The Domino’s Pizza system is the second largest pizza franchise in the world, after YUM!’s Pizza Hut, with franchise-owner Domino’s Pizza Inc. (DPZ) reporting a systemwide restaurant count of 15,914 restaurants at fiscal year-end 2018. Domino’s Pizza Inc. owns and operates just 390 corporate stores in the United States, with the balance made up of US franchised stores (5,486) and international franchised stores (10,038).
Pizza is a very well-liked food concept in many countries across the world, as it is usually the second or third most popular fast food after hamburgers and chicken, and the company has a smart and efficient business model. First of all, Domino’s Pizza operates the premier pizza delivery business and has fairly limited on-premise consumption, which means most of its stores are quite small and therefore not as expensive as restaurants offering full dining. Delivery is a point of differentiation and lowers the order threshold for the consumer. Ordering a pizza is the ultimate comfort food; having something you like to eat delivered to your doorstep, and for a very reasonable price.
Any pizza business has two potential points of strength; the pizza oven and the pizza dough. Most consumers do not have an oven capable of reaching the same high temperatures that a professional oven can. And since the best pizza is made from fresh dough being baked for a short amount of time on the bottom of a very hot oven, this gives pizza restaurants a clear quality advantage versus frozen pizza’s from the supermarket.
Fresh dough is another advantage: I learned to make pizza’s at home a couple years ago, by making my own dough and baking them on a plate in a microwave-oven. The taste advantage from using fresh dough are so significant that, even though my oven is not great, I have not eaten a frozen pizza from the supermarket ever since. Making fresh dough is also the hardest part about making a pizza; it is messy work and you have to plan your meals ahead in order for the dough to rise.
In other words, there is significant work involved which is why most people who want to eat pizza will not make one at home, but will either buy one in the supermarket and heat it up, order one from a delivery restaurant or go out to eat one. Since Domino’s is the most successful pizza delivery restaurant it is well-positioned for the second and third choices. I would argue its position as the foremost pizza delivery system has been strengthened by the rise of the smartphone, as it was one of the earliest restaurant chains with a mobile app designed to order pizza’s (it’s app was introduced over 10 years ago). This innovation has contributed to very strong same-store sales growth over the past couple years. The question is whether it can sustain this advantage with the rise of delivery aggregators.
The Franchise Model
To say the Domino’s model has delivered has delivered attractive returns is an understatement: Domino’s Pizza is valued at $11bn or so despite the fact that it owns just a couple hundred stores. This is made possible by the fact that the real money is made by franchising stores to independent owners, who pay a percentage of their revenues for the right to operate under the Domino’s name. So Domino’s receives slices of revenue generated by thousands of restaurants across the world, which of course adds up to very significant amounts of money, all while employing minimal amounts of capital.
After struggling its first few years as a public company, Domino’s Pizza Inc.’s stock began a remarkable run around 2010-2011. The stock is up over 33-fold over the last decade.
The supply chain is also a significant money-maker, with the pizza dough and other ingredients generally delivered to restaurants from central manufacturing hubs, known as commissaries. The fact that making the dough centrally is more efficient also allows Domino’s to charge its franchise partners marked up prices for supplying this key ingredient. In fact, most of the ingredients required to make a pizza (flour, tomato sauce) are so inexpensive that the priciest part of a pizza is usually the cheese (followed by meat). The fact that pizza’s are made with reasonably priced ingredients allows all participants in the Domino’s value chain to make money, while still maintaining attractive price points for the consumer.
Outside the United States, the franchise concept works a little bit differently, with master franchise partners usually being assigned exclusive territories with the ability to run their own commissaries. Some of these franchise partners have become very successful companies in their right. Domino’s Pizza Enterprises (AU:DMP) for instance, originally from Australia, but currently also operating in New Zealand, Japan and parts of Europe, has grown into a sizeable enterprise of its own (stock chart below).
Domino’s Pizza Group (UK:DOM) is another big one, originally from the UK, but also active in Ireland and other parts of Europe (stock chart below). Both companies have been long term winners but have seen some of their gains being paired in recent years, presumably over valuation concerns now that growth has slowed down quite a bit. Another challenge has been the sometimes fraught relationships with franchisees, public scrutiny over working conditions and employee compensation at those same franchisees and the challenges met while expanding into new markets.
Jubilant FoodWorks meanwhile operates the Domino’s master franchise in India, while Alsea operates master franchises for Mexico, Colombia and Spain. And then there are dozens of private companies operating Domino’s master franchises for a single or a couple of countries.
In recent years, there has been increasing consolidation in the Domino’s system, with the most successful master franchisors expanding into other markets, either by negotiating with Domino’s Pizza Inc. for additional territories, or by buying a company already operating such a franchise. The main reason is usually to pursue additional avenues for growth after approaching maturity in their established markets. What I have found interesting is how much of a difference there can be with regards to the financial returns the Domino’s brand generates in different markets. Some markets like Australia are very lucrative for Domino’s while other markets have been very been difficult. The European market currently looks something like this… The countries left blank are territories for which I don’t have data about the operator, but a significant number of them do have Domino’s restaurants.
