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Yum! Brands Wants Pizza Hut to Be More Like Domino's

Rich Duprey, The Motley Fool

Pizza is arguably the first fast food. Whether by the slice or a whole pie, it was and is the premier grab-and-go, quick-serve item.

Pizza Hut, however, positioned itself as the anti-fast-food pizza chain. The Yum! Brands (NYSE: YUM) restaurant offered instead a casual dining experience. It was a place to go to sit down and enjoy your pie with your family.

But changing consumer preferences are causing Yum! to rethink that strategy. And during its recent earnings conference call, management said it would begin transitioning its dine-in restaurants to a carryout/delivery model. To start, approximately 500 restaurants will be closed over the next two years.

With almost 7,500 locations, some 6,100 of which are traditional dine-in restaurants, the changeover amounts to around 8% of the stores. As the transition progresses, it will make the chain much more like rival Domino's (NYSE: DPZ), which is wholly takeout-based and operates almost 5,900 stores in the U.S.

Pizza delivery man with thermal bag

Taking the hit now for growth later

Pizza is a $36.5 billion industry and is the second largest category, behind burgers, in the $300 billion quick-serve market. Although Pizza Hut has more stores, Domino's is the leading delivery chain and is one of the top three in carryout.

Pizza Hut's transformation will slow the pace of store expansion, though international growth will allow the total number of restaurants to remain fairly constant. And while closing several hundred locations could have hurt performance, Pizza Hut says these stores are among its lowest-volume locations, and they will return as higher volume, more profitable restaurants.

Domino's is also attempting to expand sales through what it calls its "fortressing" strategy -- opening numerous storefronts regardless of whether there is an existing one nearby. It believes flooding the market with Domino's stores will serve as a branding opportunity because consumers will be repeatedly bombarded by the Domino's name, which in turn ought to improve the customer experience since it will shorten delivery times.

Of course, it runs the very real risk of cannibalizing sales of existing stores, and that is already happening. Comparable-store sales growth slowed to 3% in the second quarter, the fifth quarter in a row that comps came in lower than the year before.

Domino's is still posting positive comps -- the second quarter was the 33rd consecutive time they've been higher, or more than eight straight years. But as it builds out more stores, it could make comps turn negative. Domino's says it's willing to risk that if it means overall sales grow, because as the customer experience improves, it will lift all boats. Franchisees might not be so accommodating.

Too much of a good thing?

Pizza Hut also reported increased comps last quarter, up 2% in the U.S., as the number of transactions was up 3%, and it's looking to leverage its partnership with Grubhub to grow them further. Customers place orders on Grubhub, but Pizza Hut delivers the food.

Yet CEO Greg Creed told analysts that comps growth will be choppy if it doesn't do something, so the transition of the chain to a takeout business will offer more potential for consistent growth.

Still, Pizza Hut needs to watch out for cannibalization as well, especially because it has far more coverage than Domino's. Many of Pizza Hut's restaurants that are being converted were built in prime locations as dine-in places 30 to 40 years ago, but they're no longer the right spot today, making a takeout/delivery business more appropriate. They will also be smaller locations, meaning they should be cheaper to run over the long haul.

As Yum! evolves Pizza Hut into a Domino's look-alike, it has the possibility to accelerate sales growth at the beginning. But by creating too much of a good thing, it may, like its rival, eventually see sales growth stall.

Rich Duprey has no position in any of the stocks mentioned. The Motley Fool recommends Grubhub. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com