McK_SIBC Taco Bell Final

McKinsey & CompanyTaco Bell Expansion StrategyFall 2015

2

Travel Team

Colin Lillibridge▪ Junior▪ Finance and

Economics▪ Duncan Hall

Nathaniel Marti▪ Junior▪ Finance and

Med. Studies▪ The Manor

Timothy Machasio▪ Sophomore▪ Finance and

ACMS▪ O’Neil Hall

Maria Marquez▪ Freshman▪ Mechanical

Engineering▪ Lewis Hall

Jens Munthe-Kaas▪ Sophomore▪ Political

Science▪ Off-Campus

Helen Sheng▪ Junior▪ IT

Management▪ Badin Hall

Dan Murphy▪ Sophomore▪ Mech. Eng.

and ACMS ▪ Dillon Hall

Rachel Oberst▪ Sophomore▪ Finance and

Spanish▪ Ryan Hall

Chang Woo Jung

▪ Sophomore▪ ITM and

Chinese▪ Off-Campus

Edward Murphy▪ Freshman▪ Finance and

Economics▪ Duncan Hall

3

Executive Summary

• Taco Bell is the leading Mexican style fast food provider in the United States, and a major division of Yum! Brands

Client

• The company occupies a strong position in the $220B U.S. fast food market

• “Fast casual” represents a growth concept for Taco Bell to consider in its short- and long-term business strategy

Situation

• Taco Bell should enter fast casual as a strategically aligned opportunity with high profit potential

• It should do so by acquiring a separate brand, to mitigate against current customer perceptions and execution risk

Recommendation

4

OBJECTIVE: TACO BELL GROWTH STRATEGY

Fast Food Industry Performance &

OutlookTaco Bell Overview

and Position

Fast Casual Industry Performance &

Outlook

RECOMMENDATION: FAST CASUAL MARKET ENTRY

Feasibility Strategy

Moving Forward

Fast Food Investment Potential

Fast Casual Investment Potential

5Source: IBIS World – Fast food market

2007

2009

2011

2013

2015

2017

2019

2021

-4-20246

Revenue Employment

% c

hang

e

• Key drivers: increased costs and expenses, healthy eating index, and consumer confidence

• Growth will remain flat into the future – the industry is a matured market

• Stagnant domestic profits will lead to further expansion into foreign markets

• In response, traditional market players attempt to shift appeal towards millennials:

• Healthier and more customizable products• Digitization, including mobile apps

Industry Outlook

McDonalds15% Yum

9%Subway

6%

Wendys4%

Burger King4%

Chick-fil-a2%

Other59%

• Average profit margin of 5.1% - expected to remain about the same over the next 5 years

• Purchases expected to become more expensive as global demand forces produce prices upward

• Industry wage costs consume 25% of revenue, expected to increase into the future

• Marketing expenses increase as companies attempt to engage consumers on new platforms like mobile apps and music streaming websites

• Tough competition in monopolistic competition environment

Cost Structure Benchmarks

Fast Food: A Stagnant and Fragmented Industry

YOY Revenue and Employment Growth

Competitive Landscape

6




and Position


Outlook



Moving Forward



7Source: Business Insights; http://www.yum.com/investors/addl_info.asp

Taco Bell occupies a strong strategic position within the fast food market

1946Glen opens the first Taco Bell in

Downey, California.

19651st

International Expansion into

Japan

2007Re-enters the

Mexican market by positioning its restaurants as

American fast food

2013International and U.S. divisions are combined; China and India remain

separate

1978PepsiCo

purchases Taco Bell

2003 Company

opens its first unit in China

Timeline

Key Executives▪ Brian R. Niccol, CEO▪ Liz Williams, CFO▪ Melissa Lora, President of Taco Bell International

Current Position▪ Total Revenue (Franchisee and Corporate):

$8.2B▪ Revenue as a percent of total fast food market: ▪ At the end of 2014, there were 6199 store

worldwide (5921 US & 278 international)

Management Objectives▪ Become the largest fast food provide of Mexican

style cuisine in emerging markets▪ Become the most recognizable Mexican food

brand in the world

Mission Statement

“We take pride in making the best Mexican style fast food providing fast, friendly, & accurate service.”

