Domino's & Fortressing, AppFolio, LiveChat, ISRG, Old Dominion, Proponent / HEI, AMZN & Wayfair

Content Published Last Week

1. Domino's Pizza: Fortressing a Market

2. AppFolio: Moat, Retention, & Moving Upmarket

3. Intuitive Surgical: Training Surgeons on the Da Vinci

4. LiveChat / Text: Mid-Market Entry & Building A Sales Team

5. Old Dominion, XPO, Mainfreight & US LTL: A Broker's Perspective

6. Amazon: Shipping Bulky Goods Through the FBA Network

7. Proponent, HEICO, & Aerospace Distribution

8. AMZN Retail & IP Company Learning Journeys (Spotify / Apple)

Domino's Pizza: Fortressing a Market

This interview with the Former CEO of Domino’s Pizza Group explores the topic of ‘fortressing’ or ‘clustering’ stores within a market. DPZ reports multiple benefits of fortressing:

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This topic piqued our interest as we also came across a 'clustering' strategy by BFIT, the European discount gym operator.

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This got us thinking: when and why does fortressing a retail format work?

How did it work for DPZ and why would it or wouldn’t it work for gyms?

And when, how, or why could it work in grocery or other retail formats?

Domino’s launched its fortressing strategy after Papa John's took share in the 1990s by opening stores on the periphery of DPZ delivery zones:

I remember it quite distinctly. It was in Liverpool in March 2014, shortly after I had taken over as Chief Executive. We had a strategist from Domino's US, who had previously worked for Bain. He presented a chart showing the growth of Papa John's and Domino's in the 1990s. Essentially, Papa John's opened around 1,100 to 1,500 stores during that period, while Domino's opened about 200. The 1,500 stores that Papa John's opened targeted Domino's weak points, specifically the periphery of their delivery areas. Papa John's seized the opportunity to offer customers superior service and products in those areas where Domino's was weakest. This strategy led to Papa John's growth and its emergence as a serious competitor to Domino's in the US. - Former CEO of Domino’s Pizza Group

This interview goes on to explore the nature of competition for DPZ and how the company fortresses markets to combat competition.

The origins of fortressing can be traced back to Bertrand, Cournot and Hotelling’s theories of competition in the early 1900’s. In combination with (painfully) digging back through our old microeconomics books, we've planned interviews two more interviews with the Founder of a discount gym and Former CEO of a leading discount grocer to understand fortressing and competition across retail formats in more detail. Next week we plan to publish an interview with the Founder of a leading discount gym exploring this topic.

The aim of this research is to understand why, when, and how fortressing can be successfully executed, and, more importantly, when and why it goes wrong. This could be relevant for many retail formats but specifically those currently ‘fortressing’ their estate including DPZ, WING, BFIT / GYM. Please ping us with any other companies you see explicitly following a fortressing strategy and we will add it to our list to study.

AppFolio: Moat, Retention, & Moving Upmarket

This interview with a Former SVP at APPF is part of our Q1 research to understand the company’s SMB moat and its opportunity to move upmarket. APPF’s core solution is significantly more complex than we first realized. The time and cost of building software to deal with the archaic tax and regulations across all US states suggests an embedded regulatory moat that wasn't clear to us from the outset:

it's a highly regulated market, which took us a long time to build up. There were areas of the country we couldn't sell into until we developed specific features for them. This could be anything from being able to do interest payments on security deposits to complying with tax regulations in Arizona. It took years to build out these features. I appreciate highly regulated industries because they create a natural barrier if you do it well. However, this makes it difficult for a challenger. AppFolio had to raise over $80 million to get to where they are now. - Former SVP at AppFolio

This regulatory moat is one reason the business benefits from <5% annual churn from its SMB customers.

But this SMB moat is arguably already priced into APPF equity. The company has building for nearly 20 years and has acquired most of the SMB customers switching from Quikbooks / Excel or from sleepy incumbents. The SMB market seems fully penetrated. One point that seems to validate the maturity of the SMB market is APPF’s recent strategy to start charging tenants $2.50 to pay their rent. Would APPF take such a profit if it had a long runway selling its core SaaS solution?

