{audio:0:00:01} Don, can you share a short introduction on your background in the restaurant business?

{audio:0:00:09} I won't go back as far as my high school days, when I first had a fast-food job at a brand called Roy Rogers in Philadelphia, but my significant experience came in 1998 at Tricon Brands, which was spun off out of PepsiCo in 1997. I joined KFC US in 1998, in the Louisville, KY headquarters for Tricon. Right now, it’s Yum! Brands. I was working on the finance team, doing capital planning, brand planning. I was working with the operations team. Then I had an assignment overseas in China, which lasted about 11 years longer than my initial six-month assignment. It lasted from 2004 to 2015, at which point I came back to the US, worked at headquarters on the CFO staff, heading up financial plan analysis for Yum! Corporate, and then I left the company around the time of the spinoff. China spun off Yum! – it’s China YUMC now on the big board – in 2016, and I figured that was a good time for me to look for something different. That’s a bit of my background, about 18 years at Yum! Brands.

{audio:0:01:26} When you first landed in China, how did the Chinese market look?

{audio:0:01:35} That was 2003 or 2004. Back then, China was newly introduced into the WTO, and you could see quite a bit of investment going on, yet there were still a lot of underdeveloped cities. Shanghai was where I was based, so that was definitely the “Gold Coast” there, Beijing, Wanzhou, and tier-one cities; those were getting a head start, Shenzhen, and Shanghai. But if you went inland more, it was certainly an up and coming area. There was a lot of infrastructure being built. As far as consumers were concerned, middle-class wealth wasn't quite there. Those that could would access the western brands that were so new to China, KFC being one, obviously, and Pizza Hut, which was more of a casual dining experience.

{audio:0:02:26} As far as doing restaurant business back then in China, you had to do it yourself. We owned our own logistics. We sourced suppliers ourselves. We didn't outsource it like, say McDonald's might have done. We did a lot of our stuff internally because we couldn’t go to a third party and say, hey, can you go find us distribution centers and franchisees. We helped build up the restaurant business in China, developing talent and teaching how to run a restaurant from the ground up, one store at a time. It was really an interesting time.

{audio:0:03:08} How did the Chinese consumer view pizza as a concept?

{audio:0:03:15} That’s a great question. Pizza came into the country as sort of a foreign food, as you would expect, Italian. Speaking probably for not just China but for Asia, milk-based products and cheese were not a big thing, and obviously, cheese is a big part of any good pizza. So there was a bit of a getting used to thing for folks to eat a pizza. One thing that did resonate with consumers was that pizza is a sharing kind of product.

{audio:0:03:47} If you ever go to a real Chinese restaurant, not something you might find in the US or a Chinatown in a western city, but in China, you often find Chinese restaurants where everyone’s sharing at a round table with a lazy Susan. From an occasion standpoint, pizza had a good resonance with the Chinese consumers, who love to gather around and eat things. Pizza, from the beginning, was not just about pizza. It was a broad business. This was a critical insight that the leaders of the brand developed before I got there, and that’s what help bring it to become a leading brand in China.

{audio:0:04:28} You mean adding more traditional Chinese dishes plus the pizza to Pizza Hut’s offering?

{audio:0:04:33} Not actually Chinese; in fact, it was more of a broad menu of western casual dining. It was a western casual dining brand, unlike in the US, where you have Pizza Hut, Domino’s, Papa John’s, pretty much a functional pizza house delivery. It used to be the red roof Pizza Huts. There in China, from the really early days, they had escargot for appetizers, they had cappuccino, salads, desserts. When I arrived, there was a full casual dining table service. It was like casual dining. You got table service that came out professionally handled.

{audio:0:05:15} It was different because you got your own order. For many Chinese, it was like, "You mean, I have my own dish?" For a lot of folks, you had group sharing; you didn't get your own dish in typical Chinese restaurants. So it was a fascinating place. I can get into more behind how the broad menu came about, but from the very early days, Pizza Hut went way beyond just pizza. It was a broad, full casual dining experience. The anchor was pizza, but you don't just go there to have a pizza. You go there for a dining experience, be it lunch or dinner.

{audio:0:05:54} What's the penetration of pizza and revenue for a typical unit? Is it a small percentage, or do they typically choose other options, other concepts?

{audio:0:06:10} If I had to crunch the pizza menu item mix, it was always around 30% to 35%. It was not a dominant thing. It was certainly very common to have that, but folks would come there and order something beyond pizza. When I was there back in 2010 or so, we introduced sizzling steaks on an iron skillet with the sound and smell, and the whole experience. They were marketing steaks at the time, pasta, and a lot of things. Pizza is still number one on the leader board, but it's not 90% of the food sold. It's certainly central and core to the brand, but it's not as dominant as you would find in other markets.

