Kentucky Fried Chicken
To sell food in a fast, friendly environment that appeals to pride conscious, health minded consumers (www.KFC.com).
2. Introduction on the Neighborhood Program with following:
Since its inception, KFC has evolved through several different organizational changes. These changes were brought about due to the changes of ownership that followed since Colonel Sanders first sold KFC in 1964. In 1964, KFC was sold to a small group of investors that eventually took it public. Heublein, Inc, purchased KFC in 1971 and was highly involved in the day to day operations. R.J. Reynolds then acquired Heublein in 1982. R.J. took a more laid back approach and allowed business as usual at KFC. Finally, in 1986, KFC was acquired by PepsiCo, which was trying to grow its quick serve restaurant segment. PepsiCo presently runs Taco Bell, Pizza Hut, and KFC. The PepsiCo management style and corporate culture was significantly different from that of KFC.
PepsiCo has a consumer product orientation. PepsiCo found that the marketing of fast food was very similar to the marketing of its soft drinks and snack foods. PepsiCo reorganized itself in 1985. It divested non-compatible units and organized along three lines: soft drinks, snack foods and restaurants. PepsiCo Worldwide Restaurants was created to create synergism between its restaurant companies.
By the end of 1994, KFC was operating 4,258 restaurants in 68 foreign countries. KFC is the largest chicken restaurant and the third largest quick service chain in the world. Due to market saturation in the United States, international expansion will be critical to increased profitability and growth.
The organization is currently structured with two divisions under PepsiCo. David Novak is president of KFC. John Hill is Chief Financial Officer and Colin Moore is the head of Marketing. Peter Waller is head of franchising while Olden Lee is head of Human Resources. KFC is part of the two PepsiCo divisions, which are PepsiCo Worldwide Restaurants and PepsiCo Restaurants International. Both of these divisions of PepsiCo are based in Dallas.
Another strategy of KFC is currently working with is to improve operating efficiencies. This in turn can directly impact the operating profit of the firm. In 1989, KFC centered on elimination of overhead costs and increased efficiency. This reorganization was in the U.S. operations and included a revision of KFCs crew training programs and operating standards. They emphasized customer service, cleaner restaurants, faster and friendlier service, and continued high-quality products.
In 1992, KFC continued with another reorganization in its middle management ranks. They eliminated 250 of the 1500 management positions at corporate and gave the responsibilities to restaurant franchises and marketing managers.
PepsiCo acquired KFC in 1986 to add to their diversified restaurant segment, which included Pizza Hut and Taco Bell. PepsiCo produces yearly-consolidated financial statements, which includes this restaurant segment, but does not separately identify KFC, Pizza Hut, or Taco Bell. Therefore, the amount of financial information is very limited.
In 1986, after the KFC acquisition, PepsiCo now had three of the four largest and fastest growing segments within the U.S. quick service industry. In 1994, PepsiCo had some of their largest market shares (See Exhibit 1) in the U.S. Market.
As of 1995, KFC was ranked sixth in the U.S. sales in fast-food chains (See Exhibit 2). See also U.S. sales chart in Exhibit 3.
Top 10 Leading U.S. Fast-Food Chains
U.S. Sales ($M)(Exhibit 2)
Over the past seven years from 1987 to 1994, KFC worldwide sales have grown at an average rate of 8.2% (See exhibit4).
Worldwide Sales ($ millions)Exhibit 4
A big part of the increased sales is due to new restaurants and higher volume. Exhibit 5 contains the total number of units of U.S. and international restaurants and also shows the percentage of growth.
Year U.S. Intl Total Growth%
1992 5055 3674 8729
1993 5094 3939 9033 3.3%
1994 5115 4292 9407 4.0%
1995 5137 4492 9629 2.3%
KFC has also met the changing demands of society. As the world has gone to a more healthy living, KFC has come out with many changes on its menu, including Honey BBQ Chicken, Popcorn Chicken, Rotisserie Chicken and has begun to promote its lunch and dinner buffets. Dinner is also very important to KFC. See the breakdown of dayparts in Exhibit 6.
The buffets now offered at KFC during lunch and dinner are also very important. KFC is typically a fast-food service (See Exhibit 7), however with these buffets, this may persuade customers to dine-in instead of take out.
