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Anonymous

Restaurant vs Hotel Distribution & FDM Group

{audio:0:00:01} How you would describe the core differences between managing a franchise business and a traditional retail business?

{audio:0:00:14} In a franchise business the franchisees run, open and develop the stores, so the accountability of the brand owner is different. Domino's were very lucky because they had some fantastic franchisees who showed long-term commitment to the brand and took great pride in their achievements.

{audio:0:00:43} A different accountability between the brand owner and those actually operating the business with the brand.

{audio:0:00:51} That is correct. As brand owner, we create a framework which defines how the brand goes to market. Within that framework, franchisees have the freedom to do what they think is right on a local level. They have freedom on the price and range but there are certain core items they have to carry. Local marketing is also at their discretion.

{audio:0:01:28} How much freedom really is there for the franchisee?

{audio:0:01:33} There is a lot of freedom. Pricing is a real strength of the franchise model in this competitive environment where disposable income levels vary massively between stores. Franchisees can tailor their pricing to the competitive environment. Local marketing allowed one franchisee to promote pizza for breakfast, which is not an obvious thing. There is also the balance between the collection and delivery market, lunch versus dinner, SMS versus other digital tools. With all these things, franchisees have freedom to do what they think is right for their local area.

{audio:0:02:33} How do you think about setting the culture at Domino's?

{audio:0:02:39} Domino's is a global brand owned by a US business, who are responsible for the appointment of franchisees in individual overseas markets. The culture of Domino's is defined by the brand owner in the US. It is a brand which is all about ambition and growth, and creating that culture is critical in every market. Seeing what you can do and aiming high and working hard to get there is very much part of the culture. One of the critical elements in a franchise business is creating a coherent offer to the customer. When I joined Domino's, I was both surprised and pleased by how coherent the brand was.

{audio:0:03:39} The freedom I described could result in customers seeing Domino's differently in one part of the country to another or even in different parts of the same city. This is not the case because Domino's have a coherent brand image, where all franchisees pull in the same direction, because they want to grow the brand and are ambitious for the future.

{audio:0:04:02} How do you get that consistency?

{audio:0:04:06} It is about communication and experience. Americans communicate with and through us to operating franchisees and there is a very clear position on what Domino's does and does not represent. There are certain things we have to ask the US permission for but we are given a lot of freedom to operate the brand in the UK.

{audio:0:04:42} What examples do you have which would require permission from the US?

{audio:0:04:48} With new product development, the US would want to be satisfied that the product we offered was consistent with the Domino's offer.

{audio:0:05:10} How would you describe your relationship as a master franchiser with the US business?

{audio:0:05:19} The UK is by far the most successful Domino's market outside the US. It constitutes an important part of their overall profit stream. They take a percentage of our revenue so they really want us to succeed, which over the past 10 to 15 years we have.

{audio:0:05:56} How have responsibilities, hurdle rates or other terms of the agreement changed over the years?

{audio:0:06:05} It links to this point about growth. We have a master franchise agreement which is renewed every 10 years. They set growth targets, principally around stores where they specify how many stores should be opened in the next 10 years, which we will negotiate on. One of the great tests of a franchise is whether the people who run their stores are prepared to invest their money in order to grow your brand.

{audio:0:06:54} So as a master franchiser, was unit growth the key metric you followed?

{audio:0:07:02} It's interesting because there is a fine balance between growing new units and maintaining sales in existing units. You are always trying to keep an eye on order count and growth in sales in existing outlets, as well as growing the total number of stores. Growth is one of the factors. Domino's in the UK is a public company on the British Stock Exchange. In addition to meeting the needs of the brand owner in the US, as chief executive, you also need to meet the needs of your investors in the UK. It is a balancing act of satisfying UK investors while remaining consistent with the US Domino's brand ethos.

{audio:0:08:01} Did you feel pressure to develop new units to maintain the master agreement?

{audio:0:08:10} I never felt pressured because I knew it was the right thing to do. During the six years I was chief executive of Domino's we opened nearly 400 stores, 95% of which were profitable investments. You asked me what I wanted to change in the culture; I wanted the brand to feel positive about the opportunity it had for growth. Immediately prior to my arrival, growth had slowed slightly and I felt this was a massive opportunity to grasp it and take it forward.

