On the Margin
How pizza chains use technology to take market share

How pizza chains use technology to take market share

This post is part of the On the Margin blog.

Major pizza chains like Domino’s and Papa John’s have effectively leveraged technology in recent years to generate consistent sales growth at a time when that’s not always so simple. More than half of the pizza chains’ sales now come through digital channels, and neither expects that trend to go in reverse.

The ability of these chains to implement online and mobile ordering with great effectiveness in theory offers lessons for the rest of the industry — yet other chains shouldn’t expect the same success, because the pizza business is unique.

Independent pizza concepts represent roughly half of the U.S. pizza sector, a far higher percentage than in other legacy sectors within quick-service restaurants. Pizza’s profitability has enabled small, independent concepts to stay afloat for much longer than, say, an independent quick-service hamburger joint.

But the technology adoption by consumers, and large chains’ ability to adapt quickly, has tipped the scales in favor of chains — and may continue to do so for years.

In 2014, according to an analysis from BTIG analyst Peter Saleh, independents and small chains accounted for 44 percent of the pizza delivery business. But they accounted for only 18 percent of the share of pizza sales online. Independents can make up that gap, but that could be costly.

“Digital is where the customer is going,” Saleh said. “People don’t want to pick up the phone. If you’re an independent, you can’t build it yourself, at a cost of tens of millions of dollars every year.”

Companies could outsource to an aggregator such as GrubHub, but that might not be cheaper, either.

In his analysis, Saleh estimated that an aggregator would charge a concept at least 10 percent of the cost of an order. So a $20 pizza order would cost the independent a $2 fee. By comparison, Domino’s charges its franchisees a 21-cent fee per transaction to fund its technology efforts.

“That’s at least a 900 basis point difference on customer acquisition for a local guy versus Domino’s,” Saleh said. “The local guy has to pay way more for that digital customer. And we’re not talking about 30- to 35-percent margins where you can afford to give 900 basis points like that.

“I feel like the cost advantage is a real advantage for large operators.”

The solution for the independent pizza concept that wants to compete with the large-scale players is to either accept lower margins for that pizza or raise prices enough to recover the cost of using an aggregator.

But then this is the pizza business. And customers of the pizza business have been trained for years to shop based on price. Such increases could drive more business to the lower cost options.

For now, it appears, the smaller chains are taking it on the chin. Saleh said that other than value offers, most independent and small pizza concepts that use aggregators are offering similar prices.

The presence of so many independent pizza concepts is the big reason why these big concepts can continue to gain share through technology where other major restaurant chains probably cannot.

Large chains dominate the quick-service burger sector, for instance. And so McDonald’s could add all this customer facing technology to make it easier for its customers to order Big Macs, but it would only be taking business from Burger King or Wendy’s — both of which could afford to match their rival in technology adoption.

“The reason why this works so well in pizza is that chains have such an advantage because it’s highly segregated,” Saleh said. “There’s still tens of thousands of small operators, and 50 percent of the market is still owned by these small regional players. In the QSR burger category, 90 to 95 percent is made up by McDonald’s, Burger King, Sonic, Wendy’s, Jack in the Box” and others.

“So the only place these guys can take share from in the burger category is each other.”

Contact Jonathan Maze at [email protected]
Follow him on Twitter: @jonathanmaze

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