Map of European Domino’s system with white territories representing either unknown franchise owners or no Domino’s presence. Domino’s Pizza Group and Domino’s Pizza Enterprises jointly operate the Domino’s franchises in Germany and Luxembourg. I colored the different countries using a blank map found here.
Two of the companies operating in Eastern Europe secured a listing on the London Stock Exchange in 2010 and 2017 respectively, but they haven’t exactly delivered the attractive returns that their larger peers have. DP Poland (UK: DPP) operates the Domino’s brand in Poland, which failed to take root in an earlier attempt in this market. The brand has been given a second chance by a different management and is currently at 69 or so stores in this market. DP Poland’s share price has been decimated over recent years due to lagging growth of its same-store sales, significant operating losses and other difficulties while trying to scale. The company has raised additional equity capital on multiple occasions, which has led to very significant dilution in its shares (stock chart below).
DP Eurasia (UK: DPEU) is a more recent listing and started out in Turkey but has expanded by acquiring the license for Russia too. This company appears to be performing quite well from an operations point of view and has about 724 stores currently (year end 2018). DP Eurasia’s stock has been held back by currency volatility, the Turkish Lira especially but the Russian Ruble as well.
The company has sought to refinance its formerly euro-denominated debt with credit denominated in local currencies, mostly Rubles, in order to avoid having to sustain liabilities in hard currencies like the Euro with earnings in soft currencies like the Lira. Despite the fact that they’ve wisely managed to eradicate their hard currency debt, the company’s shares have still been hit by the depreciation of the Lira, which has significantly depressed the value of its GBP-dominated shares (stock chart below). The reason DP Eurasia has borrowed in Rubles instead of Lira is because commercial interest rates in Turkey are prohibitively expensive. DP Eurasia is profitable on an underyling basis (excluding items deemed non-recurring by its management).
I recently watched an investor day presentation by Australia’s Domino’s Pizza Enterprises and, as I shared on Twitter, I found it quite illuminating. For a Domino’s master franchise to be successful it is critically important to get to significant scale within a reasonable timeframe. This may seem like a bit of an open door but a lot of Domino’s operators have had to learn this lesson the hard way again and again. As DPE’s current CEO Don Meij stated in the presentation below, Domino’s Australia went bankrupt three times before finally achieving success on the fourth try. The reason why they failed the first three times is because they threw in the towel before reaching critical scale. It is easy to forget such humble beginnings in a market that is currently very profitable.
Another thing I learned was the fact that Australia is not a exceptionally big pizza market at all. Pizza is the third most popular fastfood in Australia, after hamburgers and fried chicken, while in a lot of other markets it is in second place after hamburgers. It is therefore possible to achieve success in markets where pizza consumption per capita is substantially lower than it is in the US for instance. It is also possible to struggle in markets where pizza consumption is high, like France, where Domino’s has also gone through a difficult period some years ago.
The key to operating a successful Domino’s master franchise is to have the Domino’s brand stand out against all the other pizza options that are available in the marketplace. In other words, the brand has to be put to work to generate demand, which can only be achieved with significant marketing spend. Tv is still quite important for Domino’s and generally requires a significant advertising budget. That budget has to be levered on a good number of restaurants in order to make sure the marketing expenses stay at a reasonable level per store.
Every new market that’s entered starts more or less from scratch, with limited consumer awareness and entrenched behavior that benefits the incumbents. This is why it is so difficult for a new Domino’s market to get to a scale that makes economic sense. Once you manage to reach that scale that the flywheel can start spinning, because at that point the business can self-generate its growth through reinvestment in marketing.
In the case of Domino’s Pizza Poland for example, it is clear that they have not managed to get there yet. They are currently just shy of 70 stores and they reckon they need at least 100 stores to get to positive company-wide EBITDA-margins. With an operation of this size it is essentially impossible to buy the appropriate share of voice through marketing channels like tv. This predicament is currently exacerbated by the high marketing spend from several delivery aggregators, including Pyszne and PizzaPortal, which are competing for the same customers.
This is a phenomenon that can be seen internationally; it appears that the entire Domino’s franchise has come under a bit of pressure from aggregators like Takeaway, Uber Eats, Grubhub and Doordash, which are oftentimes operating at a loss. Since the aggregators are providing access to technology platforms that many small operators would not be able to afford or operate on their own, they’ve essentially levelled the playing field for pizza restaurants again. In my opinion this has decreased Domino’s Pizza’s advantage in the mobile ordering space. Domino’s Pizza Inc.’s CEO conceded recently that the aggregators are indeed having an effect on their same store sales growth (item below). For now I have no strong conviction on Domino’s but it is a business with some fascinating developments.
Note: the stock charts are a little bit dated as there was some lag between starting the article and finishing it. I did not feel like making screenshots for all the stock charts again, so please be aware that the present day stock prices may differ from those displayed in the article.