The Dough Is In the Dough: Big Companies Make More Money Selling Ingredients to Franchisees Than Pizzas to Customers

Any way you, ahem, slice it, the fast food business a tough way to make a living: low margins, high volume, chronic staff turnover.

Which is why, as the following article explains, the big corporate pizza makers like Dominos, Papa Johns and their competitors, make most of their money from the sale of equipment and ingredients to their franchisees, their own company owned outlets and anyone else who wishes to buy from them.

This is actually consistent with the history of the fast food business. In its earliest days, McDonald's best kept secret was not its secret sauce, but the fact that most of its profits came from what was called the 'real estate sandwich.' This was not a food item, but the profit the company made from buying real estate in attractive locations and then selling those to franchisees - along with the potatoes, buns and meat that went into the classic burger meal.

In a similar vein, Southwest Airlines differentiated its service and prices by cleverly hedging its energy costs so that it could lower prices and still stay in business. In the auto and heavy equipment industries, it is the services wrapped around the product, like financing, upkeep and repair that generate the greatest profits.

As the intensity of global competition increases, discerning ways to actually make money through greater efficiencies and smarter solutions will continue to provide a significant competitive advantage to those who can identify and then create them. JL
 
Venessa Wong reports in Business Week:

Domino’s primary business is actually selling more pizza ingredients—dough, cheese, toppings—to its franchisees and company-owned stores.
Domino’s Pizza  reported a 7.4 percent revenue boost in 2013, a jump of about $123.8 million—and most of it didn’t come from selling more pizzas. No, Domino’s primary business is actually selling more pizza ingredients—dough, cheese, toppings—to its franchisees and company-owned stores.

Domino’s supply-chain business, which extends from ingredients to restaurant equipment, generated 56 percent of its revenue last year, or about $1 billion. The rest came from retail sales at 390 U.S. company-owned stores (19 percent), royalty fees paid by nearly 4,600 U.S. franchise locations (12 percent), and international supply chain and restaurants (13 percent). To motivate restaurant owners to buy from the company, Domino’s shares the profit from its supply-chain sales with restaurants that purchase all their food from this service.
It’s not the only pizza chain with this model. Papa John’s (PZZA) ingredients business, which it calls “domestic commissary,” represents 40 percent of sales.

Obviously, increased orders from restaurants can boost supply-chain revenue, but so can fluctuations in commodities. Domino’s passes along any change in commodity costs to its restaurant customers, with a fixed dollar margin. Pricier commodities mean higher food costs for restaurants, even though the fixed markup doesn’t yield higher profits. Take the recent spike in cheese prices: Domino’s said in its annual report that higher cheese prices lifted supply-chain revenue by approximately $8.6 million last year, or about 7 percent of the company’s overall $123.8 million increase.
Retail prices, however, don’t rise with commodities—not immediately, anyway. “The industry is far too competitive for that,” and typically, increases in one commodity are offset by decreases in others, said Domino’s spokesman Tim McIntyre in an e-mail. Other factors help maintain margins, too. The operating margin at company-owned Domino’s restaurants was hurt by food costs last year, although that pain was offset by higher same-store sales and lower labor, occupancy, and insurance expenses. In the end, store operating margins increased slightly despite that pricier cheese.
Cheese prices are expected to decline through 2014, according to Papa John’s (see chart below), and Domino’s expects food costs to be flat to slightly lower than last year. So don’t expect commodity prices to boost pizza revenue again in 2014.