G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Case 2-4

Papa Johns International, Inc: Twenty First Century Growth Challenges

History of Papa Johns International Papa Johns International, Inc. operates and franchises pizza delivery and carryout restaurants under the trademark Papa Johns. Corporate headquarters are located in Louisville, Kentucky. John Schnatter started the company with a pizza oven in the broom closet of his fathers tavern in Jeffersonville, Indiana in 1985. The first franchised restaurant was opened in 1986. The company first went public on 8 June 1993 at an initial public offering (IPO) price of $13.00 per share. In 1999, Papa Johns International acquired Perfect Pizza Holdings, Ltd., consisting of 118 Perfect Pizza restaurants in the United Kingdom, as part of its global expansion efforts. Papa Johns International sold Perfect Pizza Holdings, Ltd. to Smartfirst, Ltd. in March 2006, for approximately $13 million. Perfect Pizza will continue to operate 89 Papa Johns restaurants in the United Kingdom. As of 24 September 2006, Papa Johns International operated 2,978 restaurants (564 companyowned and 2,414 franchised) in 49 states (all except Vermont), the District of Columbia, Puerto Rico, and 25 countries. Papa Johns initial strategy was intended to produce highquality pizza with fresh ingredients. This intended strategy exemplifies the companys motto Better Ingredients, Better Pizza. Papa Johns strategy has evolved to include a combination of the initial intended strategy while seeking emerging opportunities to expand their menu, locations, markets, and technology and digital integrations. Papa Johns mission statements focus on customers, team members, franchisees, and shareholders. Papa Johns believes in creating superior brand loyalty throughout authentic, superior-quality products, legendary customer service, and exceptional community service.

External Environment Analysis

Intense competition The restaurant industry is intensely competitive with respect to price, menu selections, service, location, and food quality. The competing restaurants range from independent familyowned diners to publicly-traded restaurant chains with thousands of locations worldwide. Certain markets, such as tourist areas and college campus areas, are very seasonal in nature with respect to the size of the customer base and to consumer income levels. The local 1

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

economy has a major effect on the revenues that can be generated by all businesses in the area. This effect is particularly strong in areas heavily dependent on tourism. During a period of economic uncertainty, a family would be much more likely to purchase groceries than to order pizza or any other restaurant food. Price, location and macro sensitive When the economy declines, the restaurant industry is among the first to feel the effects due to a reduction in disposable income. Therefore, I can conclude that restaurant food is a luxury good with a high absolute elasticity of demand, meaning that consumers are very sensitive to personal income and product price changes. When a competitor announces a special offer and/or opens a new location in the area, the revenues of a restaurant can be adversely affected. Hedging as a method to control cost There are also many cost drivers that can affect the costs of doing business in the restaurant industry. For example, the costs of certain ingredients can fluctuate very widely in a relatively short period of time according to commodity market conditions. Many companies engage in a practice known as forward pricing, a hedging strategy where a company negotiates with a supplier to purchase a fixed amount of a product at a fixed price. Some larger companies sign supply contracts to lock in less volatile food products, such as beef, at stable prices for an entire year. Some of the products subject to the greatest variability, especially dairy products, can be locked in only for short periods. These increased costs trigger a condition known as cost-push inflation. For a restaurant to remain competitive in todays market, it must constantly look for ways to develop and market new menu items, as well as improve the quality of its food products and its customer service, and reduce costs wherever possible. Let us take a look at hypothetical circumstances that could shift supply and demand curves for one popular product in the restaurant industry, cheese. Imagine if there were a strain of the Mad Cow virus, the price of milk would skyrocket. Suppose that a liter of milk now costs $2.50. The price of cheese and dairy products would also skyrocket. Even with government intervention, the price of milk and dairy products would keep rising. Until this virus is contained or until a cure is found, the price will continue to rise. Many dairy cows would have to be killed once they are infected with the virus to keep it from spreading it to other livestock. This epidemic would affect many industries that rely on dairy products. The restaurant industry would be devastated. The pizza industry would be hardest hit because the main ingredient in pizza is cheese. Pizza chains such as Dominos, Little Caesars, and Papa Johns would have to raise their prices just to break even. Some pizza chains might even try a non-dairy cheese made of soy, but would consumers like the taste of soy cheese? Due to an increase in the price of pizza, the quantity demanded would decrease as a result of the inverse relationship between supply and demand. 2

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Internal Environment Analysis

Papa Johns International developed intricate strategic planning systems in place for their long-term growth and profitability. Its mission statements indicate the direction where they want to go. Their strategic planning determines how they will fulfill their mission statements. The most critical part of the success of any companys strategic planning is the training of its management team. To give us an idea of what matters most to a company, I examine its core values. Papa Johns core values are known within the company as FASPAC: Focus - I must keep the Main Thing, the Main Thing. I will consistently deliver a traditional Papa Johns superior-quality pizza. Accountability I do what I say are going to do when I say I are going to do it. I earn the right to hold others to a higher level of accountability by being accountable to ourselves, our customers, and our business partners. Superiority Our customer satisfaction must be consistent, quantifiable, and demonstrable. At Papa Johns, I expect excellence the best in its class in everything I do. PAPA People Are Priority #1 Always. Our Team Members treat one another with dignity and respect. Attitude If you think you can or you cant-youre right! The difference between winners and losers is a Positive Mental Attitude. Our attitude is a reflection of what I value: successful Team Members must be upbeat, proactive and passionate about everything they do. Constant Improvement I never stop trying to surpass our previous best. I constantly Raise the Bar. No matter how good I are, I will always get better.