SWOT Analysis

Management & Current Position & Goals

Strengths• Cheap and value

meal• Americanized taste• Fast and convenient

service

Opportunities• Emerging Markets:

Latin America, Continental Europe, Russia

Weaknesses• Obtains nearly all

sales in US – little international exposure

Threats• Change in consumer

preferences• Stagnation in fast

food market growth

Taco Bell leads the U.S. Mexican style fast food segment, with a roughly 3.6% share of the $221 billion U.S. fast food market

8

Taco Bell is a key part of YUM! Brands, and was its only profitable division in 2014

2014 2013 2012 2011 2010$0 B$1 B$2 B$3 B$4 B$5 B$6 B$7 B$8 B

Company sales Franchisee sales

CAGR: (6%)

CAGR: 7%

Source: Business Insights; http://www.yum.com/investors/addl_info.asp

One of Three YUM! Divisions

Divisional Restaurant Per Store ProfitTaco Bell – US Sales

2010 2011 2012 2013 2014

Taco Bell has highest profit margin per location, but its performance is falling due to changing market trends

It is the smallest division in YUM! by store count, and has the smallest growth domestically and internationally

Recently, diminishing margins in Chinese segments contributed to decreasing operating profit

KFC continues to be the cash cow of YUM!, both domestically and internationally

2010 2011 2012 2013 2014 $-

$200 $400 $600 $800

$1,000 $1,200 $1,400 $1,600

Taco Bell KFC Pizza Hut

Stores CAGR Margins

Taco Bell 6,199 1% 18.90%

KFC 14,197 1% 8.20%

Pizza Hut 13,602 2% 8.20%

9Sources: Business Insights Essentials, Forbes, YUM! Brands Investor Relations, Wall Street Journal, IBIS World

Overall trend line points downward for Taco Bell, but profit margins increase

Operating profit increased by 5 % in 2014 Sales increased by 7% - driven by 3% unit

growth and 4% same-store sales growth 62 new restaurants; 81% of these new units

were opened by franchisees Restaurant margin improvement – leverage of

G&A cost Stabilizing factor in YUM! Brands Increased capital expenditures as Taco Bell

continues to expand Positive outlook for 2015 Spin-off from YUM! discussed by analysts At the end of 2014, of the 6,314 stores

worldwide: 5921 in the United States 278 internationally

Key Developments

(in $ mm) 2011 2012 2013 2014 2015

REVENUE $2,119 $2,109 $1,869 $1,863 $1,923

OPERATING PROFIT $384 $435 $456 $480 $520

PROFIT MARGIN 15.3% 18.2% 19.5% 18.9% 21.4%

2011 2012 2013 2014 2015$0

$500

$1,000

$1,500

$2,000

$2,500

REVENUESMoving average (REVENUES)OPERATING EXPENSESPower (OPERATING EXPENSES)

Taco Bell Five Year Summary ($m)

10Source: Huffington Post, Mobile Commerce Daily, National Restaurant News, Wall Street Journal

Current efforts for brand modernization include tech and menu initiatives

While serious concerns still exist about the quality of Taco Bell, the restaurant has taken significant steps to evolve its brand. Integration of mobile and online ordering, a move to healthier and more humane egg

supplies, and increased transparency about beef recipes have begun the process of brand transformation

In November 2015, Taco Bell announced a switch to cage free eggs by the end of 2016

Taco Bell now leads the race for cage free eggs Burger King end of 2017 McDonald’s within the next decade Starbucks and Panera Bread by 2020

Cage Free EggsMobile and Online Ordering In late 2014, released mobile app for online

ordering Upon release, customers using the app

spent $10+ per visit – 20% more than they spent in store

With 3.7 million app downloads, users now spend 30% more than they do in store on average

In late 2015, Taco Bell launched its new website: Ta.co

Estimated 5mm unique visits per month Integration of a loyalty program and

DoorDash delivery Enhanced customization and menu accessibility

70% of Taco Bell customers customize their order

Cost in increased ordering time, personalized suggestions; $0.30+ charged per each add onBrand