KFC has also tried to meet the demands of consumers wanting fast-food in other "non-traditional" locations. They are currently testing airports, shopping malls, universities, and other high-traffic areas.
Financial Ratio Analysis and Capital Outlook
Financial ratio analysis is the calculation and comparison of ratios, which are derived from the information in a company's financial statements. The level and historical trends of these ratios can be used to make inferences about a company's financial condition, its operations and attractiveness as an investment. In isolation, a financial ratio is a useless piece of information. In context, however, a financial ratio can give a financial analyst an excellent picture of a company's situation and the trends that are developing.
Net Income per share:Net Income/Total # of shares outstanding
This figure is defined as Net Income divided by total shares outstanding. Net income per share evaluates the companies profit per share of stock outstanding. From an investor standpoint this figure should be at least the industry norms or better if possible. PepsiCo has a ratio that is above industry standards however there was a drop from 1994 to 1995 of almost 10% that should it continue would possibly damage investor outlook on the company in the future.
Return on Shareholder Equity: Net Income/Share holders equity
Measures the return of shareholders equity to Net Income. PepsiCo numbers are below industry averages but not far enough for concern, because the company has a long history of stable returns and investors will consider that. However, PepsiCo should concentrate on this figure in the future, if it continues to lag industry averages.
Liquidity Ratios give a picture of a company's short-term financial situation or solvency.
Working Capital:Current Assets Current Liabilities
The Working Capital of a business is an indication of the short-run solvency of the business. PepsiCo showed dramatic improvement from 1993 to 1995 but is still below industry standards. If the firm should need immediate cash, it might not be on hand. This is not probable because of their borrowing capacity can supplement short-term cash needs.
Current Ratio: Current Assets/Current Liabilities
This ratio is the most commonly used measure of short-term solvency. It indicates the amount of current assets, such as cash, accounts receivable, and inventory that can be converted into cash to pay your short-term liabilities. The Current ratio is considered more indicative of the short-term debt-paying ability than the working capital. For many years, the guideline for the minimum current had been 2.00. Presently the guideline is determined by the industry average. In this respect, PepsiCo has been consistent in staying above the industry average and is good condition regarding short-run debt-paying ability. 1995 is particularly excellent with KFC doubling the industry average, and it has risen for the past three years.
Cash Ratios:Cash Equivalents + Marketable Securities/ Current Liabilities
The Cash ratio is the best indicator of a companys short-run or immediate liquidity. Sometimes an analyst needs to view the liquidity of a firm from an extremely conservative point of view. This conservative view however is not realistic for a corporation of this size. The lower the ratio the more advantageous for the company, because a high cash ratio indicates that the firm is not using its cash to its best advantage. Cash should be put to work in the operations of the company. PepsiCo is below industry standards, but given the above definition, PepsiCo is putting to work in the operations of the company.
Solvency Ratios give a picture of a company's ability to generate cash flow and pay it financial obligations.
Debt Ratio:Total Liabilities/Total Assets
The Debt Ratio indicates the percentage of assets financed by creditors, and it helps to determine how well creditors are protected in case of insolvency. This ratio indicates the amount of debt your business has taken on relative to the total assets it owns. A high debt ratio indicates that creditors have financed a substantial portion of your business. This is often a red flag to potential lenders since it increases the possibility of bankruptcy if your net sales are not enough to meet your monthly debt and interest payments. The debt ratio is conservative because it includes all debt and near debt. PepsiCo is slightly above the industry but there has been a continuing downtrend that if continued will equal industry averages in 1996.
Debt/Equity Ratio:Total Liabilities/Shareholders Equity
Debt to equity ratio is a measure that helps determine an entitys long-term debt-paying ability. It also assists in judging how well creditors are protected in case of insolvency. From the perspective of long-term debt paying ability the company is above industry averages and need to be at or below. There is however a downward trend that indicates that the company is addressing this issue.
Profitability Ratios use margin analysis and show the return on sales and capital employed.
