question: Analysing, evaluating and imporving strategies of Papa John's international:

Case 23: Papa Johns International, Inc.: Growth Challenges*

Papa Johns International was a classic American success story. Founder John Schnatter had started selling pizza out of a makeshift kitchen in a small lounge in Indiana, and in a little more than a decade had built a business that included more than 4,000 locations. After a slowdown in growth following the 2008 economic crisis, Papa Johns had returned to its pre-crisis pattern of opening more than 200 stores per year. Such ambition was not without challenges. The U.S. economy had changed over the two decades that Papa Johns had been in business due to an aging population and to the severe economic crisis that faced the nation starting in 2008. The economy had been particularly challenging for firms serving food and drinks. Though clearly profitable (see Exhibit 1), Papa Johns had enjoyed relatively incremental growth in the new century. Despite the challenges, the leadership at Papa Johns believed that the company had developed some important advantages that could be leveraged for high growth in either the United States or international markets or perhaps even in activities that went beyond pizza. The question facing Papa Johns executives was which path would produce rapid but profitable growth.

Exhibit 1

Papa Johns, Inc., Income Statement and Balance Sheet, 20092012

In millions of USD (except for per share items)	2012	2011	2010	2009
Income Statement
Revenue Other Revenue, Total Total Revenue Cost of Revenue, Total Gross Profit Selling/General/Admin. Expenses, Total Research and Development Depreciation/Amortization Interest Expense (Income)Net Operating Unusual Expense (Income) Other Operating Expenses, Total Total Operating Expense Operating Income Income Before Tax Income After Tax Minority Interest Net Income Before Extra Items Net Income Income Available to Common Excl. Extra Items Income Available to Common Incl. Extra Items Dilution Adjustment Diluted Weighted Average Shares Diluted EPS Excluding Extraordinary Items Diluted Normalized EPS	1,342.65 1,342.65 970.71 371.94 186.50 32.80 0.36 52.48 1,242.85 99.81 98.39 66.00 61.66 61.66 61.66 61.66 0 23.91 2.58 2.59	1,217.88 1,217.88 892.10 325.78 160.92 32.68 1.75 43.42 1,130.87 87.02 84.79 58.47 54.73 54.73 54.73 54.73 0 25.31 2.16 2.21	1,126.40 1,126.40 817.29 309.10 157.13 32.41 38.46 1,039.65 86.74 83.31 56.06 52.58 52.58 52.58 52.58 0 26.47 1.99 1.84	1,078.55 1,078.55 774.31 304.24 170.69 31.45 24.12 983.33 95.22 84.19 57.48 53.73 53.73 53.73 53.73 0.14 27.91 1.93 1.51
Balance Sheet
Cash and Equivalents Cash and Short-Term Investments Accounts ReceivableTrade, Net Total Receivables, Net Total Inventory Prepaid Expenses Other Current Assets, Total Total Current Assets Property/Plant/Equipment, TotalGross Accumulated Depreciation, Total Goodwill, Net Long-Term Investments Other Long Term Assets, Total Total Assets Accounts Payable Accrued Expenses Notes Payable/Short-Term Debt Other Current liabilities, Total Total Current Liabilities Long-Term Debt Total Long-Term Debt Total Debt Deferred Income Tax Minority Interest Other Liabilities, Total Total Liabilities Common Stock, Total Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Treasury StockCommon Other Equity, Total Total Equity Total Liabilities and Shareholders Equity Total Common Shares Outstanding	16.40 16.40 44.65 49.22 22.18 12.78 18.05 118.63 487.96 291.30 78.96 31.63 438.41 32.62 60.53 10.43 103.58 88.26 88.26 88.26 10.67 18.22 36.17 256.89 0.37 280.90 356.46 458.05 1.82 181.51 438.41 22.24	18.94 18.94 28.17 32.39 20.09 10.21 13.19 94.82 445.71 263.81 75.08 27.06 390.38 32.97 44.20 3.97 81.13 51.49 51.49 51.49 6.69 15.03 30.39 184.74 0.37 262.46 294.80 353.83 1.85 205.65 390.38 24.02	47.83 47.83 25.36 30.09 17.40 10.01 14.14 119.47 424.69 239.32 74.70 25.34 417.49 31.57 42.83 1.79 76.18 99.02 99.02 99.02 13.48 33.20 221.88 0.36 245.38 240.07 291.05 1.01 195.61 417.49 25.44	25.46 25.46 22.12 22.12 15.58 8.70 12.16 84.00 402.06 214.09 75.07 28.95 393.73 26.99 54.24 5.85 87.08 99.05 99.05 99.05 8.17 22.55 216.86 0.36 231.72 191.21 245.34 1.48 176.87 393.73 26.93

Firm History and Background

By using fresh dough and superior-quality ingredients, Schnatter believed that he could make a better pizza than others. When Schnatter opened his first Papa Johns in 1985, his expectations were not very high. The first Papa Johns was a sit-down restaurant. Schnatter learned that he wasnt very good at the sit-down restaurant when he tried to serve too many different items. He paid careful attention to what customers liked and did not like and adjusted his menu accordingly.¹

The company grew rapidly, opening eight stores during its first year of operation. Papa Johns generated revenues of $500,000 in its first year.² In January 1986, Papa Johns sold its first franchise. The company remained private until the initial public stock offering on June 8, 1993, under the symbol PZZA. Papa Johns total revenues for the year ending in December 1992 were close to $50 million, having roughly doubled in size every year since 1986. After going public, the company experienced an accelerated domestic growth in the number of restaurants and opened its first international restaurant in 1998. International growth was aided by the 205-unit acquisition of Perfect Pizza, the quality leader for pizzas in the United Kingdom.