ModernizationIntegration

of Technology

Use of Higher Quality

Ingredients

Ingredient Transparenc

y

Improved Brand

Perception

In 2011, a lawsuit against Taco Bell brought the restaurant’s beef under scrutiny

In response, Taco Bell released information on the content of its beef

88% beef; 12% seasoning, spices, water, and other ingredients (Called “Signature Recipe”)

In 2014, Taco Bell launched a new beef transparency module detailing the contents of Taco Bell’s beef

Beef Transparency

11Sources: QSR Web, Mobile Commerce Daily

Breakfast presents an attractive current investment opportunity for Taco Bell

Breakfast Menu Release

• Breakfast launched on March 27, 2014• Expansion of customer engagement and

brand loyalty• Expanding beyond signature Fourth Meal• Accessing the McDonald’s-dominated QSR

breakfast market

Taco Bell Same-Store Sales Growth

The successful rollout of Taco Bell breakfast menu indicates strong brand loyalty, healthy profit margins, and potential for future expansion. Given this success, breakfast represents an especially promising current

opportunity for the company

• The successful launch of the Taco-Bell breakfast menu contributed to same-store sales growth

• Strong margins central to initiative profitability• Notably, gains in same-store sales have

declined since the post-rollout spike

Quick Statistics

• Approximate Margins on Breakfast21%

• Breakfast Share of Total Sales6%

Sunday, Monday and Tuesday breakfast sales exceed late-night Fourth Meal Q1

2013Q2

2013Q3

2013Q4

2013Q1

2014Q2

2014Q3

2014Q4

2014Q1

2015Q2

2015Q3

2015-2%

0%

2%

4%

6%

8%

10%

Breakfast rollout – March 2014

Outcomes

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and Position


Outlook



Moving Forward



13Taco Bell Franchise, LA Times, The Motley Fool, Yum! Brands Investor Relations, QSR Web, Mobile Commerce Daily

Expanding breakfast as a best option displays some growth potential within an already crowded segment

5.5% Franchise Royalty Income

CURRENT RELEVANT MARKET SIZE:

$34.5B FF Breakfast Market

4.9M Taco Bell Breakfast Sales

TACO BELL BREAKFAST EXPANSION ASSUMPTIONS:

Capture 2% of FF Breakfast Market in

next year

$38M NET PROFIT OPPORTUNITY IN THE NEXT YEAR

FINANCIAL DATA• $8.2B in U.S. system wide sales for Taco Bell in

2014• Breakfast items comprise 6% of Taco Bell sales• ~$490M in annual breakfast sales• $34.5B FF breakfast market• ~1.4% current FF breakfast market share• 5.5% franchise royalty fee• 21% margins on breakfast itemsFRANCHISINGAlthough 14.5% of Taco Bell stores are company owned, the model assumes all stores are owned by franchisees. Franchisees pay a 5.5% royalty on all salesSENSITIVITYWithin one year, we assume Taco Bell can expand its share of the FF breakfast market to X%.• 1.4% of market would yield $27M in annual

profits• 2.0% of market would yield $38M in annual

profits• 2.6% of market would yield $49M in annual

profits

KEY ASSUMPTIONS IN BREAKFAST EXPANSION MODEL

1.4% FF Breakfast Market Share

PROFIT POTENTIAL OF TACO BELL BREAKFAST EXPANSION

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and Position


Outlook



Moving Forward



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While comparatively small, fast casual industry is characterized by quick expansion

QSR Magazine; National Restaurant Association

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

0

10

20

30

40

50

Best Case Base Case Worst Case

Sale

s ($

bn)

Fast Casual

$30bn market size (revenue) Delivering fresh food Provide a high level of customization Balance price and experience Cultivate high level of customization• 550 % growth since 1999; 10x the

growth of fast food

YOY Change in Consumer Traffic Forecasted Industry Sales for Fast Casual

2009 2010 2011 2012 2013

-4%

-2%

0%

2%

4%

6%

8%

10%

Quick Service Restaurants (Excluding Retail and Casual)RetailFast Casual

Consumer preference for Mexican FC: Mexican 28 % Hamburger 25 % Other sandwich 23 % Chicken 13 % Pizza 10 % Bakery and café 1 %

Segmentation of fast casual by concept

16Statista; Washinton Post; Wall Street Journal; Scarborough Research

Millennials are “perceptionists”—and fast casual is characterized by image and experience

Perception & image are two of the most important factors in the establishment of fast casual chains.