It makes a lot of sense to start charging. We discussed this for years. When we initially offered free ACH, it was a strategy to differentiate ourselves and attract more customers. At that time, most people were paying through this method, and we were trying to encourage people to stop using checks. Offering it for free motivated people to stop using paper checks. Exactly, it's pure margin. It's free. It might upset some people, but it's not going to drive anyone away. - Former SVP at AppFolio

This change was implemented mid-2023. APPF earns more revenue from payments than it does from its core software solution; this $2.5 charge per ACH is set to drive significant in revenue growth and margin improvement in FY24.

Given the SMB market maturity, the major question we're exploring is how APPF can grow in the enterprise market. This interview focuses on the challenges AppFolio may face moving upmarket.

We find these inflection points in SaaS companies fascinating, but difficult to handicap the risk / reward. APPF is deploying its FCF from SMB to finance its enterprise GTM. The challenge is that Yardi Voyager, Entrata, and RealPage have stronger enterprise products relative to their historical SMB offerings. The enterprise market is a very different competitive landscape.

APPF's enterprise opportunity is also increasingly important as its revenue mix continues to skew towards lower margin value+ services. One argument against APPF is that its high mix of lower-margin revenue makes it difficult to hit best-in-class B2B SaaS FCF margins. This puts more pressure on long-term revenue growth to hit its rule-of-40 target. Cracking the enterprise market is crucial to underpin long-term revenue growth and hit its target FCF margin.

We have interviews lined up with customers and competitors and plan to publish a learning journey of our APPF primary research by the end of Q1.

Intuitive Surgical: Training Surgeons on the Da Vinci

Intuitive Surgical is facing increased competition from a series of new entrants including startups like CMR Surgical and established medtech players like J&J and Medtronic. A key focus of our ISRG primary research is to understand its historical GTM strategy to convert surgeons and hospitals from lap to robotic surgery. ISRG's potential sales and distribution moat will help us handicap the risk of new entrants driving adoption. This interview focuses entirely on how ISRG trains surgeons for its robots:

Fast forward to today, we're not training as many people as we used to because in a typical hospital, they have three robots. You've got general surgeons, gynecologists, urologists, and in larger hospitals, thoracic surgeons, all performing procedures. When a medical student starts their surgical rotation, they're involved in multiple procedures with a robot from day one. They learn through simulation, skills drills, and training on how to set up the robot. They follow the hospital's protocol. Today, many residents and fellows leave their programs as robotic experts. In the US, hospitals generally don't hire a urologist who hasn't used a robot during their program. It would be a waste. - Former VP Clinical Sales at Intuitive Surgical

How new entrants like J&J and Medtronic could build training operations to drive adoption for their robots is questionable:

Laparoscopic training, for the most part, isn't provided by Johnson & Johnson anymore. Companies like Intuitive are trying to offload training to residency and fellowship programs. This allows them to scale down their training operation instead of scaling it up. Johnson & Johnson has largely done the same. - Former VP Clinical Sales at Intuitive Surgical

The interview further explores the scale and scope of Intuitive's training infrastructure and when and how surgeons familiarize themselves with the Da Vinci.

LiveChat / Text: Mid-Market Entry & Building A Sales Team

LiveChat, recently renamed Text, is one of the most efficient SaaS companies we’ve studied. Its ~50% FCF margins are driven by an effective sales and marketing strategy via its partner network. This interview with a Former Sales Executive at the company discusses the efforts to build a sales organization to address the mid-market.