There is a strong correlation between the quality of restaurant management and the long-term success of a concept. Most companies offer extensive training programs in restaurant operations for all management-level employees. Managing a restaurant is not nearly as easy as it looks. In addition to basic customer-service and production skills, manager trainees also learn local store marketing, human resources, organizational behavior, purchasing, safety and security, sales forecasting, budgeting, cost control, facility maintenance, and food service sanitation policies and procedures.

Financial Analysis
A critical part of any industry analysis is an analysis of the financial health of the leading companies within that industry. There are many ratios and formulas that can be used to analyze a companys financial health at any given point in time. These ratios for each company can be compared against an industry standard, which varies by industry. For this analysis, I will look at a selection of the most commonly-used ratios.

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Current Ratio (good) The current ratio is used by lenders to determine whether a company has a sufficient level of liquidity to pays its current liabilities. I derive this ratio by dividing all current assets by all current liabilities. This measurement can be misleading if a companys current assets are heavily weighted in favor of inventories, which can be difficult to liquidate in the short term. The current ratio of Papa Johns was on a downward trend until bottoming out at 0.1799 in the third quarter of 2003 and improving from that point to a more respectable .83 in the fourth quarter of 2006 and nearing 1.0 by end of 2009. Quick Ratio Because of the presence of inventory in the current ratio, the quick ratio (sometimes known as the acid-test ratio) may be a more accurate measurement of a companys liquidity. The quick ratio measures a companys ability to cover its current liabilities by its most liquid assets. Companies endeavor to have a high value for this ratio. To obtain a quick ratio, I add the companys cash, marketable securities, and accounts receivable. Then I divide the result by the companys current liabilities. It is important to include only those securities that can be liquidated in the short term and those receivables that are not seriously overdue. However, a problem may arise if the accounts payable are due immediately and the accounts receivable are not due for a few weeks.

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Total Debt Ratio (stable) The total debt ratio takes into account all debts of all maturities to all creditors. I simple divide the companys total liabilities by its total assets. A negative equity situation occurs when the total debt ratio exceeds 1. Papa Johns has shown a steady increase in its total debt ratio throughout the time series, with three large spikes. The debt ratio had returned to a more respectable .2689 for the fourth quarter of 2006. A couple of explanations are possible for such spikes. A company can sell off some of its assets, which would reduce the total assets in the denominator. The company could also borrow heavily to invest in an expansion campaign. In the case of Papa Johns, a decrease in receivables and an increase in long-term debt due to heavy borrowing for expansion in its international markets led to the spike in the total debt ratio. The upward trend in Papa Johns debt ratio appears to be a cause for concern unless the company can keep its total debt levels to a manageable level. Return on Equity Percentage (not good) This calculation measures the amount of return that investors receive from their capital investment in a company. To obtain the return on equity percentage, I simply divide the net income by the total equity of the company. As simple as this ratio is to obtain, this ratio can also be deceptive when a management team is eager to increase a companys return on equity by incurring new debt and using these borrowed funds to buy back shares of common stock. An astute investor should combine the return on equity percentage with an analysis of how much new debt a company has incurred, along with its interest expense. Papa Johns has a slowly increasing trend line for its return on equity, except for two losing quarters (one in 2000 and another in 2004).

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Net Profit Margin (stable) The most important measure of a companys success is its net profit margin. This margin, also known as the net income percentage, is used to determine the proportion of income derived from all operating, financing, and other activities in which a company has engaged during an accounting period. This figure is most the commonly used benchmark for determining a companys performance. However, this figure can be distorted by aggressive capitalization of costs incurred and the early recognition of revenues. The seasonally adjusted net income for Papa Johns had a much more consistent performance, except for two losing quarters. An upward trend in Papa Johns net profit margin appears since 2004. The net profit margin for FY2006 is .0633. (Papa Johns International 2006 Annual Report) I conclude that the net profit margins for both companies have shown an upward trend in recent years and barring any major catastrophic events will continue to remain strong for years to come.

Business-Level Strategy
Decentralized marketing The products of Papa Johns International are differentiated from its competition due to the introduction of new specialty pizza and side items. However, the company is struggling to catch up with other chains with respect to rolling out new menu items and limited time offers. Local franchisees are responsible for local store marketing for their service areas, including direct mail, print advertising, and store-to-door couponing campaigns.