{audio:0:07:04} The brand equity of Pizza Hut is effectively a leading restaurant brand.

{audio:0:07:12} It’s the leading western casual dining restaurant in China, and in the early days, it really got its credibility by introducing Chinese consumers to the world. Today that's different. There are a lot of Chinese travelers. They've got wealth, a middle class. Of course, I’m talking about before today's current environment with the pandemic; there has been a lot of travel. But back in 2005, they didn't even have much internet access for getting exposure to western food, not just visually seeing it but to taste it and to smell it, and so forth. Back then, when I joined Pizza Hut, they would introduce festivals.

{audio:0:07:54} Every year in the summer, they’ll have a Greek festival one year, they’ll have a Brazilian festival another year. For six weeks in the summer, when the kids were off school, and it was leisure time, we'd have products that were not literally imported, but the experience and the product was delivered. Back then, there wasn't really anywhere else you could get that, even in Shanghai or other cities. It was the place to go to have Greek or have Portuguese. The Chinese didn’t travel as much. It was much harder to travel. They couldn’t afford it. But if you wanted to do that, you could just walk down to that mall or that area, that trade zone, and get that experience.

{audio:0:08:40} They even had people dressed up as Spanish-looking people or Greek. It was almost like an Epcot Center at Disneyworld, where you really feel like you're in a country. Not perfectly, but you can get the food and taste the food. It was pretty authentic. We made sure we got the food right from what does Greek fish taste like, what does Spanish paella taste like. It was festivals; it wasn't all year long. That's one of the ways Pizza Hut brought western casual dining and very little Chinese food to the menu.

{audio:0:09:23} Chinese food came about more with delivery at Pizza Hut because that’s more functional. If somebody at home said, let's go order some carry out delivery, somebody else might say, well, I want Chinese food, and if that somebody is important, you’re not going to go to that place as an offering for any Chinese food. So you have to put it in there to address that veto power, if you will, for those that insist on having Chinese food. But from a Pizza Hut casual dining standpoint, the main western casual dining brand, they call it in Chinese Bìshèng Kè, it still is a leading brand in China. There is a lot more competition, but it’s still a leader.

{audio:0:10:04} How has the brand equity of Pizza Hut or the brand image changed as the Chinese have started to travel, and other brands have entered China?

{audio:0:10:22} Yes, it transformed rapidly. Right when I got back to Louisville, we were doing some forecasting, and things were changing. In the 2000s through mid-2015, like the middle of 2010 to where we are today, it was still a very dominant brand, and there was more competition climbing up, but there wasn't yet the advent of the aggregators. In the western world, you might have the Yelps, or the Grubhubs, or the one that just bought Grubhub. In China, there's Ele.me and Dianping and so forth, and the mobile phone. One of the big step changes for the consumer was discovery, and by pulling out your phone and sorting through the list and who’s got a deal today, you could find five choices within three miles.

{audio:0:11:29} But before that, back in 2010, when the iPhone was literally two years old and those apps weren’t yet developed, you discovered by physical encounter, by walking the street. The competition grew sharply as aggregators came on board. That's not just for Pizza Hut; that's for a lot of brands everywhere in the world. For destination brands that are a sit-down and eat here kind of thing, it really transformed business. It still has very good equity today, but there is competition and ease of entry for someone to get exposure in these apps, and a lot of times, there are not economically viable promotions going on. You see that in some places, they’re trying to buy customer databases, trying to get out there. It can be a knife fight.
{audio:0:12:24} So Pizza Hut is not necessarily wise to want to go in there and be number one on a leaderboard for exposure. They just hope they can earn that by the current customers they have, keep them coming back as opposed to saying hey, we're Pizza Hut, have you ever heard of us? No, everyone's heard of them. So it's a much harder ground game for them now than it had been when I was there for a lot of those years. Not to say that it didn't take a lot of hard work, but there's more competition, and there's a different way of marketing your brand and getting that customer to choose you over those five other guys that are sorting up to the top of what you search on your tablet or your iPhone or your Android.

{audio:0:13:04} Going back to the brand equity point and how Pizza Hut became the gateway for Chinese consumers to explore western cuisine or the world. How did the KFC brand position itself alongside Pizza Hut?

