Delivery versus dine-in: Why McDonald's is going ‘big’ even as rivals slash store sizes

• Most quick service restaurants are expanding their stores but banking mostly on deliveries and takeaways rather than on dine-in consumers.
  
  
• McDonald's and Pizza Hut, however, are outliers to the general trend of setting up stores that are meant to mostly deliver.
  
  
• Customer experience has become integral to driving up sales at these outlets.
  
  
• McDonald's and Pizza Hut have become omnichannel players whose sales come from both on and off-premise channels.
  

At a time when many restaurants in India are looking to cut down physical presence and move to cloud kitchens, quick service restaurants (QSRs) like KFC, Pizza Hut, McDonald's, Burger King and more are going in for extensive store additions over the next few years.

According to a report by IIFL, as many as 820-920 such restaurants will be added every year as most franchises that run the aforementioned brands are looking to double their store count in the next four to five years. But, that does not necessarily mean more table space – a lot of them are banking mostly on delivery orders and takeaways rather than on dine-in consumers.

Small stores mean lower capex, less rental space and lower costs of servicing. They are also perfect for leveraging the increased love for delivery orders – which is growing exponentially. “Food delivery is likely to double its share of the market to 15-20%,” said a report by Credit Suisse.

And the love for fast food is also growing – all of these bode well for US-based brands. “Within the eating-out market, the share of QSR and Western fast food (~1.6% share) could increase allowing mid-teens industry growth over the next 5 years as per estimates cited by Westlife,” said Credit Suisse. Westlife is the franchise for McDonald's in India.

Big is the new small

McDonald's, however, is playing it a tad differently from its competitors in the Western fast food game in India. It is looking to build larger restaurants and catch the dine-in customers as well as the take-out and delivery consumers.

“Westlife/McDonald’s reiterated their preference for the larger-size, longer-lease store model, which they have successfully figured out; the rest of the listed universe has pivoted to a smaller -store format. Westlife believes that the large-store format is better suited from a longer-term perspective given that catchment volumes continue to grow,” said Credit Suisse.

The secret sauce of winning the large-store game lies in the type and kind of meals served. In addition to burgers, sodas and sides, McDonald's also has a strong breakfast menu and coffee and chicken-related items that bring in more footfalls throughout the day.

“The success/failure of store formats (large vs small, long lease vs short) depends on brand pull, ability to access various day parts etc. Therefore, while larger stores work for Westlife, newer players like Burger King or delivery-focused ones such as Jubilant could find smaller formats more suitable,” said Credit Suisse. Jubilant is the franchise for Domino’s in India.

Size does matter

In the last few years, the business dynamics of Western fast food retailers underwent a transition as the delivery channel ‘unfolded’. This is especially so in the case of KFC and Pizza Hut, both from the Yum Brands stable.

“Since FY19, both Yum franchisees reduced the store size of all new stores for both KFC and Pizza Hut by 40% thereby reducing capex, occupancy, and operating cost,” said a report by Mirae Asset Capital Markets, referring to Devyani International and Sapphire Foods that run KFC and Pizza Hut.

Mirae also says that most of these stores are operating at margins upwards of 20%, implying payback in less than three years. This low-gearing, the research firm predicts, will translate into free cash flow generation, and help Yum Brands expand to tier 2 and tier 3 towns.

Pizza Hut takes a leaf out of Domino’s playbook

Pizza Hut, in particular, charted a story of extensive transformation from a dine-in brand to an omnichannel brand, like McDonald's. Pizza Hut’s strategy was in stark contrast to its closest competitor, Domino’s. While Domino’s heralded a new era of pizza delivery long before app-based ordering kicked in, Pizza Hut – which placed itself as a premium brand, intended to bring walk-ins into its large stores.

Pizza Hut’s offerings were priced at a 15-20% premium to Domino’s, even when the average ticket size of the pizza category itself was high at ₹450. According to a report by Phillip Capital, Pizza Hut’s premium positioning, elevated focus on dining-in, and a lot of gaps in its product portfolio compounded the problems. The payback period of Pizza Hut (for franchise owners) was at 8-9 years while that of Domino’s stands at two-and-a-half to three years.

“Moreover, store size being almost double Domino’s, its ROCE (return on capital employed) was in single digits, and as a result, never motivated franchisee operators to put more stores,” said Phillip Capital. Domino’s, on the other hand, is now the largest QSR chain in India with 1,567 stores as of FY22.

Over the years, however, Pizza Hut has pivoted – it has expanded its product options, introduced economy-range products, experimented with omnichannel format since 2016-17 and reduced its store size by a net 45%, as per Phillip Capital. It achieved this by reducing the size of its kitchens with better utilisation, value engineering and removing non-core kitchen equipment.

“Similarly, it has been able to halve its dine-in area to 500 sq. ft. from 1,050 sq. ft. earlier, with optimum utilisation of space. Interesting thing is, it has been able to do this without impacting average daily sales (ADS), given its focus on the delivery channel,” said Phillip Capital.

It also focussed on delivery, but has retained some of its initial dine-in strategy to become a true omnichannel player like McDonald's. In FY18, McDonald's’ on-premise sales was 82% of total sales, but the mix is now almost the same between off and on premise. Similarly, Pizza Hut and KFC too changed tracks to become omnichannel players with equal sales both on and off-premises. Domino’s, on the other hand, overturned its off and on premise strategies to focus extensively on delivery.

Another chain from the Yum Brands stable, KFC too went in for value engineering, to include more tables. Although dine-in space, on an average, reduced by 60% to 500 sq. ft, the number of tables did not reduce at the same rate, indicating that the company had used its store space well, Phillip Capital said.

Where do QSRs get their sales from?

Source: Phillip Capital

Future-ready experiences

Being an omni-channel brand comes at a cost to players like McDonald's, Pizza Hut and KFC alike, which means more overheads in addition to maintenance of ‘larger spaces’. For example, Westlife, which runs McDonald's, is investing 30% of its capex on renovating the look and feel of its stores.

Moreover, half of all its McDonald's outlets have been upgraded to the Experience of the Future (EoTF) model – where customers are provided with WiFi to work at the stores, and also boasts of digital offerings like self-ordering kiosks. It intends to upgrade all of its stores to the EoTF model which will bring in more customers and keep them there for a long time.

“The significant improvement in customer experience tends to bump up walk-ins and leads to higher daily sales driving a strong return on the incremental invested capex – at around 35%,” said Credit Suisse.

Ultimately, big outlets or small, the success of Western fast food retailers will depend on how well they can satiate both – the customers’ hunger pangs as well as their rising need to have memorable experiences.

SEE ALSO

A hyperlocal OTT born in funding winter wants to tell stories in Indian dialects

Shark Tank India judges Peyush Bansal and Aman Gupta invest in Hoovu Fresh - Here’s all about this floral startup