"Our strategy, as I mentioned earlier with Ikea, was to focus on winning country contracts rather than global ones. We knew we couldn't compete with companies like LivePerson or Zendesk, who could handle a global client like Ikea. Instead, we targeted and won contracts with Ikea Canada and a region in Germany. This approach allowed us to work with larger brands, using their logos and testimonials to build trust in a larger market. We didn't have a five-year, $10 million contract with Ikea, but we had $100,000 contracts with two countries, which still allowed us to grow. It's a different kind of growth. - Former Sales Executive at Text

Old Dominion, XPO, Mainfreight & US LTL: A Broker's Perspective

LTL carriers who enjoy a strong local market presence rely less on third party carriers for the last-mile leg. Not only does this translate into a lower cost base for the carrier and lower prices to the end customer, it also enables the carrier to maintain control over its freight:

Oak Harbor, a private carrier, is quite prominent on the West Coast, operating from Washington down to southern California. That's their primary area of operation. On the other hand, Old Dominion doesn't really like going into Washington. For instance, a shipment of two pallets from Los Angeles to Seattle might cost around $400 with Oak Harbor. However, the same shipment with Old Dominion could cost $700. This price difference can be significant for a small customer who only ships a few LTL shipments per month. They would typically opt for the cheaper carrier. Conversely, Oak Harbor doesn't really like going to places like New Mexico, where they have no presence. For the same shipment size from Los Angeles to Albuquerque, Old Dominion might only charge $350, while Oak Harbor could charge $650. In the LTL world, carriers sometimes issue embargoes due to freight volume. If a large volume of freight is flowing into the Chicago, Illinois market, and certain carriers are using Chicago-based carriers or owner-operators to make their deliveries, that local company might issue an embargo to their partner carriers on the LTL side. They might say, don't bring any more freight to us, we need to service our own clients first. In such cases, the asset-based company that already has a large network of their own trucks is more likely able to handle the volume of freight for their own customers. - A Former Solutions Specialist at Old Dominion

In this interview, a former Solutions Specialist at Old Dominion sheds light on his experience as a broker dealing with LTL carriers.

Amazon: Shipping Bulky Goods Through the FBA Network

One differentiator between Wayfair and Amazon is that the latter doesn't offer warehousing solutions for bulky items to its suppliers in Asia. Suppliers must provide Amazon with a specific pick-up point or drop the goods at an FBA warehouse for overseas shipments because Amazon prioritizes the storage of the goods it purchases/sells directly. This can save time and money for the supplier when shipping via W vs AMZN:

Amazon doesn't provide storage services. Instead, it purchases storage services in China for its own merchandise. - Former Senior Manager at Amazon Logistics

In this interview, a Former Senior Manager at Amazon Logistics sheds light on the process of moving bulky goods through Amazon's FBA network.

Proponent, HEICO, & Aerospace Distribution

Proponent is a private aerospace aftermarket component distributor that grew out of a partnership between Kapco Global and Avio-Diepen. The business operates in the same world as HEICO’s Seal Dynamics and Air Cost Control, its two niche distributors.

This interview with a 30-year aerospace veteran explores how Proponent scaled, why its philosophy is different to HEI, and just how unique HEI’s two distributors really are in the market:

Everyone was pursuing Air Cost Control. They have a unique niche that no one else could match. The founders, a husband and wife, started at Airbus and established excellent relationships with all the electrical interconnect suppliers. After several years, they created a distribution company and transferred all their Airbus relationships to their new venture. - Former VP at Proponent

This interview continues our exploration of understanding how components are distributed to airlines and 3P MRO shops and the potential synergies of HEI / Wencor’s vertically integrated strategy. Other interviews on this topic include:

1. Wencor, Seal Dynamics, & Aerospace Aftermarket Distribution

2. TransDigm, AdelWiggins, & The Aerospace Aftermarket

3. Satair & Aerospace Distribution

4. AmSafe, HEICO, & Aerospace Aftermarket Distribution

AMZN Retail & IP Company Learning Journeys (Spotify / Apple)

In this podcast, we explore our new content format "IP Company Learning Journeys" which curate our internal primary research. Each journey provides a framework of which content to read and insights from our library on each company. This episode provides context and insight into why and how we launched this format and we walk through how we curated our work on Amazon's retail business as an example:

1. How a unit flows through AMZN’s network from supplier, inbound, through the network to the customer

2. Structural differences in AMZN fulfillment network design vs 3P carriers and how this impacts variable cost per shipment

3. A seller’s perspective of the economics selling via FBA and FBM

4. How to decouple the AMZN Retail P&L from consolidated numbers and estimate underlying retail FCF

5. Endemic and non-endemic advertising across Amazon and the long-run opportunity