Existing fast casual customers are more likely to refer to fast food as “gross” or “unappealing.”

Related to status

Overall Trends:- Generational shift in consumer

trends has opened up market for increased quality proposition

- Fast casual chains are running out of white space; overseas expansion imminent?

- Average check between $8-9; fast food chains average $5.3

- Concerns about impact of increasing meat prices and labor costs

- Answer from the fast food industry has been increased customization; McDonalds build-your-own-burger

•Fast food chains pride themselves on efficiency; fast casual is an experience

•High level of customization; are you expected to customize?

•Fresh and healthy options; i.e. can you see the process?

•Locally sourced foods; related to perception

Local Healthy

ExperienceVaried

Educated Urban lifestyle

Health conscious

Aged 20-40Infrequent fast food

consumers

Shifting perceptions translate to restaurant segment growth differentials

Source: IBIS World

Overall, today’s restaurant industry is in a mature market stage. Total revenue remains about the same, while profit generation requires

extra investment on non-price factors like new customer trends

U.S RESTAURANT INDUSTRY

Segment Avg. Operating Profit (’14)

Market Share

Fast food 11 - 13 % 31 %

Fast casual 6 – 7 % 9 %

Casual dining 4 – 5.5 % 24 %

Family dining 6.5 – 8.1 % 21 % Casual Dining Segment•1.8 %

Fast-food segment•3.5 %

Fast-casual segment•9.5 %

Increased costs of ingredients add industry pressure

Consumer trend of preferring healthier optionsPurchase not rooted in calories, but brand perception

Increased labor costs add pressure to franchises

Distress levels are at record low

17

Segment GrowthKey Industry Comparisons

18Business Insights, Yum! Brands Investor Relations, QSR Magazine

Among all quick service restaurants, fast casual presents an increasing threat to fast food industry health

McDonald's32%

Subway11%

Panera BreadStarbucks1%

Burger King8%

Dunkin' Donuts6%

Chipotle3%

Wendy's 8%

Taco Bell7%

Pizza Hut5%

KFC4%

Carl's Jr./Hardee's

Sonic Drive-In3%

Domno's Pizza3%

Chick-fil-A4%

QSR Magazine Rankings

• QSR 50 Ranking#6

• Mexican Segment Rank#1

Taco Bell has a strong position within the Fast Food industry, specifically the Mexican segment. Chipotle, however, has made gains in the Mexican QSR space. Increase in healthy eating habits threatens the fast-

food industry as a whole

Quick Service Restaurant Market Breakdown:

• Revenues have declined and remained relatively flat in the past four years.

• With increasing margins, and strong sales growth, Taco Bell remains a major player in the QSR restaurant.

• Taco Bell still dominates the Quick Service Restaurant Mexican Segment.

• Chipotle (QSR 50 Ranking #15) is showing strong growth in the Mexican Segment with a #2 Ranking

19




and Position


Outlook



Moving Forward



20

FC option shows significant profit potential, but financial and customer experience cost factors are key

Achieve ~7% margin based on industry

standard

CURRENT RELEVANT MARKET SIZE:

$30B in total FC sales 23% Mexican Concept

TACO BELL FC ENTRY SCENARIO ASSUMPTIONS:

Capture ~10% of FC Mexican Concept

$48.3M NET PROFIT OPPORTUNITY

RE-BRANDING & ADVERTISEMENTStudies on millennial generation’s spending habits and restaurant preferences indicate that a thorough process of changing brand perception is necessary in order to penetrate the market. Such rebranding could require additional expenditure on advertisement and promotion.NEW STORE vs. REMODELINGU.S. Taco Co was a $500,000 investment during its year in business. Wendy’s previously launched incentive-program for existing franchise owners to remodel their stores as estimates indicated a potential increase of 5-10 % in restaurant sales. CANNIBALIZATIONAlthough fast-casual restaurant customers spend about 40 % more per visit, the adjusted amount of money spent is difficult to assess as there are no companies that have recorded the full effect of a switch. There is a danger of cannibalization.

