Yum!: Plenty of Good News to Digest

The parent of Taco Bell, KFC, and Pizza Hut is like McDonald's was 15 years ago, says CEO David Novak of his outfit's growth potential

When it comes to growth, the fast-food industry has become a slowpoke. Per-store sales are declining at many of the biggest chains as Americans, bored by the same old burgers, are migrating toward newer brands that promise fresher food and more variety. The result: McDonald's (MCD ) pushed its chairman and chief executive, Jack M. Greenberg, into early retirement at yearend, and then, in the fourth quarter, reported a loss of $344 million -- its first ever. Meantime, Diageo (DGEAF ) was forced to take a $2.2 billion charge after unloading its struggling Burger King unit at a loss to a trio of private-equity firms.

It looks like somebody forgot to tell Yum! Brands (YUM ) to step off the gas. Investors who want a place setting in this industry might want to take a close look at how Yum is doing. The parent of five chains -- KFC, Pizza Hut, Taco Bell, Long John Silver's, and A&W All-American Food -- reported that net income jumped 18% in 2002, to $583 million, as revenues rose 12%, to $7.76 billion, and per-store sales climbed 4%. In addition, Yum opened a record 1,500 locations last year, lifting its total to 33,000 and putting the Louisville (Ky.)-based outfit ahead of McDonald's as the world's biggest in terms of outlets.


  Yum sees no slowdown in 2003. It plans to open 1,500 more restaurants this year and promises to boost earnings by at least 10% and sales by 7% or more, despite an expected 2% decline in per-store sales in the first quarter. Little wonder then, while McDonald's stock has fallen 17.5% in 2003, Yum is off just 5% year-to-date, which still leaves it up 44% since PepsiCo (PEP ) spun the operation off in October, 1997, as Tricon Global Restaurants (Tricon renamed itself after its ticker symbol in May, 2002).

And Yum's stock, which closed at $23.04 on Feb. 24, may have more running room left, say Lehman Brothers and Bear Stearns analysts, who recently upgraded Yum to outperform. Mitchell J. Speiser of Lehman Brothers says Yum should hit $34 within the next 12 months. "With McDonald's struggling, that leaves Yum! as the only healthy, multinational restaurant company," he told investors in a Feb. 12 note.

The most important ingredient in the chain's recipe for success is multibranding under the same roof -- putting a KFC in the same site with a Taco Bell, for instance. Yum Chairman and CEO David C. Novak cites surveys showing consumers prefer the combos to single-brand outlets by 6 to 1 because they offer something for every family member at one stop. Declares Novak: "It's the biggest sales and profit driver since the drive-through window."

Also, Yum is boosting advertising. It has bumped up its 2003 marketing budget by roughly 3%, to more than $700 million. And it's paying more attention to training its 750,000 employees. That, in turn, has allowed Taco Bell to take 90 seconds off service times, and annual turnover rates among hourly workers have fallen to 128%. That's still a stunningly high number, of course, but it's down from 156% a year earlier -- and well below the industry average, which hovers around 190%.

Novak, who joined Pizza Hut as a marketing exec in 1986 and became CEO in 2000, recently spoke with BusinessWeek Senior Correspondent Michael Arndt about his strategy for Yum. Here are edited excerpts of the conversation:

Q: How is it that you're growing while your competitors are suffering?


We're in a much different position from our competitors because we're on the ground floor of three major opportunities in an industry that most people think is mature. We've just barely scratched the surface internationally. McDonald's has 16,500 units outside the U.S. We have 10,000 with two brands, KFC and Pizza Hut. We're like McDonald's was 15 years ago.

The second point is that in the U.S., we have a growth strategy that we think is going to transform the quick-service restaurant industry -- putting two brands in one restaurant. That can get our unit sales volumes up from $1 million on average today to $1.4 million or $1.5 million. This is a way of leveraging our asset base. This is also a strategy that gets us out of the burger fray. And consumers love this.

Q: What's the third opportunity?


Since we were spun off, we've been focused on becoming a great restaurant-operating company. For example, at Taco Bell, we've really focused on speed of service. That's one reason Taco Bell has had such great success in the last couple of years. Even though people on the outside might not see it that way, we look at our businesses as embryonic, not tapped out.

Q: I'd like you to expand on that last point. A lot of people think that America has as many fast-food restaurants as it can stomach. The burger chains, in particular, have run up against this limit -- that they can't add any more restaurants without cannibalizing sales of existing outlets.


The burger category has a great strength in that it's "America's food." People love hamburgers. As a result, there have been people fighting it out for a long time. A lot of people might say McDonald's has reached its zenith. I don't agree with that, by the way, but that is what some analysts might say. We're in a very different situation. We have three chains -- Pizza Hut, KFC, and Taco Bell -- each with dominant shares. We're much more insulated than the burger segment. I also believe the quick-serve restaurant industry has something that will always be powerful: the drive-through window. There is nothing like a drive-through window in a time-constrained society.

Q: So why are the burger chains in trouble?


When you have great brands and you don't grow, I believe it comes more from self-inflicted wounds than there being anything inherently wrong with the category.

Q: Let's talk about the so-called fast-casual segment, which is one area where we're seeing a lot of growth. These sit-down restaurants offer quick-service sandwiches but at slightly higher prices. How are they affecting the fast-food category?


If you go out and look at how many chains there are with 1,000-plus stores, there aren't many. So the verdict is still out on how many of these brands will actually survive. But I do think they offer good food and convenience to the customer. The way we look at fast-casual is, it just forces us to get better and better.

Q: How have you reduced employee turnover so significantly?


What we've done is launched a program called Customer Mania. Within this program, we're teaching our team members life skills. We teach you how to deal with customers. We teach you how to listen and be empathetic. And we teach you how to recover when you make a mistake, because we all make mistakes. Regardless of whether you build a career with us or you want to go off and be a doctor, these are skills you can use throughout your life.

Q: So it's not that you're paying people more or offering better fringe benefits?


No. It's employee recognition. Here's why people stay in the business. They know what's expected of them. They know that people care about them inside the restaurant. And they feel recognized.

Q: One other thing I wanted to ask you about is the industry's single-minded focus on price. The burger chains all have 99-cent or $1 menus. Is that a good tactic?


What we focus on is the big V, which is value. And value is not just price. It's products, service, quality, convenience divided by the price. Now in our category, and I think in any category, value is critical.

The quick-service industry, just like most retail businesses, has always been based on giving people enough so they feel good about what they paid for. But we're not interested in getting into the 99-cent price wars, because that doesn't work for our concepts.

Q: Are you picking up any market share because of the troubles at the big burger chains?


Not really. People still want to eat burgers. When people don't want a burger, especially for the heavy user -- the male 16 years of age to 34 -- the top choice is Mexican food. And Taco Bell basically owns the fast-food market for Mexican food, with a 75% share. But what we're focused on is the customer. The real challenge is execution. This is a game of execution.

Arndt covers the fast-food industry from Chicago

Edited by Beth Belton