China, Inflation, and Margins

The Wall Street Journal reports that Yum Brands (owner of the KFC, Taco Bell, and Pizza Hut restaurant chains) has experienced a substantial decline in profit margins in China.  While the company continues to grow sales rapidly in China, inflation has caused its costs to escalate significantly.   Meanwhile, Yum Brands has been offering value-priced meals to attract customers.   In an inflationary environment, value-priced meals may seem quite attractive.  However, if costs rise faster than prices, the firm has a problem.   The story reminds us of the risk that inflation brings for firms operating in China.   A firm that sources components and raw materials in China may be able to raise prices in developed nations in which it sells the finished products. The problem is more severe for firms making and then selling products in China, given the low incomes of average citizens.