{audio:0:13:29} KFC was ahead by a couple of years, back in 1989 or 1987. It was more of a functional brand, fast food, although there are still a lot of broad menus. It’s not just the bucket of chicken, its heritage, its signature product, but it's also sandwiches and wings. The positioning for KFC was more a part of your daily life. We were trying to be part of Chinese daily life. You don’t have it every day, but you could have it during your lunch break, you could have it even for dinner. They had breakfast, they had congee, zhou in Chinese. It was really a broad menu. The Chinese will have poultry before they have beef, it's a very consistent top protein, and the KFC brand is really powerful, not just in China but throughout Asia: Japan, Southeast Asia, it’s a dominant brand that’s often ahead of the hamburger chains.

{audio:0:14:32} KFC in China really had a lot of love from the Chinese consumers. The first store up near Tiananmen Square had lines going like crazy. A lot of people will talk about their first experience in a western kind of exposure as KFC. KFC always worked really hard to be accessible to the Chinese, throughout the day, part of daily lives. Not priced so high, but you're going to pay more to KFC than you would to a local, less highly positioned brand or the Chinese neighbor who’s cooking and sells great food, but KFC is good. And for kids, even from when kids are young with the Chicky birthday parties, all the way through their lives, KFC has been a lot. It’s more functional, obviously with a different menu. It’s fast food, but it’s not just KFC buckets of Original Recipe by Colonel Sanders. There are a lot of menu choices that consumers can choose throughout the entire day or the week.

{audio:0:15:46} What was the reasoning for Pizza Hut opening their own stores versus franchising?

{audio:0:16:01} In simple terms, it was the high economic terms. We could invest less than $1 million in a business, and a week after it's open, we could probably sell it for double that back in the day. We felt that was one good reason. Then we could invest our capital in that and grow a very high return; two-year paybacks, cash flow paybacks on KFC, and Pizza Hut at its peak. That's probably the number one reason. Another reason was recruitment. Back in the day, could we recruit good operators? That’s so fundamental to the business. A lot of companies don’t really get that, but you really have to make sure you run a good restaurant. Running a restaurant is a very hard business. It’s not impossible, you don’t have to be a rocket scientist, but you have to be on your game. Have good people, be a good leader, they have to like to work for you. They’re not getting paid really rich salaries, so they could do anything, they could easily leave. It’s a hard business. At that time, we couldn't actually find great entrepreneurial franchisees.

{audio:0:17:16} I guess the third reason, kind of like what your Starbucks would do, is brand control. We want to make sure but that’s not to say we couldn't trust a Chinese person to run them. We have good franchisees today; we've had them. Not a big mix, but we do have really good operators. But we didn’t want to have, God forbid, some franchisee out in some city is selling dog leashes or dog treats. You have to have brand control, and we felt that our brand could afford to do that. In fact, it was in our shareholders' interest to invest and get those returns. But over time, we recognized that there are good reasons to have franchisees come in and invest their own capital. We could refranchise a current store, not just have them build them, but we could sort of train them up, they could run three to five stores in a city that’s a little more remote. It’s probably more feasible for them to run these stores than it would be for corporate.

{audio:0:18:15} What was the typical unit economics of a Pizza Hut in China? You mentioned $1 million, roughly. Is that the capex for a Pizza Hut?

{audio:0:18:29} I was there for 11 years but back about a decade ago or so, it might cost $800,000 to $1 million to build a restaurant.

{audio:0:18:42} They would be 200-300 seats. And the AUV, average unit volume for the sales could be around $1.5m or more, so you’re getting a nice asset turnover ratio there.

{audio:0:19:04} The one year's sales, one year's worth of sales. Say you build a restaurant for a million, let's use round numbers, and steady-state sales would be $1.5m.

{audio:0:19:14} That’s the steady state after a certain number of years?

{audio:0:19:17} After a year or a year and a half. It has a honeymoon period, and then you go forward, and it settles around 1.5. Again, I’m using averages.

{audio:0:19:27} It’s pretty quick to get that payback after a year.

{audio:0:19:32} There’s a combination. We had some stores that were just so busy in some cities, trade zones, that we had to build a new one just because of the experience. People would say, I’m not going to Pizza Hut; it's just so busy. I'm not saying that happens today, but there were times when we had to deliberately go into trade zones for KFC and Pizza Hut and relieve that pressure. At least during the peaks, the weekends, you had to give them that access to the brand.

{audio:0:19:58} This was 2010 with pure dine-in.

{audio:0:20:02} Pure dine-in, yes, around that time. I don’t have the precise year in front of me, but early 2010s or so.

{audio:0:20:11} Let’s say $1.5 million in sales after a year or a year and a half, what was the typical cash flow of a dine-in store in China?