Return on Assets: Net Income before minority share of earnings and Non-recurring Items/Total Assets
Return on Assets measures the firms ability to use its assets to create profits by comparing profits with the assets that generate the profits. Generally the larger the RAO ratio the better, because this tells investors and competitors that this is stable company. This ratio for PepsiCo is somewhat alarming because it has been lagging the industry by 4-5% and does not show an upward improvement trend.
Net Profit Margin: Net Income before minority share of earnings and Non-recurring Items/Net sales
Net Profit Margin gives a measure of net income generated by each dollar of sales. The company is well above industry average and that is very desirable. There was however a drop of one percent from 1994 to 1995 should this trend continue it could damage the corporations profitability.
Total Asset Turnover: Net Sales/ Total Assets
Total Asset Turnover measures the activity of the assets and the ability of the firm to generate sales through use of assets. PepsiCo is utilizing its assets with regards to sales in that they are using fewer assets to produce more net sales.
Opportunities represent external finding which can enhance a companys performance. Opportunities that KFC can take advantage of are as follows:
The growth in the fast-food industry is limited due to the aggressive pace of the growth in the 70s and 80s. As a result, the market is saturated and "the cost of finding prime locations is rising." With the higher cost of the initial investment, the new restaurants are pressured to increase per-restaurant sales. Many companies are realizing that in order for them to grow they need to pursue foreign market. One of the potentially profitable markets is Mexico. Mexico has over 91 million people and growing. This give companies a huge customer base to work with. Also, the companies are able to take advantage of the close proximity to the US. The transportation cost to Mexico compared to other countries is very minimal. Despite the advantages, US companies in general have not expanded much in the Mexican market compared to European or Asian market. Therefore, the companies can expect lesser competition when expanding in Mexico.
US companies are able to invest less money in buying assets in Mexico due to favorable exchange rate. This opportunity gives the companies a reduced risk in investing in Mexico. Also, the companies that are already in Mexico are able to import raw materials at a favorable rate by converting dollars into peso.
This strategy helps to "improve economies of scale within its restaurant operations." For many companies that own more than one fast-food chain, "dual branding" is an ideal way to expand quickly and increase profit. The companies no longer need to wait for the store to be built or spend time and money looking for the location. By adding a brand to the existing fast-food store, the companies are able to expand quickly and for less money. The companies are also capitalizing on the increased customer base due to the increased menu offering. Increased profit is another benefit of "dual branding." The companies are enjoying higher profit due to the low cost in expanding and the reduced advertising dollar spent by advertising the two chains together.
In January 1990, Mexico passed a law that favored franchise expansion. The law provided for the protection of technology transferred into Mexico. The law also allowed royalties. Before 1990, there was no protection for patents, information, and technology transferred to the Mexican franchise. Also, before the new law royalties were not allowed. This resulted in higher number of the company owned fast-food chains rather than the franchises in Mexico. However, with the new law, the companies are given an opportunity to benefit from selling franchises. The fast-food chains are now able to expand to other regions of Mexico by selling franchises to individuals rather than keep building company owned stores in centralized locations to keep the operation simple and effective.
5. Australian opportunity
Growth in international profits were highest in Australia, which is now KFCs largest international market.
6. New distribution channels offer a significant growth opportunity.
Especially in the last few years, consumers are demanding fast food in non-traditional locations, such as shopping malls, universities, hospitals, and other high-traffic areas. Consumers are demanding greater convenience when purchasing. The locations listed above are some of the most popular non-traditional locations that could be exploited by a fast-food chain. The fast-food chains are recording high sales in those areas due to high-traffic. Consequently, the companies are constantly looking and testing for new high-traffic locations to expand.
Threats to a company are those business characteristics that endanger the companys position within its industry as well as jeopardize its profits. The threats that KFC faced with include the following:
1. Saturation of the US market.
According to the National Restaurant Association (NRA), food-service sales in 1995 will hit $289.7 billion for the U.S. restaurant industry. The NRA estimates the sales in the fast-food segment of the food industry will grow 7.2% to approximately $93 billion in the United States in 1995, up from $87 million in 1994. Although the restaurant industry has outpaced the overall economy in recent years, there are indications that the U.S. market is slowly becoming saturated.