{audio:0:08:58} Where could incentives between master franchiser and franchisee be aligned or misaligned?

{audio:0:09:06} The purity of the franchise system is that everybody benefits from sales. Franchisees pay a royalty to the US based on sales; when their sales go up, so do their profits. There is good sales growth such as order count growth and bad sales growth, where you increase revenue with price inflation. Bad sales growth is a dangerous route to go down whereas healthy order count growth is positive and unites the whole chain. This means everybody is in the same place, in terms of trying to deliver a result.

{audio:0:10:03} Why do you think order growth is an important variable for increasing sales?

{audio:0:10:15} Order growth is a measure of customer satisfaction. If your order count is going down in a growth market like pizza, it probably means your competitor is doing something that may be more popular with customers than your offer. Order count is an important metric because it is a measure of how happy your customers are with your offer.

{audio:0:10:53} Going back to the incentives, there is definitely a benefit to the whole system to increase sales, but an individual franchisee cares about profitability and earning a living, whereas the master franchiser has a hurdle rate to hit to maintain that 10-year agreement?

{audio:0:11:18} Domino's franchisees are not short-term investors; they take pride in their long-term commitment to the brand. They recognize that long-term sustainable growth in profitability is built on the back of customer satisfaction which is measured by order count.

{audio:0:11:51} How do the economics of a franchisee break down at the unit level?

{audio:0:12:03} The biggest cost and one of their main challenges is labor, which is difficult in the UK market, particularly in an environment with a lot of new competition. With the entry of the aggregators, competition for and reward levels of drivers increased, putting pressure on their P&L.

{audio:0:12:41} Food has a gross margin average of 75%

{audio:0:13:03} Is labor the biggest chunk of that?

{audio:0:13:07} Yes, it is in the low 30s and rising. Labor costs are variable according to the labor environment in the particular marketplace, London and the South East being the most challenging.

{audio:0:13:25} Have the unit economics of franchisees changed since aggregators arrived?

{audio:0:13:36} The aggregators are part of it but remember that successive governments deliberately raised minimum wages higher than the inflation rate to improve living standards, which put pressure on labor costs at food businesses such as Domino's.

{audio:0:14:04} I believe the EBITDA margin for the unit is now 12%?

{audio:0:14:11} Probably slightly higher.

{audio:0:14:13} Has that come down due to this cost pressure?

{audio:0:14:17} It actually went up sharply in 2014 to 2016 because those were very good years. The first three years I joined the brand, the profitability rate improved and sales were fantastic. It has come down from that now and because there is so much uncertainty around the sector at the moment it is very difficult to predict.

{audio:0:14:48} How do franchisees typically finance themselves?

{audio:0:14:54} Usually they start by remortgaging their house or borrowing money. One of the great things about a brand like Domino's is that banks are very confident. When somebody goes to a bank to borrow money for Domino's they know the sorts of returns because they can see from 1,100 stores around the country how profitable an investment it can be. A franchisee might remortgage their house to start their business and thereby put everything in to build the business.

{audio:0:15:49} How much do they need to start?

{audio:0:15:53} The average Domino's store costs £300,000 to open. They could probably borrow between 150 and 200 and would have to find the rest themselves. Once they get going, the cash flows will allow them to open a second, third or even a fourth store. The early period is the most challenging.

{audio:0:16:26} Does a unit pay back that quickly?

{audio:0:16:29} If you get the right location, a unit can pay back within two to three years.

{audio:0:16:48} Is there any risk in banks not lending as much to new franchisees?

{audio:0:17:00} I have not been aware of any such risk because the business has been and continues to be successful. Banks are in business to fund successful businesses and a Domino's store meets that criteria. I do not see any good reasons why banks would make life more difficult for franchisees.

{audio:0:17:28} Do you help the franchisee by going with them to the bank or showing them the unit economics of stores or results?

{audio:0:17:34} We would if they were prepared to do that but banks already know. If a store might have an element of risk, we could either make a capital contribution or not charge royalty for a year to help the franchisee get the business going. There are various schemes we use to help franchisees get new stores off the ground.