{audio:0:20:23} The operating margins could get around the 20% range, so it's quite robust; pre-tax margins around 20%, plus or minus. Some other factors were the rent, and again I'm using averages. We had what we called train wrecks, stores that didn't work; we had home runs that were just so successful, a heaven's arrived kind of thing. It's hard to talk in averages, I always get cautious when I do that, but I’m giving you kind of the average there, in a rough timeframe.

{audio:0:20:57} How did KFC compare to Pizza Hut in cash payback?

{audio:0:21:02} Very similar. In fact, today KFC has stronger unit economics from an investment standpoint. But KFC has very strong unit economics as well. A little bit less, not much less, to invest. To think about it, on the investment side of KFC, if you look at the pie chart of what you’re spending money on, it’s a lot more equipment in the KFC China business. You have these fryers and chillers and all that, and less on the décor. It's nice décor but not as top-notch and luxurious. At Pizza Hut, it’s a bit less; you have some more ovens, not as many fryers, not as much heavy equipment, so your mix is more towards the décor, the dining. It's casual dining, and some of the restaurants are beautiful; really top-notch, great architectural design, great ambiance.

{audio:0:21:57} But all in all, KFC is in a similar ballpark. Sometimes they can be higher return. We can talk about this later, but a lot of the best returns were in new cities; those are cities that there was a first KFC or a first Pizza Hut. It was a huge thing for us, it still is today, but there are fewer cities that are new for KFC. There was always a time when the mayor of that city was thrilled to have that grand opening of that first KFC, hitting its tier 4 or tier 5 city in inland China.

{audio:0:22:34} The payback is just incredible at two years. Year two sales must be what, $2 million-plus?

{audio:0:22:43} No, it would grow, our same store sales back then might be, if we had some good years, high single digits, but 5%. We wouldn’t go from $1.5 to $2 million, but it would, on average, grow single digits. We had good margin controls because we had scale; we were growing quite a bit on the scale front. That helped us with supplier input costs because we could buy a lot more and get a better price, absent inflation, of course. It was good economics, and again I’m talking about a time frame that was about a decade earlier than today, and things have changed. There is more competitive pressure, and the dynamics overall have changed in China.

{audio:0:23:23} Why is KFC unit economics still pretty strong versus Pizza Hut today?

{audio:0:23:30} That's a really good question. I think the aggregators and the move to delivery have affected Pizza Hut more. At Pizza Hut, you have an asset, and a lot of the assets are meant to be used for in-store consumption, not take out. I won’t get into it, it could take another half hour, but there was a time when Pizza Hut in China had two brands, Bìshèng Kè and Bìshèng. Those in Chinese mean happy restaurant you go to, and the other one was more like home delivery. They both had Pizza Hut logo themes in them, but they weren’t the exact same brand. The delivery brand was more functional.

{audio:0:24:15} Because people at home aren’t going to want to have a fancy, elaborate meal. People like that today with the pandemic, but back then, they just wanted something to fix my meal solution. I don’t want to cook, I want something delivered, and they called. You used your phone back then you actually made a phone call. Then Pizza Hut dine-in was come over, come into our restaurant. Well, when people start not coming to your restaurant, that’s an expensive asset to deliver from. Today it’s evolved where I think it’s just the one brand, they had to call it quits on the other one which was more serving the phone-in call center versus the mobile, and the way people are changing their behaviors now.

{audio:0:24:58} KFC has a lot of on-the-go kind of clientele. People take out; they go back to their office, they go back home, they carry out their food. They don't have to sit around with three people and have a great casual dining experience at a KFC. It’s had that kind of business model from the early days, so its transition to this new way with delivery has not been as tough on their assets. That’s one of the reasons.

{audio:0:25:23} I think also KFC's brand is still a bit more powerful. It's got those signature recipes. People love the Original Recipe chicken; chicken wings are huge in China. Pizza Hut pizza is certainly differentiated, and it's good. It's got its lovers, but I’m not sure you could say that the salads or the steaks at Pizza Hut are way better than anywhere else you could find. I think there is a core signature brand that KFC’s equity is built upon versus the Pizza Hut dine-in over there. That’s Don Miller’s assessment.

{audio:0:26:03} Is that because pizza didn’t resonate as much with the Chinese consumer versus KFC’s chicken?

{audio:0:26:10} There are definitely more pizza players now. There is Domino’s, there has always been Papa John’s, but there are a lot of other western dining options if you want that. Western dining is still a small sliver; it's never going to be bigger than Chinese food. It’s China, right? But for casual dining destination brands, people don't order a lot of delivery for western food. You go out for nice western food; it's part of the experience.

