day cycle. We then collect the chicks and do the last 80 days of breeding. The whole process can be monitored and controlled. Every chicken can be individually tracked to ensure its health and quality.
We have also established a support system under which we offer breeding hens, poultry feed and medicines to the farmers. This has been a very successful company-plus-farmer breeding model.
China Knowledge at Wharton: How do you ensure that farmers follow the breeding standards in the first 100 days?
Shu: We have initiated many monitoring policies. First, we choose farmer families only after close scrutiny. We look at the infrastructure, location and facilities. We also study the farmer's reputation and personal integrity. Only when we are satisfied do we sign contracts. Our contracts are also very different. We have a “five-household joint guarantee” system; we only sign contracts with five households together. If one household has problems, all the five families will be penalized. On top of this, the farmers also need to find a reputed person in their village to be a guarantor.
We have technicians; one technician manages 50 farmers. Their job is to train the farmer on breeding practices. They visit the farmers on a regular basis to monitor the process for the company.
We have also set up a fund. When the farmer sells one chicken, both the farmer and the company put 0.1 yuan into the fund. In case there is a loss due to roup [a disease that afflicts birds], the farmers are compensated by the fund.
We have several incentives. We reward the best farmer every year. As farmers live in the same location for generations, their reputation matters a lot to them.
China Knowledge at Wharton: Why do you need to put the chickens back in the feedlot for the last 80 days?
Shu: In the last 80 days, we need to accomplish four objectives. The first is to control the shape and weight of the hens. The second is to ensure they are healthy and disease-free. We can control the medicine, especially the hormone intake, to ensure the chickens are in their natural state. The third is to classify the chickens and to set up breeding records to make sure they can be tracked. The fourth is to prepare for unified distribution.
China Knowledge at Wharton: What made you diversify from chicken breeding to fast-food restaurants?
Shu: In the early nineties, I became the biggest chicken-breeding company in Fei Xi county. Then, I became the biggest chicken-breeding company in Anhui province. When my business reached a certain size, I began wondering whether I would spend the rest of my life breeding chicken.
In the late nineties, I began to think of diversifying. In 1999, my team and I attended a three-day course on the restaurant franchise business. I began to pay close attention to KFC, McDonald's and Dicos. I visited many fast-food restaurants and food-processing enterprises and finally made the decision to start a Chinese-style, fast-food franchise business.
I had confidence in my choice because the fast-food business was growing rapidly every year and there was a lot of potential. Secondly, with my experience in chicken breeding, I could tap the entire value chain — from breeding to restaurants, from farms to the dinner table.
China Knowledge at Wharton: What did you do to stand out in the new business?
Shu:From the beginning, I differentiated. In fried chicken, we could not compete with the foreign brands. So we had to do something else. We adopted a Chinese menu and focused on stewed chicken dishes. Foreign brands use 40-day birds; we use 180-day birds. We developed a number of dishes. We also set up detailed operational rules.
We changed our branding. We were originally known as Fei Xi Old Hen, which is a very popular and well-known local specialty in Anhui. In March 2012, we renamed the restaurants Home Original Chicken because Fei Xi Old Hen was not known outside Anhui. Furthermore, Fei Xi has the same character as 'Fat'. So it was mistaken as fat chicken. Another reason was that the old name was too long to remember or popularize.
China Knowledge at Wharton: How was the business when you opened the first restaurant?
Shu: When we opened our first outlet, the raw material cost was more than 70%; the industry average was only 30%. If you added up other costs including labor, we had to budget for a huge loss. For every 100 yuan we billed our customers, we lost 30 yuan. Later, we adjusted our pricing, streamlined management processes and improved brand awareness. Gradually, our operations began to make money. It took two years for the first restaurant to get out of the red.
China Knowledge at Wharton: How did you achieve rapid growth after that?