ADDITIONAL COST FACTORS IN FAST CASUAL SWITCH

$6.9B Potential Market Share

ESTIMATED PROFIT POTENTIAL OF TACO BELL FAST CASUAL

Sources: QSR Web, Mobile Commerce Daily, Business Insights

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and Position


Outlook



Moving Forward



22Source: Mintel

Market Penetration

1

Product Penetration

2

Market Developme

nt3

Diversification4

New Product

Same Product

New Customers

Same Customers

Why an acquisition • Growth of 26.7% is predicted from

2013-18, reaching $38 billion in 2018• US social trend toward eating healthy• Taco Bell’s current image will detract

from its effectiveness in the fast casual market

• Entering fast casual under a different name gives substantial risk mitigation; core brand will not suffer negative externalities

Alternative ways of entering fast casual1. Develop FC internally and launch a

new brand2. Develop FC internally and introduce

under current brand3. Expand in untapped markets to

target new customer segments4. Inorganic entry, through

acquisition

Counterarguments to address• Competitors and case studies include

failures• Barrier perceptions surrounding Taco

Bell are too strong and negative• Strong competitors in Mexican fast

casual• Lower profit margins; increasing costs• Fast food market is still much larger

than fast casual• Execution/startup risk (will Taco Bell

deliver a good product?)

CONCLUSION: Taco Bell should enter fast casual market

through an acquisition

Recommendation: Taco Bell should enter the fast casual industry through acquisition

23




and Position


Outlook



Moving Forward



24

Negative brand perceptions are barrier to be addressed in fast casual entry

CHEAP VALUE MEAL

AMERICANIZED TASTE

FAST & CONVENIENT

UNHEALTHY & LOW QUALITYPositive Reaction

Negative Reaction

Sources: Armitage, Brand Audit for Taco Bell

NO ATHENTICITY

• Traditional “Quick Service Restaurant” (QSR)

• Offers “Fourth meal,” enables order after midnight

• Drive thru, Taco Bell mobile application

• Majority of sales based on take-out• Relatively low investment into store

interior• Minimum or no in-store dining service

and workforce

CHEAP & BAD DINE-IN

• Menu variety includes tacos, burritos, etc.

• “Americanized,” or “Tex-Mex-Style” food• American adoption of popular Mexican

foods like the Cantina Bowl

• Bad choice for authentic Mexican food• Relatively small amount of vegetables

• Ingredients substituted according to price and Taco Bell’s own recipe

• Nationwide restaurant distribution• Relatively low prices• Promotional value meal deals like Big

Box

• Cheap price and quick service imply low quality food, fail to attract older

customers• Growing concerns about healthy eating

damage Taco Bell’s brand image

NBC News

25Business Insider

Comparable cases present compelling argument for brand departure when entering the fast casual market

Super Chix Company Overview• An exploratory venture by YUM! Brands;

started in 2014• Company Slogan:

“The Last True Chicken Sandwich”

Menu

Outcome• Scored 4 out of 5 stars on Yelp. • Opened 3 locations within 1 year• Recognized as top competitor with Chick Fil-A• Sold company to Christophe P., Nick O. & Jeff. S.

• Straightforward food options: nuggets, salads, sandwiches

• Emphasis on high quality ingredients prepared with integrity

• “We only use the highest quality potatoes”

• In accordance with growing trend against genetically modified ingredients.

• Madagascar Bourbon Vanilla Beans

KFC 11 Company Overview

Menu

• KFC’s Fast Casual Counterpart, opened August 2013 in Louisville, Kentucky

• Encourages slow paced dining that is convenient.