{audio:0:26:55} It’s not a very functional order. That’s why I hinted earlier that for the pizza delivery, they realized that they had to put something on the menu that was Chinese. So they had some Chinese noodles, some soups, not a very dominant thing but enough, let’s say 20% of the menu. That’s because people might want to order for three or four people at home, and maybe one or two of them want to have something Chinese, so there would be a variety of things. To have exclusively pizza and salads and pasta wasn’t going to cut it for those that really demanded some kind of Chinese option. That said, you wouldn't find folks saying, let's get Chinese food at home, let's go order pizza and Chinese food. It's more about, hey, we have it. We're not all about Chinese food, but we have it. It's there on the menu, just like when you go to a place, and they have one or two foreign food options.

{audio:0:27:52} How do you look at Dominos’ or Papa Johns’ opportunity in China?

{audio:0:28:00} Papa John’s came in pretty aggressively over 10 years ago in China. They looked over and saw that we were developing a major growth category. They came in and put a lot of investment. I think they had a master franchisee. Their positioning was certainly pizza centric. What do they say, “Better ingredients, better pizza”? That’s over here in the US. I’m not sure that translated perfectly to the Chinese consumer, but I think they felt they were the connoisseurs of pizza. Pizza Hut had always been a bit of a hybrid with dine-in and deliver, and Papa John’s, I think from its earliest days, was always was a delivery brand. Unlike Pizza Hut’s early days, the red roof, it was casual dining that had to transform itself, which it is still doing today, from the red roofs to the delivery/carry out, the Delco. But Papa John’s brought that in. Delivering pizza was not a big market, so they kind of did their first foray into dine-in. I don't think it was a major home run. They had some openings; they had some closures. I haven’t studied their business very hard, but we didn’t look over our shoulders very much back when I was there.

{audio:0:29:27} Domino's was coming in with more delivery, as well. It was almost exclusive delivery. Maybe they had one or two seats in front of the restaurant or inside the restaurant. During my tenure in China, until 2014-2015, Domino’s wasn't really beyond just the four tier 1 cities or tier 2 cities, I think, using the franchise model. It really wasn't a significant competitor. They were very pizza centric, maybe had some wings or some dough sticks, but it wasn't a broad category. Those are different brands. I don't think they’re that material to the companies today, as I understand it. But I may be wrong.

{audio:0:30:12} Because if they’re only delivering pizza as a concept, that didn’t really reasonate, or isn't really what the Chinese consumer is looking for when they want delivery, because it’s more functional. Therefore, sometimes, they probably just want Chinese food as a functional solution.

{audio:0:30:29} That is as far as I knew back then. Things may be changing. People are getting more. I think the new generations are growing up with pizza as part of the standard menu in the top tier cities. Like Coca-Cola, 30 years ago, they probably didn't have any Coca-Cola or Pepsi besides just tea or other things, just like coffee versus tea with the coffee chains. As far as I know, it’s maybe changing now, but it’s probably more of a market. People are just used to trying new things. Pizza is a universally loved product, not in just Italy or the US or the UK, it’s just human. Everybody loves pizza in some form or way. It’s a big category. I'm not sure if it's really going to be like it is in the US; maybe it will, but I don’t know.

{audio:0:31:20} Looking at delivery specifically, could you share a bit of insight into when you first started to see delivery pick up and become a real growth area in China.

{audio:0:31:41} For the Yum! Brands China, a lot of delivery came out first with the Pizza Hut, as I mentioned. The dine-in brand was getting big, but back in the day, the consumer didn't necessarily love to be at home because they were multigenerational, and there could be three generations living in a small apartment. They weren’t as luxurious or as wealthy as they are now. Today things have changed, there has been a huge real estate boom in China, and they're fine to come home and stay at home and eat there, but back in the day, they went out.

{audio:0:32:22} So delivery has evolved as that trend has come on. In 2005, folks wanted to go out to eat; they didn't want to get things delivered. Pizza Hut looked to address that first, and they did that with the branding of the Pizza Hut at-home service versus Pizza Hut dine-in. That involved setting up a call center. We wanted to have a really professional experience that was consistent with the Pizza Hut brand. You’re not going to call each restaurant. You're going to call a call center where people are trained, take your order efficiently, give you a confirmation number, call us back if you want to make a change, really professional.