2. Increasing competition and rising sales of substitute products.
Faced by slowed sales growth in the fast-food industry, other segments of the industry have turned to new menu offerings. McDonalds introduced its McChicken sandwich in the US market in 1989. Jack in the Box has introduced chicken and teriyaki with rice. Dominos has introduced chicken wings to its menu. Pizza Hut has tried marinated, rotisserie-cooked chicken.
3. Changing preferences of consumers.
During the 1980s, consumers began to demand healthier foods and KFC was faced with a limited menu consisting mainly of fried foods. In order to reduce KFCs image as a fried chicken chain, it changed its logo from Kentucky Fried Chicken to KFC in 1991. In 1992, KFC introduced Oriental Wings, Popcorn Chicken, and Honey BBQ Chicken as alternatives to its Original Recipe fried chicken. In 1993, KFC rolled out its Rotisserie Chicken and began to promote its lunch and dinner buffet.
4. Obstacles associated with expansion in Mexico.
One of KFCs primary concerns is the stability of Mexicos labor markets. Labor is relatively plentiful and cheap in Mexico, though much of the work force is still relatively unskilled. While KFC benefits from lower labor costs, labor unrest, low job retention, absenteeism, and punctuality continue to be significant problems. Though absenteeism is on the decline due to job security fears, it is still high, at approximately eight to fourteen percent of the labor force. Turnover also continues to be a problem. Turnover of production line personnel is currently running at five percent per month. Therefore, employee screening and internal training continue to be important issues for foreign firms investing in Mexico.
Another area of concern for KFC has been the increased political turmoil in Mexico during the last several years. For example, on January 1, 1994, the day NAFTA went into effect, rebels (descendants of the Mayans) rebelled in the southern Mexican province of Chiapas on the Guatemalan border. Around 150 people were killed. The peso crisis of 1995 and resulting recession in Mexico left KFC managers with a great deal of uncertainty regarding Mexicos economic and political future. KFCs approach to investment in Mexico is to approach it conservatively, until greater economic and political stability is achieved.
Strengths can be found internally in a company and can be used to the companys advantage. The strengths identified are as follows:
1. KFC's secret recipe.
The secret recipe has long been a source of advertising, and allowed KFC to set itself apart. Also, KFC was the first chain to enter the fast-food industry, just before McDonald's, which opened its first store a year later, and the "secret recipe" was the initial home replacement strategy.
2. Name recognition and reputation.
KFC's early entrance into the fast-food industry in 1954 allowed KFC to develop strong brand name recognition and a strong foothold in the industry. The Colonel is KFC's original owner and a very recognizable figure, both in the U.S. and internationally, in their new logo. In fact, in the fourth annual LogoValue Survey, done by The Schecter Group, the KFC logo was the only one which significantly enhance the brand's image (Logos add 1).
3. PepsiCo's success with the management of fast food chains. PepsiCo acquired Pizza Hut in 1977, and Taco Bell in 1978. PepsiCo used many of the same promotional strategies that it has used to market soft drinks and snack food. By the time PepsiCo bought KFC in 1986, the company already dominated two of the four largest and fastest-growing segments of the fast food industry (Wright, p.424-426).
4. Traditional employee loyalty.
"KFC's culture was built largely on Colonel Sanders' laid back approach to management" (Wright, p.433). Before the acquisition of KFC by PepsiCo, employees at KFC enjoyed good benefits, a pension, and could receive help with other non-income needs. This kind of "personal" human resources management makes for a loyal workforce (Wright, p.434).
5. Improving operating efficiencies by reducing overhead and other operating costs can directly affect operating profit.
Due to the strong competition in the US, the fast-food chains are reluctant to raise prices to increase profit. Many of the chains are turning to operating efficiencies to increase profit. For many companies, operating efficiencies are achieved through improvements in customer service, cleaner restaurants, faster and friendlier service, and continued high-quality products.
Weaknesses are also found internally like strengths. Weaknesses, however, can limit a companys potential. The weaknesses for KFC are identified as follows:
1. The many sales of KFC lead to a confusing corporate direction.
Between 1971 and 1986, KFC was sold three times. The first two sales, to Heublein, Inc and to R.J. Reynolds, left the company largely autonomous. It wasn't until the sale to PepsiCo in 1986 that changes in top management started to take place. These changes happened almost immediately after the sale (Wright, p.421-426).
