Indigestion At Taco Bell

Kenny King is seeing red. For 10 years, King was a loyal franchisee of Taco Bell Worldwide, operating 51 restaurants in Arkansas, Missouri, Oklahoma, and Texas. But last year, without telling him, Taco Bell opened a store on the campus of Henderson State University in Arkadelphia, Ark., not far from one of King's operations. Before long, King's worst fears were realized: Annual sales at his Arkadelphia outlet were down by $75,000, to $575,000. "They've talked about closing the other outlet, but they haven't given me any real indication," he says. "I'm pessimistic about the future."

King isn't the only one. Pushing into airports, stadiums, and convenience stores across the country, the Irvine (Calif.) fast-food chain has expanded its network by more than 37% over the past five years, to roughly 3,700 outlets. But while the growth has boosted corporate sales and profits, many of the 320 franchisees complain that the glut is contributing to a slowdown in sales growth at individual outlets, compounding the effects of a weak economy (charts). Many of the franchise operators also fear they will be gradually replaced by company-owned and -operated stores. While the number of franchised restaurants has risen since 1987 by only 15%, to 1,400, company-owned stores have soared almost 56%, to 2,300.

The fracas at Taco Bell is far from an isolated incident. Franchisees at KFC Corp., another unit of PepsiCo Inc., are complaining about similar encroachment on their turf. Burger King is defending itself against three separate lawsuits by franchise operators over the same issue. And in Iowa, the legislature recently responded to franchisee outrage by passing a law banning any new fast-food outlet within three miles of an existing franchise from the same system or within a population radius of at least 30,000. "You have the beginning of a grass-roots movement," says Jack Hadder, president of Franchise Analysis Inc., a market-research firm.

Still, the battle at Taco Bell has gotten a lot of attention, largely because of the aggressive growth strategy pursued by CEO John E. Martin. Martin, now 47, was hired by PepsiCo in 1983 to revive sleepy Taco Bell. At the time, the Atlanta native had a reputation as a hard-charger, earning his fast-food stripes as head of Burger King Corp.'s overseas operations in the late 1970s, before leading a turnaround at Burger Chef Systems Inc.,

a money-losing chain owned by rival General Foods Corp.

Martin's plans to boost Taco Bell sales and improve profits have often met with resistance from franchisees. The first clash came in 1983, when Martin raised the royalties due from franchisees to pay for increased advertising. Franchisees now hand over 10% of their sales to Taco Bell, compared with 8% in the early 1980s. Then in 1988, many franchise operators howled when Martin introduced a concept known as "value pricing." He told Taco Bell stores to roll back prices. Tacos that once cost 79 apiece were reduced to 59. Taco Bell's annual sales soared almost 76% from 1988 to 1991, to $2 billion. But in many locations, store owners complained that bargain pricing wasn't increasing sales so much as hurting profits.

OBSESSION. Still, the greatest backlash among franchisees has come in response to Martin's current growth strategy, which is aimed at making the Mexican-food operation as ubiquitous as the Golden Arches. Besides adding conventional stores, Martin is designing new outlets that are less expensive to build and operate. Last year, he introduced Taco Bell Express, with a limited menu and no seating in outlets similar to concession stands. Over the summer, he rolled out street carts. Martin is now exploring the possibility of using vending machines. Altogether, he is hoping for 250,000 distribution points by 2001.

Martin also wants the company to own as many new stores as possible. Not only would that enable him to claim a greater share of the chain's profits, but it would also give Martin tighter control over the retail network. Roughly one-third of franchisees still aren't participating completely in Taco Bell's value-pricing scheme, according to the International Association of Taco Bell Franchisees, which has 280 members. The company says the varied pricing from store to store confuses customers and dilutes the value of its nationwide ad campaign. "If you don't believe in the structure," Martin says, "we certainly don't want to expand with you."

Franchisees say Martin is so obsessed with growth that he doesn't care how expansion affects existing stores. Ron Bellamy, a Texas operator and president of the franchisee association, says King's experience isn't unique. He says his group has documented almost 70 cases where corporate expansion plans have threatened to steal business from established franchises. "They have become overzealous and selfish at grasping at opportunity," Bellamy charges.

Unfortunately, franchisees' contracts with Taco Bell give them little room to maneuver. As in most such agreements, store owners have exclusive rights only at their own restaurants. Taco Bell may put up another restaurant or may wheel in a cart around the corner or down the street. Moreover, Taco Bell isn't required to do any market-impact studies on existing outlets before opening a new one. "Years ago, they needed us," grumbles one California franchisee, who declines to be identified. "We moved across the country and invested millions. Now, they don't need us."

So Taco Bell's franchisees are fighting back. In March, the franchisee association showed its muscle by negotiating a contract to purchase food and packaging from an outside supplier rather than deal with Pepsi Food Systems, a PepsiCo subsidiary. One franchisee has even filed suit against Taco Bell. Richard Cohn, the owner of nine Taco Bells in the Chicago suburbs and a frequent critic of Martin, alleges that Taco Bell plans to build a company-owned store near his most profitable restaurant, in an attempt to coerce him into selling out to the company. Taco Bell has denied all charges.

BENIGN CANNIBALS? Martin insists the squabbles arise from resistance to change. "Sometimes you have to lead people kicking and screaming to the right answer," he says. Martin contends that the fast-food business depends so much on casual passersby that new stores don't necessarily hurt existing ones, especially in crowded metropolitan areas. Moreover, he says, a recent internal study shows that, so far in 1992, franchisees have complained of potential damage from the company's expansion plans in only 13 instances. He declines to give any other details.

Even so, Martin felt recently that he needed to reassure the troops. In an October speech at the annual franchisee gathering in San Antonio, he told the crowd: "Yes, you are wanted!" He invited existing franchisees to participate in the development of carts and kiosks. Martin also has shown some flexibility in expansion plans. When John Antonaccio, who has a franchise in Piscataway, N.J., objected to Taco Bell's plans for a new outlet just two miles away, the company canceled the project. "I felt very threatened a year ago," Antonaccio says. "But I am willing to continue to give the company a chance to keep doing what they've been doing lately."

Other franchisees aren't as charitable. Many are already looking askance at the Hot 'n Now hamburger chain, which Martin bought in 1991. Franchisees say the chain is aimed at the same low-price market as Taco Bell. For its part, Taco Bell denies any competitive threat, insisting that hamburgers and tacos are two different markets. Still, if Martin starts selling hamburgers as aggressively as he has tacos, he's sure to keep causing Kenny King and other franchisees plenty of indigestion.

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