Cultural lessons to be learned from Domino's

This MBA waxes poetic:

Domino’s is one of the major purveyors of relatively cheap delivered pizza. Increasing cost of raw materials, fuel, and low-end labor is going to be felt more acutely by those dependent on low cost/high production. It appears from the article below that they are having to deal with an organizational culture that has become complacent over the last several years. Now with the high tide of prosperity naturally ebbing to low tide, the rocks below the waves are starting to reveal themselves.

Those who have built strong cultures of quality and efficiency will float out on this low tide rather than breaking up on the rocks and sinking. The high tide will eventually return… and with fewer competitors still afloat.

[size=5]Domino’s Pizza puts franchisees on notice[/size]
Posted by Stefanie Murray | Press News Service February 26, 2008 14:38PM

ANN ARBOR – Frustrated by a group of underperforming franchisees whose shops are pulling down U.S. sales growth, Domino’s Pizza Inc. CEO David Brandon warns the company is prepared to replace lagging store owners by refranchising some shops.

Brandon also said the economy is having a major impact on consumers’ pizza buying habits, going so far as to agree with one analyst’s assertion that the United States is in the midst of a working-class recession.

“We’ve got some disengaged operators who are not performing … in 2008 we will challenge our franchisees much more aggressively than we have in the past,” Brandon said during a conference call today with analysts and investors. “We need to get our domestic franchisees fired up about competing to win and move out those who can’t or don’t want to engage in what it takes to succeed.”

Brandon’s remarks top what was a rough year for Domino’s.

Higher interest payments the company had to pay on big new loans it took out during a financial restructuring last year drove Domino’s 2007 profits down 64.3 percent to $37.9 million, on revenue that increased less than 2 percent to $1.46 billion.

The pizza delivery company earned $1.03 a share last year, down from $1.56 in 2006. Analysts had forecast earnings of $1.09 a share. For the year, Domino’s more than 8,600 worldwide stores increased global retail sales by 6.6 percent, a gain driven almost entirely by strong international pizza sales. Total sales were weak among the company’s U.S. stores.

Domino’s same store sales in the U.S. fell 1.7 percent in 2007, while its international same store sales were up 6.7 percent. Same store sales measure performance only at stores open at least one year, which is a retailer’s best metric of health.

Across the board, Domino’s roughly 570 company-owned pizza shops performed better than its stores owned by franchisees. Domino’s has about 2,000 franchisees who own more than 8,000 stores.

As a result of Domino’s not meeting its internal earnings target, none of its full-time employees were granted company performance-based bonuses for 2007, for the first time since the program started in 2001.

Throughout 2007, Domino’s bottom line was held down by costs from its financial restructuring as well as rising costs of energy, cheese, wheat and labor. U.S. sales improved in the midyear before declining.

“The U.S. economy looks weak and consumers are clearly reining in their spending,” Brandon said. “Food costs, particularly the commodities we rely on in the pizza business, continue to be extraordinarily high.”

take a look in the detail though - some of the international Domino’s are doing very well particularly the UK but it is not ‘one of the major purveyors of relatively cheap delivered pizza’ its upper end of the market; same I think in Australia and Europe as well?

The downside with franchising is that in way too many cases the franchisor sits back once the deal is done. If they value the brand they have to work hard and apply pressure to the franchisee’s in a similar way independents do with Area Managers/GM’s etc. It hardly ever is ‘your own business’ with our name on it.

Very true. Even its corporate stores in the US are not doing badly like the franchise-owned stores. Building a culture is one of the keys to overcoming the “agency issue” of managers or franchisees. Unless non-owners feel some sort of non-financial ownership in the business, they will simply compare earnings to effort – trying to maximize the former and minimize the latter.

In Australia Domino’s ARE the cheap brand, far from the upper end of the market.

They are the bastardisors of price and the public expectation of delivery any time of the day. Their quality matches the price but for many people they only look at price.

