Published on July 5, 2021
I believe what makes Domino’s unique is that the franchisees came up within the system. The vast majority of the franchisees were in store slinging pizzas for somebody else for a long time. When they become franchisees, they know the system and know the culture. - Former VP, Domino’s PizzaIt’s amazing to think that almost all of Domino’s US franchisees started as delivery drivers or in-store workers. Years of experience flipping and delivering pizzas ingrains the culture and system into the franchisee owner. The franchisees are mainly sole operators and the largest franchisee has a very small percentage of total US system sales.It’s slightly different in the UK. The top 3 franchisees generate over 50% of system sales for the UK master franchise. This has both pros and cons. It’s far easier to grow because the top franchisees are well funded, great operators, and deeply understand the business. The challenge is that they have their own opinions about how total EBITDA should be shared throughout the system.The economics of a master franchise is also very different to the parent US franchisor. The UK master franchise has two core lines of revenue: royalty income and supply chain revenue. UK franchisees pay a royalty of ~5.5% of sales to the master franchise who then pays 2.7% up to the US franchisor. The net royalty rate for the UK business is ~2.8% of system sales. In 2020, UK royalties were 14% of total revenue and net royalty income was ~35% of UK EBIT. The remaining 65% of UK EBIT is mostly driven by the supply chain business.Supply chain revenue accounts for ~70% of revenue and 63% of EBIT for the UK. In the US, supply chain revenue is 58% of total revenue and less than 35% of EBIT. Over the last decade, the US supply chain business consistently generated a ~11% EBIT margin. It’s estimated that the UK supply chain business charges 30% gross margin on the ingredients to franchisees. If we net out the corporate store income and JV profits, the UK’s supply chain business generates ~20% EBIT margin. It’s clear the UK master franchise is far more reliant on the profitability of the supply chain business than the US.Domino’s can increase the supply chain margin in two ways: selling more ingredients or increasing the price. Increasing the price hurts franchisee economics so driving higher order volume is the number one priority. It also reminds us of this quote from our previous interview with Former DOM CEO comes to mind:"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"Over the last few years, the rise of food delivery aggregators, labour price inflation and Brexit increasing food cost inflation has created tension between franchisees and the UK master franchisor. These higher external risks may lead franchisees to question the true ROI on splitting stores. However, we believe the UK franchisee tension is yesterday’s news and will soon be resolved because the unit economics of a Domino’s store are so strong.