Corporate-Level Strategy
Employee Outsourcing I believe that Papa Johns International should outsource its local store marketing operations to professional marketing companies that would perform more professionally and consistently than would local store employees and would also free up the employees for more important operational duties. It may also be more profitable to outsource the delivery service to professional delivery companies whose drivers typically perform more professionally than do company employees, and at a lower cost.

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Computer system upgrade Currently, delivery drivers are cross-trained to perform all functions within the restaurant, including food preparation, order taking, production, and cleaning duties. Some of these duties tend to dirty up a drivers uniform. The order-taking operations can also be outsourced to centralized call centers capable of routing orders to any of several locations, using the companys PROFIT system (Papa Johns proprietary UNIX-based computer system). Product diversification Papa Johns International has diversified its product line recently. The company added chicken strips, chicken wings, and other side items over the last few years. These additions to the menu are typically the result of ideas submitted by employees throughout the company. The company has not restructured its corporate portfolio in recent years. Use of Global Position Satellite (GPS) for delivery The next process innovation I can expect in the near future will be an upgrade of the PROFIT system that will enable delivery drivers to send the addresses of their destinations directly to their GPS navigation systems when they dispatch their deliveries. This innovation will speed delivery service by directing drivers to their destinations more efficiently and safely.

Global Strategy
Adaptation to local culture and taste preferences While Papa Johns prefers to maintain standardization throughout the system, the company crafts its franchise agreements to allow its international franchisees to adjust their menu offerings, operating procedures, and personnel policies to conform to the legal and cultural requirements of their countries. For example, a Papa Johns restaurant in Saudi Arabia would have two separate dining areas, one for single men and another for women and families, to conform to the code of Islamic law known as sharia. Also for Indonesia and most Islamic Country, a halal certification is a must.

Summary and Conclusions

Proposed key success!! Stay competitive The restaurant industry is incredibly diverse and extremely competitive. The industrys four restaurant chains combine for a 19.90 percent share of the total market. The restaurant industry is monopolistically competitive, meaning restaurants of all kinds differentiate their products and advertise in order to attract and retain loyal customers. A critical part of their marketing strategy is to cross-promote their products with entertainment companies such as major film studios and professional sports teams.

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

Standardization of menu items for easy and controllable marketing Standardization of menu items within a restaurant chain means that a Papa Johns Pizza in Chicago is expected to look and taste the same as a Papa Johns Pizza in Beijing or Moscow. This standardization is critical part of the brand recognition strategy. It is not only necessary to introduce new products, but to look for ways to improve existing products, in order to ensure a companys long-term sustainability.

Economy sensitive commodity, CPI, inflation The restaurant industry is very sensitive to local economic conditions because restaurant food is considered to be a luxury good with a high absolute elasticity of demand with respect to price, consumer income, and advertising. The major cost drivers in the industry are food, labor, and real estate. The costs of certain food items fluctuate widely according to commodity market conditions.

Maintain low employee turnover Employee turnover, regarding recruiting and training costs, is another serious problem in the industry. Any restaurant with an annual employee turnover rate of less than 100 percent is doing very well. Increases in these costs result in cost-push inflation, which drives up prices and further erodes the value of the dollar. Many restaurant companies borrow heavily to finance their expansion efforts, so it is important to look at prevailing interest rates and their expected changes. There are many ratios and formulae that I can use to analyze a companys financial health at any given point in time.

Maintain good liquidity on cash flow I use the current ratio and the quick (acid-test) ratio to analyze a companys ability to cover its short-term debts with its most liquid assets. A problem may arise if the accounts payable are due immediately and the accounts receivable are not due for a few weeks. Accounts receivable are less common for an individual restaurant than they are for the corporate headquarters. These ratios can be unpredictable from one quarter to the next, but can be better viewed on a trend line. The total debt ratio is the ratio of a companys total liabilities divided by its total assets. An increase can result from heavy borrowing to finance an expansion campaign or to repurchase shares of company stock, or it can result from the sale of some of its assets.

Two important measures of a companys profitability are the return on equity and the operating income return on investment. The return on equity ratio however, can be misleading if a companys management team increases this ratio by borrowing money to buy back shares of common stock. An investor should combine this percentage with an analysis of the amount of new debt incurred, along with the interest expense. The operating income return on investment tells us how effectively a company is using its assets, The ultimate

G5034 Strategy and Execution

Student: Fajar Hari Utomo (1040002010) Lecturer: Janpie Siahaan, MBA.

measure of a companys success, and the most commonly used benchmark, is its net profit margin. In conclusion, as long as the economy remains strong and restaurant chains continues its present strategy of developing new products, improving existing products and service, and most importantly, keep their food and labor costs manageable, the industry will continue to thrive for the foreseeable future.