They have performed well here recording massive profit increases which I would believe would be due to to their reduction in size of their pizzas which they publicly admitted to on a national TV Current Affairs program as well as expansion of store numbers. They said that reduced the price to increase profits and to match PH who did the same 11 months earlier.

They have had the luxury as has PH and Eagle Boys of having supply contracts locked in for 12 months at a time giving them the ability to ride out the costs increases over the past year. As one Eagle Boys operator told me EB have cost increases caps in place when contracts expire meaning that they won’t pay the going rate when new supply deals are negotiated. This means the indies would be carrying the manufacturers losses to the chains.

Despite quality / size etc Domino’s will probably continue to dominate here due to the massive TV advertising expenditure and as we now enter massive reduced consumer expenditure (from rapidly increasing mortgage rates - now at 8.9%, up 2% points from 12 months ago) consumers will trend towards cheaper pizzas. We have started to see this as our sales level out and even drop from our recent highs (still up 20% for the first 2 months of the year).

Domino’s are doing fantastic marketing and this has resulted in further downturns in PH. Pizza Hut have now listed about half or more of their stores in Western Australia for franchising. They have always been company stores but with sales spiralling downwards they are trying to pass the costs to franchising these outlets. Funny thing they haven’t listed any stronger stores only the lesser trading ones.

With all this I can only see Domino’s continuing to grow and increase profits providing they can continue to negotiate favourable buying terms. They are slowly increasing their offer of $5.95 large (11 1/2") to $6.95 and as I saw yesterday at one store to $7.95.

Dave

I’ve been thinking about this a lot lately. The increases in cheese and flour are certainly affecting us, but it isn’t putting us in panic mode. We probably use about the same amount of cheese and flour per pizza as Domino’s or Little Caesars, but the cost increase as a percentage of their sales is MUCH larger.

Our average pizza price is $17.00. A $1.00 increase in cost per pizza hurts, but it isn’t devastating. What happens when you’re selling pizza for $5.00? Of course they have prices hedged and locked in, but that only lasts for a few months at the most. Eventually the prices will catch up to them. They’re commodities, and with minor variations we’re all paying pretty much the same.

My mistake I thought I had read it someone where but obviously not - they certainly are NOT the cheap brand in the UK which is also performing well.

It sounds like the issue is in the NUMBER of pizzas sold. After all, the money corporate makes is based upon the SALES of the franchisee, not their profit. Domino’s corporate has no financial stake in how much money the owner of the franchise makes.

No its not the number of pizzas sold that are important to Domino’s it is the total sales of all the stores. As they earn royalties they want stores doing $20,000 rather than $10,000.

Domino’s have obviously identified a proportion of the franchise population who’s stores just ain’t growing the same as others.

They obviously have a financial stake in how much money/profit the franchisee makes as without these guys making profit the franchise is worthless - otherwise a) total sales would fall as each franchisee leaves and b) without a profitable business who would buy into it? As the corporate profit is based on the success of the business as whole they obivously have a pretty big financial stake in profitability.

Lets not also forget that Domino’s has 500+ corporate stores - not an insignificant business by itself!

Right, but what I’m eluding to is that as costs rise, net profit drops. However, the corporation is concerned with royalties, not net profit.

Having worked on the corporate side of a franchisor… I can understand Domino’s position. Lets face it 8 of 10 small businesses fail, and a pizza franchise is a small business. Some franchisees think all they have to do is open the doors and invest the money and BANG! The store will be successful!

It just doesn’t work that way.

A franchise is not much more than a brand and a set of systems. The company can’t make the pizzas, pay the bills, check the quality, etc.

I’m sure that Domino’s is concerned with the financial health of their franchisees. They have to disclose store closings and lawsuits in their UFOC and it doesn’t help to sell franchises when more franchisees are failing than succeeding. However, I’m sure they have to keep a distance enough to let that franchisee sink or swim. If you help one failing guy you have to help them all. That could break the company.

I’m not a fan of Domino’s pizza… Tom M’s plan was to engineer a bland pizza cheap pizza that would appeal to the masses. Ever since the bankers took over… the food has gotten alittle better but its not something I would spend my money on.