• Global Cuisine- flavors like Sweet Orange Ginger, Caribbean Tango and Southwestern Baja

• Salad, Flatbreads, “Crispy Bites”, Rice Bowls• Emphasis on fresh, healthy, and

sophisticated options• Mashed potatoes: “Now they're

"smashed" and infused with garlic”• Items not available: fried chicken bucket and

KFC signature biscuits • Entrée Prices: $4.99-$6.99

Outcome• Closed after a year• Scored 3 out of 5 stars on Yelp

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and Position


Outlook



Moving Forward



Important factors to consider in acquisition

• Scalability – e.g., from regional to national

• Expertise in fast casual• Cultural alignment

• Product quality

• Customer loyalty

• Fair multiple• Cost, distribution, or

sourcing synergies

Attractive Price

Brand Strength

Expansion Potential

Effective Manageme

nt

27

CONCLUSION

Conclusion: Taco Bell should look to enter the fast casual market through acquisition

Given these findings, and taking into account the company’s current investment opportunities and management objectives within fast food, we believe a fast casual market entry presents high upside

potential and makes long-term strategic sense for Taco Bell

Ultimately

Strategic Rationale

Feasibility and Execution

Overall market saturation of Fast Food industry Continuing market growth of Fast Casual industry Growth story and consumer trends drive compelling profit potential

Strategic alignment demonstrated in past attempts to introduce fast casual concepts

Inorganic entry represents a feasible option in response to barrier perceptions concern and execution risk

APPENDIX

31Sources: Taco Bell, Business Insider, Nation’s Restaurant News

A Case Study: Taco Bell Cantina demonstrates management’s interest in a fast casual entry

Taco Bell Cantina opened in Chicago’s Wicker Park neighborhood on Tuesday September 22, 2015

San Francisco location will open later this month

Taco Bell Cantina serves alcoholic beverages Alcoholic beverages retain Taco Bell branding

Twisted Freezes (Similar to Baja Blast) Twisted Freezes range from $6.19 to $7.19

depending on the choice of alcohol Large increase in price point

Taco Bell is currently experimenting with a fast casual restaurant concept that places itself in direct competition with the likes of Chipotle and Qdoba. This initiative reflects its plans to expand, as well as the stresses put on the brand by new initiatives such as the Taco Bell Cantina restaurant. The success of Taco Bell Cantina depends on

its ability to adapt its brand.

Urbanization Localization

Green Transparency

Digitization

5 Consumer TrendsNew Taco Bell Fast Casual Restaurant

Taco Bell’s new Cantina restaurant integrates the preceding five consumer trends into the existing brand

Drive thru window replaced by walkup windowNew Taco Bell units have lower costs

Reduced square footageRecycled materials

Open kitchen design increases transparencyFresher ingredients are used in foodBase menu stays same with Taco Bell classics

32Mobile Commerce Daily, National Restaurant News

In Absence of Fast Casual: Alternative investment options for Taco Bell

Taco Bell has already made efforts at menu expansion and improvement, digitization, delivery and customization, and brand redevelopment. These initiatives have improved Taco Bell’s performance. However,

costs of these initiatives, potential for limited impact, and possible loss of customers lead us to recommend an entry into Fast Casual through acquisition.

Menu Expansion

and Upscaling

Delivery and Customizatio

nDigitization

Marketing and Brand

Redevelopment

Entry into Fast Casual

Menu Expansion and Upgrade Expansion of successful offerings Further capitalization on breakfast menu success Continued development and release of new

products Potentially high costs of development Diminishing impact of continued menu

development Marketing expenditures on new product lines

Digitization Release of mobile app and website (Ta.co) 3.7 million app downloads and 5 million monthly

visitors to website Mobile and web customers spend more than

average in-store customer Digitization already in process

Delivery and Customization Integration of DoorDash delivery with website

and app Online ordering enhances customization options 70% of Taco Bell customers customize their order Higher labor and ingredient costs associated with

less uniform orders Limited impact on the business with small

investment

Marketing and Brand Redevelopment Taco Bell is currently improving brand image

with quality ingredient initiatives Upscale brand showcased in Taco Bell Cantina Deeply ingrained negative perceptions and

stream of undesirable publicity surrounding Taco Bell

Risk of alienating loyal customers and losing sales in lower quality fast-food segment

McK_SIBC Taco Bell Final

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