{audio:0:33:02} We focused on the whole experience from the call you make to the delivery was our own team. We had our own drivers; we didn't have third party drivers or Uber Eats; obviously, they didn't have that back then. They came in very well-groomed, clean, sealed. This was before even the pandemic; it was really top-notch. Pizza Hut helped us learn about the delivery process. It was expensive, though, for us as a brand. There was quite a bit of investment in the call center and the drivers, even though they were often on a bike versus a car, but there was quite a cost versus people just coming into the restaurant and you handing them the food or serving the food. That’s much cheaper fulfillment than getting the food out there. Delivery is an economic challenge for any brand.

{audio:0:33:51} For KFC, they saw Pizza Hut’s growth, and they saw that consumers more and more didn't want to go out. They delivered to offices and homes. Both of them use the same call center, and we would know if someone was calling the KFC number or the Pizza Hut number and deliver accordingly. Because KFC was so penetrated, they didn't have to have every store deliver. If you lived in a neighborhood that had three KFCs within two kilometers – this was very common in Shanghai – one of those was usually the delivery hub. It was probably the lowest volume store, which was beautiful because they had room to cook more and have people in and out, whereas the high street store wouldn’t want to do the delivery. It was interesting building a business model around that as KFC versus Pizza Hut.

{audio:0:34:45} What was the density you had to get to to make the economics work?

{audio:0:34:51} It was a challenge. We had to condition folks to pay a delivery fee. When we started doing that, it wasn't very common in the US or other places to have a delivery fee, but we could not afford to cannibalize ourselves and deliver for nothing. So we had some delivery recoup by charging a fee. As far as driver drops, we had two, at best two and a half. We had to obey all the laws with our traffic and all that, but we had pretty good density, pretty good drops. I think I speak the truth today in saying that delivery, leaving aside the pandemic and its destructive power, delivery is always a higher cost than dine-in. Unless you're doing the cloud kitchen thing, that's a different ballgame. But for the traditional restaurant destination, delivery is tougher economically. That said, it was a payback for us to do that because if we didn't offer delivery, somebody else would. McDonald's offered delivery, and Pizza Hut had to offer delivery because people wanted that. The economics from a purely segment perspective were below the traditional dine-in. Still profitable but not quite as profitable. You still made money on it.

{audio:0:36:20} But you’d need to get that 2 to 2.5 drops per hour to make the economics work?

{audio:0:36:26} I don't know. No, I think we could still make money on less than two, one and a half, but obviously, you get more profit there. We still had enough room for margin, but it was not nearly as much margin. As it turns to 2, 2.5, you can do much better.

{audio:0:36:41} How did you start to see the delivery market change as the aggregators entered China?

{audio:0:36:48} That was within a matter of months; it was phenomenal. I was coming back to China during that time, and I remember people coming into my office at headquarters in Kentucky and saying, what's going on in China? Look at what's going on. Things would change week to week. Dianping was there; it was a website where you could search for restaurants, and people leave their comments about restaurants they've been to, in Chinese, of course. Ele.me and Dianping and Meituan, I think some of those are consolidated now. They all got into this business. Just like you see now with Ant and Alibaba, the speed of consumer behavior changing is just fascinating. I miss being able to use mobile for payment; it's just QR codes. I like Apple Pay, but you can't use that kind of Alipay over here. Those things are so convenient.

{audio:0:37:45} So the consumer adoption of using these apps to discover where they’re going to eat next is always about that decision of where am I going to eat now. Either plan ahead one hour, ten minutes, or a day or two. You often use your mobile, and that really transformed the marketing strategy for the brands and how you access consumers. So for KFC delivery, Yum! Brands looked at partnering with the aggregators like you might find with Yum! and Grubhub. How do we work with you to see if there’s something that can make sense for us commercially? Do you want your app not to have our brand? Probably not. If somebody’s in Grubhub or Ele.me, you probably want to have KFC in there. Do you want us to be top? Maybe we don't want to pay for that; we don't need to have top, people already know us. If they're going to get to us through your app in order to do rewards, well, that's fine. There is that issue, there's the aspect of commercially, who owns the customer data.

{audio:0:38:49} By Yum! Brands doing its own delivery, we know exactly that Don or Roy orders pizza every second Thursday of the month, and we're going to make sure we're on top of that. If a third party's aggregators are doing that, they have all the customer data. We have no idea. It’s like in the old days; we didn't know. We couldn't identify who's coming into our restaurants. If we don't have that data digitally, then we don't know, and Ele.me, Meituan and Dianping have it. This is obviously very high-value marketing data to have, so you can apply and devise your marketing plans and strategies to cater to those needs at the right time and invest those dollars wisely. There are a lot of considerations that have come about since I was there that they have to grapple with today.

