Dive Brief:

• Pizza Hut could temporarily close as many as 500 underperforming units in the U.S. in the next 24 months, remodel them and reopen them with a carryout and delivery focus, Yum Brands president, CFO and COO David Gibbs told investors during a Thursday earnings call.  
• The pizza chain will work with franchisees to rebuild a store in the area to better capitalize on delivery in that market, Gibbs said.
• In some specific situations, the company may have to deploy capital in the short-term to flip the market, give it to a new franchisee and then get the capital back from the store, he said.

Dive Insight:

Renegotiating franchisee partnerships and finding partners focused on growth will be important for Pizza Hut's success with these remodels. The company has been dragged down by one of its largest franchisees, NPC International, which received a downgraded credit rating from Moody's and S&P in April. Much like other franchisees, food and labor costs have been keeping margins under pressure. Additional competition from third-party delivery has been slowing down developments of traditional restaurants in favor of smaller locations as well.

The need to focus more on delivery channels has never been greater. Even Domino's, which grew same-store sales to 3% during Q2 2019 compared to 6.9% in the year ago quarter, has been struggling to compete against third-party operators and is focusing in on value and improving the delivery tech.

With the pizza industry intensely focused on improving the delivery experience, it is a bit odd that Pizza Hut's unit count remains so strongly focused on traditional dine-in stores. Out of its nearly 7,500 units in the U.S., about 6,100 are dine-in and 1,300 are express units with carryout and delivery, Gibbs said.

Pizza Hut is leveraging Yum Brands' investment in Grubhub to expand its reach with delivery. CEO Greg Creed told investors during the call that Grubhub has been rolled out to 300 locations and the company plans to expand its test during Q3. So far the test revealed that Grubhub's customers are incremental and attracting customers to the Pizza Hut brand for the first time, he said. The chain will still use Pizza Hut drivers and is basically leveraging the new channel as a way to reach new customers, he said. 

Having more delivery-focused locations will also help attract more customers on the go, especially as its top competitor, Domino's, has been quickly deploying its own off-premise focused model since 2012 and has been focusing on improving the carryout experience.

But switching over its existing restaurants to a smaller off-premise focus could be risky. McDonald's, in particular, struggled to get franchisees on board with its tech-centric remodels given the costs and downtime of restaurants. Pizza Hut executives admitted that it is hard to estimate the time span from closure to reopening, so this strategy may not go over well, especially with struggling franchisees. 

Subway, for example, ended up offering grants of up to $10,000 to jumpstart remodels across its franchisee system to allow for remodels to reach 10,500 units by 2020. McDonald's had to give its franchisees more time to meet its remodeling deadline to ease tensions. However, McDonald's remodels have been coming back online faster and resulted in a boost in overall U.S. comp performance during the second quarter. As long as Pizza Hut can get these stores back on track and have a partnership with a franchisee focused on growing, results could very well improve as they have for McDonald's.