2. KFC has a long time to market with new products.
Because of the nature of the chicken segment of the fast food industry, innovation was never a primary strategy for KFC. However, during the late 1980's, other fast food chains, such as McDonald's, began to offer chicken as a
menu option. During this time, McDonald's had already introduced the McChicken while KFC was still testing its own chicken sandwich. This delay significantly increased the cost of developing consumer awareness for the KFC sandwich.
3. Conflicting cultures of KFC and Pepsi Co.
While KFC's culture was largely based on the Colonel's laid back approach to management, while PepsiCo's culture is more of a "fast track" attitude. Employees do not have the same level of job security that they enjoyed before the PepsiCo acquisition (Wright, p. 433-434).
4. Turnover in top management.
PepsiCo bought KFC in 1986. By the summer of 1990 PepsiCo's own management had replaced all of the top KFC managers. However, by 1995 most of this new PepsiCo management had either left the company or been moved to a different division. In addition, Kyle Craig, who was named president of KFC's US operations in 1990, left in 1994 to join Boston Market (Wright, p.434).
5. Recent contractual disputes with franchisees in the United States.
This is also an example of the conflicting cultures of KFC and PepsiCo. KFC's franchisees had been used to little interference from corporate offices. In 1989, the CEO announced new contract changes - the first in thirteen years. "The new contract gave PepsiCo management greater power to take over weak franchises, to relocate restaurants, and to make changes in existing restaurants" (Wright, p.434). The franchisees protested these changes and the relationship between the corporate KFC and the franchisees in the United States have been strained ever since this announcement (Wright, p.434).
Through an analysis of the strengths, weaknesses, opportunities, and threats of KFC, the following potential problem areas were identified:
1. No defined target market.
The advertising campaign of KFC does not specifically appeal to any segment. It does not appear to have a consistent long-term approach. The U.S. has enormous changes in its demographics. Single-person households have increased from 12% in 1970 to 25% in 1995. With this kind of dramatic change, KFC does not have a proper approach to its target market.
2. Saturation of the U.S. Market.
There has been an increase in the overall number of fast-food chains. Access to restaurants is now easier due to non-traditional locations, for example in airports and gas stations. Also, the age of Americans tends to change the frequency of eating out.
3. Health Conscious Consumers.
There has been a trend toward an increasingly healthy diet in America. This put KFC at an extreme disadvantage due to its fried product offering.
4. Increased Start Up Costs.
Prime locations have increased in cost due to limited room for expansion. New technology has increased efficiencies, but resulted in greater increased start up costs. Restaurant and equipment packages range from $500,000 to $1,000,000.
Low profitability and high risk of doing business in Mexico.
Due to the current devaluation, profits are greatly reduced. This reduction in earning power has brought about much political unrest. Mexico has a largely unskilled labor pool that provides little stability. Cultural attitudes toward punctuality, absenteeism and job retention tend to make managing employees difficult under present circumstances. High turnover rates lead to high training costs and can threaten the brand integrity. In the past, the Mexican economy has triggered violence toward American firms by frustrated nationalists. The culmination of all these problems led to low profitability due to a low profit product margin.
The strategic alternatives for KFC are as follows:
1. Re-franchise all company owned Mexican units into franchises
2. Completely divest KFC of Mexican operations
This alternative includes canceling all franchises and selling off all company units in Mexico.
3. Leave Mexico as is and grow other foreign markets.
Based on our analysis of the salient problem and the strategic alternatives, we recommend that KFC re-franchise all of the 129 company units in Mexico. This most effectively mitigates the risk of doing business in Mexico by making a franchisee responsible for the profit and loss of each unit. KFC will still receive royalties based on the sales of each unit. However, franchises will protect the company from currency devaluation. KFC is able to reduce this risk while still maintaining a presence in one of the largest growing markets. Expansion is not recommended at this time due to the volatility of the economic and political situation in Mexico.
The Re-franchising Program
This program will involve the selling of all company owned KFC units, in the country of Mexico, to individual franchisees. This should mitigate risk while still maintaining a steady cash flow from the region. The sale of the 129 company units will take place during a three year time period.