{audio:0:39:41} I guess you had to repurpose some of the stores back to the delivery and carry out formats?

{audio:0:39:49} Yes, right. Self-serve kiosks, partition areas for pickup, like you see in many brands. Really adapted, so if you order online and we know, because of geofencing, you’re about to arrive, you don’t have to wait in a line of six people to pick up your order, which many other competitors had done already. So yes, reformatting those things, sometimes the dining room size may not be the right size because it was built when we had a lot more dine-in and less delivery. For KFC, we have a beautiful model where they’re able to access that lowest buy-in with high available capacity to cook and produce for the delivery channel. Pizza Hut is having to adapt its dine-in restaurant, which is a big challenge because that almost rhymes with the iconic red roof from the 1980s, the pan pizza Pizza Hut brand, a dine-in salad bar kind of destination in the heartland of America. Now a lot of pizza you see is about delivery in the pizza market.

{audio:0:39:49} How would you compare the US and the Chinese market structure and how the aggregators have changed the landscape in both the markets?

{audio:0:41:28} I can speak more from a Pizza Hut-centric aspect from the US side. Pizza Hut had to repurpose the brand to beat delivery for many, many years. It has a franchisee base, it still has those red roofs, and so it’s had a need to really partner with somebody that has digital knowhow to leverage those assets. Pizza Hut has not been known for building its own super great software infrastructure for mobile technology and digital technology. They brought in some really big talent in the last year or two, from Walmart and so forth, the young brands, so they know they need to go after that. A lot of that has to do with stepping up your game, being nimble in the digital space, having your assets address that, and having the brand be relevant there. But Domino’s and Papa John’s are fierce competitors, as you probably know, in the US.

{audio:0:42:29} Why are Domino’s so much stronger than Pizza Hut?

{audio:0:42:33} They don’t have some of the legacy issues. I don’t want to make excuses, but there are reasons. It could also be execution; I think Pizza Hut is not executed as well from the branding, from the franchisee base, perhaps, and also from the technology. Domino's is pure pizza, really from the early days, and the delivery side of things. They were built in the days when there was litigation because they were just running red lights to get those pizzas delivered within 30 minutes, infamously. They really focused on that, all power to them. Pizza Hut has a great brand, It's still one of the largest brands. They've probably shown more innovation across the spectrum from revamping their menu, making sure they had the right digital solutions, assets as well, such as design. They don’t have the red roofs; they were very much delivery/carry out; Delco.

{audio:0:43:30} Papa John’s, in the last couple of years, has had some challenges for various reasons. They were very much a pure DNA, pizza-focused company. They really felt proud of their pizza product, had good followers, and good franchise growth as well. They got to the game later but had good unit economics to allow them to grow and give their franchisees good unit economics. The were able to say, do you want to invest in our business? Let's partner together and do that. Pizza Hut has had to grapple with legacy, not just legacy assets from the restaurant but legacy POS systems. I know there has been work on legacy POS systems integration. It's not something consumers are going to see, but it affects how you run a business. Great businesses have great infrastructure. Look at Amazon; look at Walmart.

{audio:0:44:29} What was the typical cash payback for a Pizza Hut red roof dine-in in the US?

{audio:0:44:35} Since I had worked there, there were very few and far between red roof investments, so I can’t really speak to that. They were certainly attractive decades ago, back in the 80s and 90s. You’ll find hardly any new investments in those red roof casual dining spots. There might be a handful here and there.

{audio:0:44:59} Are they smaller units or did they repurpose the old ones?

{audio:0:45:01} The model now is the Delco unit, so your inline strip mall kind of unit that's on an end cap somewhere. It's got virtually no seating; it's just a place for having your vehicles parked to take the product and deliver it out.

{audio:0:45:23} What are the economics of the Delco units, in terms of the cost of building them out?

{audio:0:45:27} I never worked directly in the US division for Pizza Hut, but Delco was the best investment for franchisees. The new investments seemed to have pretty good returns overall. The thing was the complexity of having to deal with an incumbent red roof and wanting to develop a Delco maybe a few blocks away, or maybe it’s somebody different, and how do you deal with the competition in the same family? Overall, in the greenfield areas, the economics were quite attractive; on par, more or less. I think the investment was south of a full casual dining restaurant; I'm not sure if it even eclipsed a million dollars. It's probably less than $1 million. I can’t speak with any authority.

{audio:0:46:19} It wasn’t a two-year cash payback though, like China?

