Why Domino's Spent Millions to Fix Its Pizza

There is a great entrepreneurial story behind Domino's Pizza (NYSE: DPZ  ) . The company was founded in 1960 by two brothers who borrowed $900 to pay for their first store and used a Volkswagen Beetle to deliver their first pizzas. Today there are more than nine thousand stores around the world, with more than four thousand of them located abroad. Since 2008, Domino's Pizza has experienced massive international store growth, beating the growth rate of competitors Yum! Brands (NYSE: YUM  ) -- which owns Pizza Hut -- and Papa John's Pizza (NASDAQ: PZZA  ) . 

However, Domino's future in 2010 looked quite bleak. Strong competition, harsh criticism over the taste of its pizzas, and low consumer satisfaction levels were playing against the company's revenue. That's when management decided to adopt a surprising market strategy: admit that its product was awful. The company spent millions in creating a new pizza from the crust up, expanding its menu offering, and advertising the process. The results have been amazing.

Between 2000 and 2013, America's customer satisfaction index score for Domino's Pizza increased from 69% to 81%. More importantly, the company's revenue has also improved significantly. How exactly did Domino's Pizza manage to turnaround its business, though, and what are the company's plans to keep delivering growth revenue in the future?

Source: Domino's Pizza Investor Relations.

A massive business transformation
Domino's amazing turnaround was a result of extensive efforts to improve the company's processes and menu offerings by introducing new recipes, using mobile technology to attract new customers, and improving supply chain management. As a result, the company not only improved its top line performance but also became the fourth largest e-tailer in the U.S.

Domino's main competitive advantage has always been the ability to deliver pizza quickly. In order to implement fast service, however, the company had to rely heavily on frozen, pre-made ingredients. This allowed employees to assemble pizza in record times, but it also had a negative effect on quality. Because of poor quality control, most customers started to recognized Pizza Hut as the best-tasting pizza and relied on Domino's only for quick delivery.

The first task for J.Patrick Doyle, who became the CEO of Domino's in 2010, was to change the company's core pizza recipe. Domino's tested dozens of cheeses and sauces before determining the final ingredients of its new pizza. It carried out blind taste tests with 1,800 random pizza consumers, coming out on top and beating both Pizza Hut and Papa John's by a wide margin.

To market its new pizza, the company implemented an honest marketing campaign that apologized for its old pizzas. To attract new customers, the company developed mobile apps with great user experience, allowing customers to design their own pizzas. To protect its core competence, management began revamping the company's online tracking system to minimize delivery time. The results were astonishing: at the end of the first quarter of 2010, the company posted a 14.3% increase in revenue. Furthermore, since these changes were implemented the company's stock has risen a whopping 400%.

It's all about competitive advantages
Domino's Pizza strategy worked because it focused on building new competitive advantages without losing old ones like its fast delivery service. This strategy allowed the company to deliver great results despite increasing competition.

Notice that the world's third-largest pizza company, Papa John's, is trying to capture market share from Domino's and Pizza Hut by differentiating its pizza with natural ingredients and by offering diversity in its topping options. With 80% of its locations in North America, the company has plenty of growth opportunities available in emerging markets where it is planning aggressive expansion. This expansion is being facilitated by reducing the investment needed to open a franchise restaurant to roughly $200,000.

On the other hand, Yum! Brands recently experienced a tough quarter due to poor sales in China. The company's top line performance and customer confidence were particularly affected by a breakout of avian flu and bad publicity on poultry issues. 

My Foolish take
Although the environment remains competitive, Domino's long-term focus on building competitive advantages has allowed the company to develop an economic moat. It not only offers an interesting value proposition, but also has plenty of growth opportunities available since its presence in international markets is still very limited. This is especially the case if compared with Yum! Brands. 

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