The food industry has always been evolving rapidly in line with consumer preferences. Within the pizza industry, the Take 'N' Bake category has been gaining market share at the expense of competing categories such as dine-in, carry-out, and delivery services.
Unlike customers of traditional pizza chains, customers of Take 'N' Bake pizza chains take uncooked pizzas home to bake them in their home ovens. While the pizza restaurant market as a whole grew by a five-year compound annual growth rate of 3% from $32 billion in 2007 to $38 billion in 2012, Papa Murphy's (NASDAQ:FRSH), the largest Take 'N' Bake pizza chain in the country, increased its revenues by an 8% CAGR over the same period.
What are the key factors driving Papa Murphy's outperformance relative to the overall pizza restaurant industry? Do Papa Murphy's strategies share similarities with those of restaurant operators Zoe's Kitchen (NYSE:ZOES) and Denny's (NASDAQ:DENN)?
Food quality matters
In general, consumers are increasingly putting a greater emphasis on food quality and spending more dollars at restaurants that can live up to such expectations. This extends to all food products and even applies to pizza, which has traditionally been seen as a fast-food item. A recent study by the U.S. Department of Agriculture indicated that one in eight Americans eat pizza on any single day.
Papa Murphy's is committed to delivering high-quality pizza to its customers. Firstly, it makes its dough fresh from scratch each day instead of using frozen dough like typical competitors. Secondly, Papa Murphy's understands the concept of 'garbage in, garbage out', and makes it a point to use premium ingredients in the preparation of its pizzas. These include traditional red sauce made from California tomatoes and specialty toppings such as artichoke hearts, sun-dried tomatoes, and feta cheese. Thirdly, it is leveraged to the health and wellness trend because it excludes trans fats from its pizzas. In addition, it also avoids the use of non-meat fillers, which usually have low nutritional value.
The results speak for themselves. Papa Murphy's was rated as the top pizza chain in the U.S. for four consecutive years from 2011 to 2014 in Nation's Restaurant News' annual survey. The 2014 survey found that 69.7% of respondents indicated that they will recommend Papa Murphy's to their friends; 73.8% of them will return to Papa Murphy's a second time.
Another company that similarly places a strong emphasis on food quality is Zoe's Kitchen, the country's biggest fast-casual restaurant group that serves Mediterranean cuisine. Zoe's Kitchen ensures that fresh ingredients are sent to its kitchens for food preparation every day.
It also emphasizes the use of traditional cooking methods such as grilling and baking and eschews unhealthy methods like frying and microwaving. Zoe's Kitchen also has low-calorie (500 calories and below), gluten-free, and vegetarian menu items to cater to the varying needs of its customers. As a result, about 94% of its surveyed diners plan to recommend Zoe's Kitchen to their friends. Furthermore, it quintupled its restaurant count to 102 in a span of five years.
The successes of Papa Murphy's and Zoe Kitchen's suggest that consumers are attracted to restaurants that offer high-quality food.
Papa Murphy's operates on a highly franchised business model (95.1%) with 1,349 franchised stores and 69 company-operated stores as of December 2013. It increased its franchised store count by 27%, or 98 units, in 2013. Looking ahead, Papa Murphy's guided for a minimum of 105 franchised stores to open this year.
Locally, Papa Murphy's is likely to expand its store footprint in the less-penetrated Southern and Eastern U.S. In terms of expansion abroad, Papa Murphy's recently inked a 20-year master franchise agreement to open up to 100 franchise stores in the Middle East.
Denny's is another restaurant company that has realized the benefits of franchising. Currently, about 90% of its stores are franchised, compared with a third of them prior to 2006. Between 2007 and 2012, it refranchised 380 company-owned stores which were underperforming.
This allowed Denny's to focus its attention on its best-performing stores; it gave franchisees the opportunity to turn around its underperforming stores. This turned out to be a stroke of genius, as Denny's improved its operating margin from 8.9% in 2007 to 11.5% in 2012.
In addition to accelerating store growth via franchising, Papa Murphy's store operating model also has differentiation from those of traditional pizza-restaurant chains. Papa Murphy's is capex-light, as it does not need to allocate space and cash to dining areas, freezers, and ovens. It's also cost efficient because it doesn't have to recruit wait staff and delivery drivers; it also boasts shorter operating hours of 11 am to 9 pm.
More importantly, Papa Murphy's asset-light, cost-efficient operating model allows it to offer its pizzas at compelling price points. Based on its internal estimates, Papa Murphy's average customer check of $5.39 is among the lowest of national pizza chains. Furthermore, its customers don't have to pay additional charges such as tips and delivery fees which are associated with dine-in and delivery operations, respectively.
Foolish final thoughts
All pizza chains aren't created equal. With its unique asset-light operating model and focus on high-quality food offerings, Papa Murphy's has significantly outpaced the growth of the industry over the past few years. Going forward, I expect Papa Murphy's to benefit from consumers' increased emphasis on food quality.