Shu: Our model became sophisticated only after 2005. We opened more than a dozen restaurants that year and then began to achieve accelerated growth. The compound annual growth rate (CAGR) in the past eight years stands at more than 80%. Our 220 restaurants today are all directly managed; none are franchised yet. We added 65 restaurants in 2012, and plan to open 100 this year. The Initial investment on fixed assets in a restaurant in Anhui is around one million yuan. This can be recouped in one-and-a-half years.
Right now, 96% of our restaurants are making money although the net margin is very thin – just single digit. Our annual revenue was around 480 million yuan last year.
China Knowledge at Wharton: Do you have national expansion plans?
Shu: Not yet. Our 100 new outlets this year are all located in Anhui province, which is our base. We have to wait for the right time to expand to other areas.
China Knowledge at Wharton: How much does local chicken account for in the raw material costs of your restaurants?
Shu: Around 40%. We bred 2.7 million chickens last year, and around 2 million were supplied to the restaurant business. The taste and nutrition value of local chicken are significantly better than fast-growing chickens. It’s especially good for stewing chicken soup.
We are exploring and deepening our industry chain around chickens. In breeding, we are not as big as the huge agricultural enterprises which produce several million chickens every year. But we operate across the industry value chain.
China Knowledge at Wharton: How did the bird flu of 2004 impact your business?
Shu: It was almost a fatal blow. But it was a turning point. We opened our first restaurant in October 2003. The bird flu in the beginning of 2004 made chicken breeding a disaster zone. No one was buying chicken; people didn't even want to hear about chicken.
The then mayor of He Fei, the provincial capital of Anhui province, came to visit my chicken plant to see the impact of the bird flu. I suggested that he should take the lead and eat chicken in my restaurant. He did it and drew a lot of media attention and press headlines. Later, I organized thousands of citizens to eat chicken together to dispel people’s concerns. By the time the bird flu totally vanished, our brand Fei Xi Old Hen had obtained quite some exposure and popularity.
China Knowledge at Wharton: It has been more than 30 years since you started to breed chicken. It’s rare for a Chinese entrepreneur to stick to doing one business for so long. What makes you so focused?
Shu: Indeed, of the others who started chicken breeding in the early eighties, very few are still doing the same thing or even doing well in their business today. If one decade stands for one generation, we belong to the first generation entrepreneurs. Most of the players in the market today are third or even fourth generation.
In my view, entrepreneurs who failed can be divided into three categories. First are those who failed because of over-expansion. There was an entrepreneur in Fei Xi County running a textile company. He hired several hundred people in the early nineties, while we had only 10 people at that time. Later, he expanded quickly into property, hotels, trading… finally he went bankrupt.
The second category was over-conservative. They stayed in one business and never thought of upgrading processes or products. They didn't initiate any industry innovation. They didn't learn about branding or operations management. So their business died halfway.
The third sort failed because of personal reasons. Some entrepreneurs, after they became rich, went for gambling, consumption, and all kinds of entertainment. Their businesses gradually sank.
China Knowledge at Wharton: I heard that you can understand what chicken crow [cackle] means. Can you?
Shu: If you blindfold me and I walk past chickens, I can tell you how old are they are; big and little chicken walk differently and you can tell the difference by the sound. When the chickens are feeling warm or cold, thirsty or hungry, sick or normal, they make different noises. The chickens express some emotions as well. When the hen is laying eggs, she feels very proud. So she tries her best to crow and show off. It’s not difficult to understand if you observe carefully over a long time.
China Knowledge at Wharton: Have you ever thought about entering any other business?
Shu: It’s very difficult for a human being to resist temptation. People did encourage me to get into real estate development and micro-credit. I stayed away. That was lucky as the current macro environment which strictly controls the property market would have made my life very tough. For entrepreneurs, it is very important to resist temptation.
This determination might have something to do with my personality and willpower, but it is also related to my early experience. I had tried to enter the feed business but failed. I learnt that it is important to be focused.
If you follow the world all your life, nobody will follow you when you are old. But if you are focused on doing one thing well all your life, the world will follow you when you are old.