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Pizza Hut works to fix its asset problem

The chain lost its place as the country’s largest pizza chain mostly because it has too many dine-in locations, says RB’s The Bottom Line.
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the bottom line

When assessing a restaurant chain’s performance, or its prospects, we pay a lot of attention to innovation and marketing and economic conditions, and probably not enough to one thing that might matter more than all of that: the restaurants themselves.

Pizza Hut is a case in point.

Five years ago—yes, just five years ago—the Plano, Texas-based chain was firmly entrenched at the top of the pizza business. In 2013, it generated $5.8 billion in U.S. system sales, according to Restaurant Business sister company Technomic.

Its next largest rival, Domino’s Pizza, had $3.8 billion in system sales that year. In other words, Pizza Hut was more than 50% larger.

Domino’s rapidly closed that gap and then roared past it. Today, it is 20% larger than Pizza Hut, though the gap between the two seems larger now than it was back in 2013.

Much of the focus has rightly been on what Domino’s has done to increase its system sales by 75% during that period. At the same time, however, Pizza Hut has declined by 5%. In a two-chain race, Domino’s was the hare, and Pizza Hut turned the other direction.

The shifting pizza landscape

Source: Technomic Top 500 Chain Restaurant Report.

A huge reason for Pizza Hut’s decline over that period can be traced to its assets.

It’s easy to forget because today we recognize Pizza Hut as a quick-service chain much like we do Domino’s. But it emerged and grew as a full-service dining concept. And much of its assets remain that way.

About 40% of the chain’s nearly 7,500 locations, or 3,000 restaurants, are dine-in units. Most of those are older, more traditional “Red Roof” restaurants.

That’s not a good thing. Consumers have shifted rapidly away from restaurants with wait staff, at least at restaurant chains. But this is particularly true in a pizza category that has seen numerous full-service concepts struggle in recent years.

In simple terms, consumers clearly prefer their chain pizzas at home.

Today, dine-in is just 10% of Pizza Hut’s U.S. sales—even though 40% of its locations were built for that business.

While those dine-in locations have delivery and carryout, most of them weren’t built for that purpose.

“When you have a dine-in store that does delivery, even though sales are only 10% dine-in, if it’s in the wrong spot and it takes too long to get to customers’ households and the kitchen is not set up for delivery, you’re at a very big competitive disadvantage,” David Gibbs, president, and chief operating officer at Pizza Hut parent company Yum Brands, told investors on Wednesday.

What’s more, he said, the locations are “not in the right trade area,” and are also “dated and potentially in need of a remodel because we’re waiting to move them into a delivery and carryout store.”

The weakness of Pizza Hut’s dine-in business probably does as much as anything to explain the chain’s challenges over the past several years and its loss of the top spot.

Indeed, Gibbs noted, Pizza Hut’s delivery and carryout business easily outperform its dine-in business, typically by 7 to 10 points. So, while same-store sales were flat at Pizza Hut U.S. in the first quarter, takeout and delivery sales performed better while dine-in sales struggled.

To Gibbs, that means the part of the business that represents the future of Pizza Hut is doing just fine.

“It really is a great indicator of the future health of the business,” he said. “The part we know is the future of the business is growing quite strongly. It’s just the drag that we have from the dine-in stores that [have] more of a middling performance.”

Pizza Hut has been working feverishly to improve its technological capabilities and give its customers more ordering and delivery options. It’s working on beer delivery, for instance. It bought online ordering service QuikOrder last year. It is even working with FedEx on robot delivery and created a pizza-making truck with Toyota. Digital ordering, Gibbs noted, has gone from zero to 50% of the company’s business in a decade.

Still, the gap in performance between takeout and delivery, and the chain’s dine-in sales puts the onus on Pizza Hut to convert those older locations to fit with the way consumers want their pizzas.

That’s easier said than done, requiring a healthy number of financially solvent operators. The company has been able to bring in some franchisees, like big Burger King operator GPS Hospitality.

But credit rating agencies recently downgraded Pizza Hut’s biggest franchisee, NPC International, noting that its operating performance” will remain challenged for the next 12 months.” That alone could make it harder for Pizza Hut to convert those units.

Still, Gibbs said, “We’re trying. We’re slowly working our way out of those stores and having great success relocating those stores to the better part of the trade area, closer to the households where a delivery and carryout unit should be.”

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