{audio:0:18:12} Do you have certain requirements of the financial leverage of a franchisee? Recently various franchisee groups have gone bankrupt, such as Pizza Hut in the US and Applebee’s recently.

{audio:0:18:28} We have good connections with the franchisees in terms of their finance. We constantly track the performance of every store and are also well-connected with the banks. We keep an eye on it as it is not something to take for granted but because the brand is so successful it is not a big issue.

{audio:0:18:53} Because you have that two to three year cash payback on the units.

{audio:0:19:01} This is not a 10 year plus investment.

{audio:0:19:11} A Domino's store looks easy to run from the outside but it is not. I remember in my first week, I went to Domino's on a Friday afternoon and not much was happening. People were folding a few boxes and then suddenly at 5 o’clock the orders screen starts filling up. It is extraordinary to see how the orders go from virtually nothing to over 100 pizzas an hour in a window between 4 and 6 o’clock on a Friday. Coping with that and organizing the right drivers to deliver to customers is not as easy as it looks.

{audio:0:20:09} Is there a limit to the order per hour metric one can have at peak time?

{audio:0:20:15) We always encourage keeping an eye on the peak and coping with it because customers measure your performance at peak. If a customer waits an hour and a half for a pizza at peak, you will lose them. Doing a great job and using techniques to prepare for peak is critical to the operational success of the store.

{audio:0:20:54} How has the franchisee network evolved for Domino's in the UK over the last decade?

{audio:0:21:04} The network has significantly reduced because many franchisees move on. The existing remaining franchisees bought their stores because they are proven franchisees who know how to run Domino's stores. In the six years I was CEO, the number of franchisees almost halved because franchisees took the opportunity to move on, while other franchisees were so hungry to grow that they bought the territories of those who left.

{audio:0:22:13} They wanted to do different things with their lives. It may sound easy from the outside and the numbers look great – you put X in and you get your money back in Y years and everybody loves Domino's – but it is not an easy thing to do. You are at your busiest at a time when most people are relaxing so you only want to do that for so long.

{audio:0:22:47} What are the pros and cons of a more concentrated franchisee network?

{audio:0:23:10} The benefit of concentration is in terms of the experience and the confidence you can have in the capability of these excellent franchisees who do a good job for the brand, but there is benefit in refreshing the franchisee base. Many franchisees train their children to take over the business in the medium to long term – which brings a different wave of people into the brand – but there is benefit in bringing people in from outside. That was one of the things that as I was leaving, we determined we needed to do. We accepted they would need support to be successful, but also recognized the value of refreshing the franchisees.

{audio:0:24:10} How much power do those large franchisees have?

{audio:0:24:15} They have a lot of influence because they are passionate about the brand and understand the business well.

{audio:0:24:27} Do they really just want to protect the economics of their units?

{audio:0:24:36} Yes, at the end of the day, they are dependent on Domino's being successful. If the Domino's brand is less successful, it does not matter how well they run their units, they will not be as successful as they could be.

{audio:0:25:03} How do you deal with the balance between growing units which benefits everyone, but then you have large franchisees in your network who do not agree with your growth strategy because it might influence their sales?

{audio:0:25:22} We want to grow profitable units, not just numbers of stores, because that is not good for the brand as a whole. We have a view of where a store is likely or not to be profitable, which we would share. Over the last three years, we have invested heavily in both people and software to be able to more accurately predict the success of a store. Having those types of open discussions with franchisees is key. It is not only about having a certain number of stores, but having the right stores that are making money. By doing that the franchisee gets good cash flow and will think about the next store and the brand will grow and become stronger.

{audio:0:26:24} What was the biggest challenge discussing unit growth with franchisees?

{audio:0:26:30} The debate was around whether that store was going to make money, which is why we needed to invest more in both people and software to identify the opportunities.

{audio:0:26:48} The franchisee thought if they followed the fortressing strategy it may affect sales, so you had to debate that with the franchisee?