{audio:0:46:22} No, it wasn’t a cash payback like China, back then. Cash backs today are three to five years, according to a Yum! trial; I looked at that early this week. Pizza Hut in China payback is three to five years now. For Pizza Hut US, if you can get a five to seven-year payback, it's still probably okay, and people will invest in your brand. You don't have to have two to three-year paybacks for someone to invest in your business, typically.

{audio:0:46:49} How did Pizza Hut deal with this challenge between the incumbent franchisee and repurposing the store base or even outsider franchisees coming in with a Delco unit versus the old red roof?

{audio:0:47:11} Every franchise system has incumbents. You just have to stay North Star principled about it. We want to have really good operators that love the brand and are going to be committed to the brand and take care of the brand. Because the brand is a sum of everyone's execution, it's not so much those ads on TV, you can see what that’s about, but you really know your brand by how you experience it. And that’s hard. Cotton clean, is it hospitable, is it accurate, is their product quality good, is it fast enough? There's a motto called CHAMPS, and I'm going through that. Doing that with every transaction is hard, so I think Pizza Hut is continuously, like everyone, looking to say if you’re not stepping up to do enough for the brand. For example, your asset needs to be remodeled. KFC has had this issue before, if your asset is tired, you need to invest capital to refresh it. Because everyone else in this trade zone is five years ahead of you, you may have a good restaurant, but they're not going to come to you if you don't have that curb appeal.

{audio:0:48:15} So really nurturing and developing franchisees is a continuous process for Pizza Hut in the US. They’ve done some pretty great breakthrough initiatives with reworking some of the deals with the franchisees in the last couple of years. For example, we would work on royalty or other aspects of the relationship for the commitment of franchisees to do certain things like invest in technology or in asset remodels. We would give them some kind of incentive to partner, because the Pizza Hut franchisor, that means Yum! has an interest in the system and bringing the brand up. But it's not going to be solely Yum! to invest in that; they have to work on the investment from the accounts of the franchisees.

{audio:0:49:07} How did you compare the franchisee network of Pizza Hut in the US with Domino’s, in terms of concentration, the quality of the operators, the scale?

{audio:0:49:18} I’m sorry, but I really can’t speak with too much authority on that kind of comparison. I do know that there is a more homogenous pool of franchisees in Domino's because when they have franchise meetings, franchise connections, or franchise boards, they're pretty much uniform in that they're all Delcos. If you get into a forum where you have a purchasing board or other kinds of cooperatives represented by various franchisees in Pizza Hut, some might own more of a dine-in legacy asset, red roof sellers may have more Delco and may be more current, so the agenda might be different there and it’s a different dynamic.

{audio:0:50:09} They’re different business, really.

{audio:0:50:11} Yes. That goes for a lot of brands. At KFC, they would have some folks that were in trade zones where buckets of chicken were all they sold. They called it high-end buckets of chicken, and not much drive-through, not much dine-in business. Other ones had buffets; other ones did a lot of sandwiches. Some folks that only sold buckets said, I don’t want sandwiches, it’s complex, it’s more equipment, it’s training, etc.

{audio:0:51:11} We saw a recent bankruptcy with a large Pizza Hut franchisee. How do you look at the concentration of the networks?

{audio:0:51:50} You’re talking about the NPC bankruptcy. What’s going on in the world right now didn’t help much. That was big. I think they also had Wendy's. I believe they had been around for many years, and I believe they had a balance sheet that reflected more of a legacy type of asset, although they were probably trying to invest and turn that around a bit. It's hard to take a big footprint and turn around the asset configuration. Delco is not a big footprint. You're basically building, cooking and a small area to get folks and pizzas coming in and out, and some parking spots. In dine-in, you have a whole dining room, and you're paying rent for that. Even if you own it, you're virtually paying something on the cost of owning that. If you're not using it, it's dead weight.

{audio:0:52:59} Do you have rules around how much financial leverage the franchisees could have to buy the asset?

{audio:0:53:08} There are certainly guidelines and limits to make sure they are not completely on the edge. We had a franchise finance team that would be very thorough and diligent to be sure that folks had the proper financial headroom to invest.

{audio:0:53:35} Today, in the recent annual report, there is a stat that 90% of sales in the US are delivery or takeout, but I guess most of the stores are still legacy dine-in.

{audio:0:53:47} No, not most of them, but there is still a significant legacy that’s been out there for many years.

Yum! Brands: Scaling Pizza Hut in China

Former VP Corporate Planning at Yum! Brands

inpractise.com/articles/yumc-pizza-hut

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Don Miller

Former VP Corporate Planning at Yum! Brands

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Yum! Brands: Scaling Pizza Hut in China(October 27, 2020)

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