The Severance Program
This is a program designed to aid general managers that will be displaced due to the sale of the franchise units. It is likely that the new franchisees will bring in their own people and many general managers will be replaced. It is important to avoid any bad will from former KFC corporate managers and the severance package should help to defray some of the negative feelings of present general managers. Every General Manager will qualify when their respective unit is sold.
The Evaluation and Control Program
This program will be used for evaluation of the two previous programs. It is important to determine the effectiveness of the programs. In addition, this program will include a plan to ensure continued brand integrity for Kentucky Fried Chicken.
Sales price per unit: This price will be based on the price, which includes the building and equipment packages. Land price will not be included because it is leased and the new owners will assume this payment.
TOTAL CASH GENERATED
Restaurant and equipment package: $500,000.00
Total number of restaurants: 129 units
Total expected cash from sale: $64,500,000.00
Restaurant and equipment package: $500,000.00
Total units in Mexico City 60 percent of units
Total cash from sale: $39,018,518.52
Restaurant and equipment package: $500,000.00
Total units in Guadalajara 17 percent of units
Total cash from sale: $11,148,148.15
Restaurant and equipment package: $500,000.00
Total units in Monterey 22 percent of units
Total cash from sale: $14,333,333.33
This will give a summary of expected royalties that will be received from the sale of the units to franchises. The royalties will be reported as they are expected to be generated, during the sale of the respective units, which corresponds to the time line. Royalties after the re-franchising is complete will not be included in the budget due to the completion of the proposed program. It is only necessary to look at the specific time frame during the implementation of the program. The expected royalty fee is 6%.
Royalties generated July 1996 to December 1996: Projected number of units sold: 9 units
Projected royalty fees: 6%
New Royalties generated 1996: $418,500.00
Royalties generated 1997:
Projected number of units sold: 40 units
Projected royalty fees: 6%
New Royalties generated 1997: $1,860,000.00
Year to date $2,278,500
Royalties generated 1998:
Projected number of units sold: 40 units
Projected royalty fees: 6%
New royalties generated 1998: $1,860,000.00
Year to date: $4,138,500.00
Royalties generated 1999:
Projected number of units sold: 40 units
Projected royalty fees: 6%
New royalties generated 1999: $1,860,000.00
Year to date: $5,998,500.00
Total royalty fees generated by the re-franchising program: $13,252,500.00
This budget is used to calculate the proposed cost for the trip of our corporate executives to Mexico. Following is a brief description of the estimated costs.
Meals $120.00 per person
Taxis $50.00 per day
Air fare $404.00 per person
Tips $75.00 per person
Hotel $300.00 per person
Local air fare $400.00 per person
Total projected cost: $3296.00 per person
Meeting room expense $300.00
Total cost of trip: $10,188.00
The following is an account of the expected miscellaneous expenses that will be included in this program.
Professional services ($250 per hour) $37,500.00
Two quality auditors salary $360,000.00
Packet ($2.00 x 129) $258.00
Human Resource specialist salary: $122,500.00
Consulting fees ($200 per hour) $60,000.00
Severance max liability $635,000.00
Total package cost for 4 years: $1,215,258.00
TOTAL PROJECTED COSTS: $1,255,446.00
In 1997, PepsiCo spun-off its restaurant business to a separate subsidiary called Tricon. This company includes Pizza Hut, Taco Bell and KFC. This will include 29,000 restaurants between the three chains. In Mexico, Tricon weathered the storm and now has the brands that consumers love. In fact, KFC sales in Mexico were up 39% in 1997 and also had a strong growth in profits.
Garcia, Augie. Discussions, March 12, 1999
Gibson, Charles H. Financial Statement Analysis, 7th edition. 1998.
Tricon 1997 Annual Report. Tricon Global Restaurants, Inc.
Dun and Brandstreets Industry Averages. 1993,1994,1995 editions
Table Of Contents
Mission Statement .1Stated Objectives *
Year U.S. Intl Total Growth%*
Financial Ratio Analysis and Capital Outlook*
Company Ratios: ..10
Implementation Plan .. .34
The Re-Franchising Program 34
The Severance Program . ..35
The Evaluation and Control Program .36
Projected Costs ..39