{audio:0:27:06} Yes and the big franchisees became big by opening and buying many stores, so in a way they understand the message. There are some franchisees that have been with the brand as long or longer than the very big franchisees. They might have three or five stores because they did not understand the message. The people who did well were prepared to invest and grow and absolutely buy the point you make about the fortressing strategy.

{audio:0:27:46} What do you say to a franchisee if they demand more profit from the master franchiser?

{audio:0:28:00} At the end of the day, you have to keep hammering the message. We had a franchisee with a store in a particular town and we thought he needed a second store because there was a lot of new residential construction occurring in part of this town. For years he said no, and when an opportunity came up, he suddenly said, why are you not giving me that opportunity? We reminded him that he did not want it for years. You have to keep talking about where the opportunities are and by doing that, you do the right thing. I am very proud of the number of successful new stores we opened in the six years I was CEO. The brand would not be what it is today if we had not opened that many stores. I am also very confident there are more store opportunities available to us; our job is to present the data and prioritize the most important ones.

{audio:0:29:17} What was the catalyst which caused push back from franchisees when Domino's looked to roll out more stores?

{audio:0:29:31} Recognizing that stores take a bit longer and also the labor cost point I mentioned earlier; it was no longer as easy as perhaps it had been.

{audio:0:29:48} So the pay back become longer because of the higher labor cost?

{audio:0:29:55} How different was it because they have a 12% EBITDA margin? Were some units lower than that, making it trickier to warrant another store?

{audio:0:30:07} It was certainly the case that some of the stores took longer to pay back, but the vast majority of them are now delivering very acceptable results.

{audio:0:30:19} How could you solve the issue as a master franchiser? Could you decrease the loyalty rate or were your arms tied by the US business agreement?

{audio:0:30:34} It comes back to how you can ensure the stores you open are profitable. You have to understand the market better and have the right people speak to franchisees and think through their appropriate growth plan. It is not being focused on how many stores, but thinking about how much profit those incremental stores will create.

{audio:0:31:05} In your master franchise agreement, is it the EBITDA or the profitability of new stores, or is it just new stores?

{audio:0:31:13} It is a new store number but to get any number you have to choose the right opportunities. We thought there were 1,600 store opportunities in the UK. Today Domino's today is 1,150 so there are 450 opportunities left. The important thing, if you want to open 50 stores a year, is that you open the 50 best opportunities in the first year, not the 50 worst. You need to use the data to prioritize where you can open successfully.

{audio:0:31:56} Will that lead to longer pay backs due to splitting territories for franchisees?

{audio:0:32:06} If you choose the right opportunities it will not; remember the market is growing. Whilst an opportunity may not look particularly attractive today, in five years’ time, if the market grows by 6% to 8% the opportunity will be more compelling.

{audio:0:32:34} When we see franchisees negotiate what they need to cover increased costs, how much freedom do you have as a master franchiser to deal with the franchisees?

{audio:0:33:02} We have a lot of freedom but we would usually work with the US to come up with the right solution and work with the franchisee. The key is always sales because the margins are high. If you set it up to drive sales, everything else takes care of itself.

{audio:0:33:25} Perhaps some new units were opened which were not the best opportunities or locations and franchisees got scared because they saw sales decline in two stores?

{audio:0:33:39} There would be some examples of that yes, but over time, most of the stores gradually move forward and a lot of franchisees would just shrug their shoulders and say, give it three years it will be fine. For a franchisee this is not a one-year gig; it is a long-term plan.

{audio:0:34:06} What are the major differences between sub-franchising agreements in the UK, Australia or the US?

{audio:0:34:16} The royalty rate is highest in Australia and lowest in the UK.

{audio:0:34:33} Could the concentration of franchisees change that?

Former CEO at Domino's Pizza Group

Domino's Pizza Group: Master Franchising

How to create a win-win relationship between the franchisor and franchisees

Why a focus on order count growth is crucial to maintain a healthy franchisee base

Balancing the pressure to grow new units and maintain profitability in the franchise network

Costs and challenges of running a Domino’s restaurant in the UK

The power of optimizing the crust on a pizza

Catalysts that drove tension between UK master franchise and franchisee

How the delivery aggregators changed the UK restaurant landscape

Why Domino’s still has a competitive advantage in the UK