In a strong demonstration of faith in Chinese product quality, KFC is replacing Nestle with Mengniu products.

The global fast food behemoth yesterday signed a dairy product supply agreement with Inner Mongolia Mengniu Dairy Industry (Group) Co Ltd, China's top dairy producer.

Under this strategic alliance, Mengniu's dairy products will be sold at KFC's 2,000-odd stores in China from next year, replacing multinational Nestle. Milk will be the first of Mengniu's products that will be available at KFC outlets.

Though this is not an exclusive agreement, executives from both sides hinted the two companies would not consider a similar partnership with each other's competitors for now.

This is a significant step that demonstrates KFC's commitment to localize in China, said Mark Chu, KFC brand general manager with Yum! Brands Inc (China Division).

But Chu refused to elaborate on why KFC ended its partnership with Nestle, KFC's dairy supplier of choice in China in the past two decades.

"Nestle is a quality supplier. We'll start other kinds of cooperation in the future," Chu said.

Nobody from Nestle could be reached for comment.

This year marks the 20th anniversary of KFC's entry into China, which contributes around 20 percent of its sales revenue worldwide. Currently, more than 90 percent of KFC's products are localized, and "there will be more", according to the company.

Chu said KFC has had its eye on Mengniu for many years. "Its explosive growth, high-quality products and brand popularity among Chinese consumers are more impressive than its counterparts."

Set up in 1999, Mengniu has rapidly grown to become the leading player in the liquid milk, ice cream and yogurt segments. Going by its interim financial report, by September, Mengniu's first-half profit surged 41 percent and its sales rose 32.8 percent to 10 billion yuan (US$1.33 billion).

KFC's rival McDonald's has been partnering Chinese dairy producers like Sanyuan since 1992 when it entered China, as part of its strategy to localize and cut costs.

Industry insiders said Mengniu products would be priced lower than those of Nestle at KFC outlets, but executives from both sides refused to comment, saying they would set "reasonable" prices.

For Mengniu, the deal is both a bid to strengthen its brand and promote sales. Last year, the company set the target of entering the Global Top 20 list of dairy producers by 2011.

The agreement with KFC comes on the heels of a deal with Starbucks Coffee, which in June appointed Mengniu as its liquid milk supplier in China, again replacing Nestle.