OSI's troubles reflect broader perils for business in China

U.S.-based food processor OSI Group spent more than two decades and US$750 million building a business in China that served McDonald's Corp. and other fast-food chains.

That all collapsed in July after a Chinese television report showed workers in the company's Shanghai plant allegedly making chicken nuggets and patties from expired meat. OSI's operations across China now are paralyzed, after state media excoriated the company and customers throughout the country cut ties.

Meanwhile, OSI has become a lesson in the perils faced by foreign companies in China, when their operations are under unprecedented scrutiny by regulators and state media and negative publicity can destroy a business almost overnight.

Reaction to the OSI broadcast by state-run Dragon TV on July 20 was swift and severe. Authorities closed the plant and ordered an investigation. The city's Communist Party chief was quoted by Xinhua, the official news agency, as saying "all companies that break the law will be punished by the law."

OSI Chairman Sheldon Lavin within days issued a statement saying that what happened at the plant "was terribly wrong, and I am appalled that it ever happened in the company that I own."

But the company's global customers weren't taking chances. Burger King Worldwide Inc. and the operators of the KFC and the 7-Eleven chains cut all ties with OSI's China operations. McDonald's halted orders from the Shanghai plant, then suspended OSI's supply to the hamburger chain's 2000-plus restaurants across the country. McDonald's said last week that it is reconsidering its relationship with OSI in China altogether.

On Friday, a month after the initial TV revelations, Shanghai authorities announced the arrest of six China employees of OSI's Shanghai plant on accusations of selling expired products.

Authorities still haven't announced the results of tests conducted on meat from the plant. Several people briefed on the situation said the tests haven't revealed any safety problems. There have been no reports of illness from the incident.

Meanwhile, OSI's China plants effectively have ground to a halt, the people briefed on the situation said.

An OSI spokesman said the company's 10 facilities in China are all open for business. The company declined to comment further.

OSI said Monday that it hired an outside company to oversee OSI's vegetable processing plant in the southern city of Guangzhou.

OSI is the latest in a growing list of foreign businesses falling afoul of regulators in China, in industries such as dairy, technology and pharmaceuticals.

Chinese regulators last month levied 1.24 billion yuan (US$202 million) in fines against 12 Japanese auto-part makers for alleged price manipulation. BMW, Volkswagen AG's Audi and Mercedes-Benz parent Daimler are awaiting possible punishment following similar probes. Microsoft Corp. and Qualcomm are being investigated for potential monopolistic activity.

BMW, Audi and Daimler responded to the investigations by cutting prices. Qualcomm has said it is cooperating with authorities; Microsoft has said that it abides by laws in China and is cooperating with investigators.

The actions are deepening the impression among some foreign businesses that they are being harshly targeted. The American Chamber of Commerce in Beijing reported in March that 41 per cent of 365 companies surveyed said the business environment is less welcoming than it used to be. Some 61 per cent of European companies that have operated in China for more a decade said doing business in the country is getting more difficult, according to a survey this year by the European Chamber of Commerce.

Legal experts said OSI may have violated a regulation issued in March that made tampering with production dates and expiration dates illegal. But they said the fallout has been harsh, given the apparent lack of food-related sickness.

"The real question is why is such heavy-handed action being taken against any company?" said Lester Ross, a Beijing-based attorney with U.S. law firm WilmerHale.

The China Food and Drug Administration and Shanghai's municipal FDA didn't respond to requests for comment.

Experts said Beijing could be sending a message to domestic companies by going after high-profile foreign businesses. "Officials are going out of their way to target the most visible companies," said Ben Cavender, a senior analyst at China Market Research Group.

OSI qualifies. The company began operations in 1909 in a suburb of Chicago and in the mid-1950s became a supplier to McDonald's. When OSI arrived in China in 1991, fast-food sales were just taking off. The company invested in ranches, hatcheries, feed mills and slaughterhouses. It is now one of China's biggest poultry producers, capable of processing more than 300 million chickens a year. It also supplies pizza toppings, hamburgers and the lettuce that goes on them. OSI doesn't disclose how much of its revenue comes from China.

The repercussions from the OSI incident has threatened sales at McDonald's, which considers China a key growth market, and KFC parent Yum Brands Inc., which generates more than half its sales in China.

The Dragon TV exposé opened with an anchor standing in front of a photo of a McDonald's Big Mac. "Occasionally we eat Western fast food because it's convenient and even more because these enterprises are all large, we think their standards are high," she said. Later scenes showed OSI Shanghai plant workers handling chicken that had passed its use-by date, picking ground meat off the floor and working on production lines with no gloves.

Dragon TV declined to comment on the source of its video footage.

McDonald's said last month in a Securities and Exchange Commission filing that its global comparable sales forecast for this year is at risk because of the issue.

The People's Daily, the voice of the Chinese Communist Party, highlighted articles on the Shanghai plant on social media using the hashtag "McDonald's and KFC's Shady Suppliers." The police department in Anhui province announced on its microblog that officers had seized expired products from KFC and McDonald's in three cities. Attached was a cartoon hamburger with flies coming from it.

Some Western executives in China have complained that their companies are blamed for industry shortcomings caused by poor regulation. They said they are held to a higher standard than their Chinese counterparts.

To protect themselves, some foreign food companies are taking supply-chain oversight into their own hands, driving up costs in China.

Wal-Mart has said it tests at least 600 products daily in China to catch flaws before the food is sent out to stores. Chicken processor Tyson Foods Inc. has spent hundreds of millions of dollars in recent years to build its own farms in China so that it can control the safety of its entire supply chain, from chicks hatching to the grocer's shelf.

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