This domestic and international growth continued unabated until 2001, when it decreased dramatically leading to a 1 percent contraction in domestic growth in 2003. Since 2003, growth has been positive and relatively stable, and Papa Johns executives believed that there was significant opportunity for domestic unit growth. Papa Johns was among the highest return on invested capital (ROIC) in the restaurant category. While domestic growth was anticipated to be stable, international opportunities were significantly large and promising. Papa Johns had 350 domestic restaurants and 1,100 international restaurants that were contractually scheduled to open over the following 10 years.³ Exhibit 2 shows the historical growth of Papa Johns restaurants including projected growth through 2017 and Exhibit 3 reports the current international locations of Papa Johns restaurants.

Business Structure

Papa Johns had five major reportable segments of its business: domestic restaurants, domestic commissaries, domestic franchises, international operations, and variable interest entities. Domestic restaurants were restaurants that were wholly owned by Papa Johns in the contiguous 48 states. Domestic franchises were restaurants in which Papa Johns had licensed to franchisees for a franchise fee. These franchisee restaurants, as well as company-owned restaurants, were supported by domestic commissaries that supplied pizza dough, food products, paper products, small wares, and cleaning supplies twice weekly to each restaurant. There were 10 regional commissaries that supported domestic restaurants and franchises.

An important part of Papa Johns strategy revolved around the central commissary. It allowed Papa Johns to exercise control over the quality and consistency of its products.⁴

The commissary system was frequently cited by industry analysts and company officials as a key factor in the success of Papa Johns. The system not only reduced labor costs and reduced waste because the dough was premeasured, but it maintained control over the consistency of the product. The centralized production facility supplied all of the Papa Johns stores with the same high-quality ingredients for their pizza. One of the most important aspects of this system is that it allowed Papa Johns to start up more stores because it did not require the purchase of additional expensive equipment for each store. Part of the companys strategy was to expand into new markets only after a commissary had been built that could support the growth and geographical expansion of restaurants.⁵

Papa Johns was rated number one in customer satisfaction among all pizza chains in the American Customer Satisfaction Index for nine consecutive years from 1999 to 2008. As Schnatter had remarked in a 1997 interview, We keep it simple, consistent, and focused. We dont keep changing what we are doing.⁶ Papa Johns president, U.S.A., William Van Epps, echoed this emphasis.

Papa Johns core strategy was to sell a high-quality pizza for takeout or delivery. Its focus on using the highest- quality ingredients to produce a high-quality pizza was communicated in its motto; Better Ingredients. Better Pizza. Schnatter considered it a sign of success when Pizza Hut sued Papa Johns over the assertion that it had better ingredients and, therefore, a better pizza. Papa Johns was ultimately successful in proving it used fresher ingredients and was, therefore, able to continue using its slogan. Papa Johns stated goal was to build the strongest brand loyalty of all pizzerias internationally. Early on, Schnatter also introduced a signature bonus that served to signal the quality of the product: Each pizza was accompanied by a container of the companys special garlic sauce and two pepperoncinis.

Technology, Menu Enhancements, and Company Growth

Papa Johns had long strived to be on the cutting edge of the use of technology. The company made ordering pizza even more convenient with the introduction of online ordering in 2001. It was the first pizza company to offer online ordering. Papa Johns online sales grew exponentially in the first decade of the 21st century with growth rates of more than 50 percent a year not unusual. In November 2007, Papa Johns led the way, once again, by offering text message ordering.⁷ More than 20 percent of all Papa Johns sales came online or via text. Papa Johns was also using both the internet and mobile technologies to make potential customers aware of current promotions and to allow them to easily order a pizza from virtually anywhere.

In October 2006, Papa Johns introduced online ordering in Spanish in an attempt to meet growing customer needs and expectations. In 2012, Papa Johns became the first pizza chain to offer online ordering in Canada.

Papa Johns also extended its menu. In January 2006, Papa Johns announced that it was adding dessert pizzas to its carryout and delivery menus. We created Papas Sweetreats in direct response to consumer demand, said Catherine Hull, Papa Johns vice president of strategy and brand marketing.⁸ In July 2008, Papa Johns introduced another permanent addition to its menu: Chocolate Pastry Delight.

Menu additions and new ways to order did not signal a change in strategy, according to company executives. Nigel Travis, president and CEO of Papa Johns, stated in the company annual report 2007, our stated strategy from a year ago remains unchanged. We will continue to focus on quality, growing the brand globally, and competing aggressively. It has proven the right course in a challenging economic time and has the opportunity to be even more successful as the economy rebounds. Papa Johns targeted restaurants in the international arena as the companys primary source of long-term growth. Papa Johns saw its use of innovative marketing, product offerings, and industry-leading technology as a major advantage over its competitors.⁹

Papa Johns outlined its company strategy in one annual report as follows; Our goal is to build the strongest brand loyalty of all pizzerias internationally.

Papa Johns strategy for accomplishing this goal centered on five key activities. The first was a commitment to using high quality ingredients in its menu items. The second was operational efficiency from using commissaries and centralizing procurement. A commitment to training and development of its employees and franchise members was the third key activity. Marketing constituted the fourth key to Papa Johns strategy. Papa Johns marketed nationally through television, print, direct mail, and digital activities. The company also emphasized community-oriented marketing at the restaurant level. Such activities were often directed at schools and sports activities. Building a strong franchise system was the final key element of Papa Johns strategy. The company sought to attract franchisees with either restaurant or retail experience and then sought to develop franchisees through a variety of training and development activities.

Cost Management and Operational Support Systems

Papa Johns subleased retail locations to franchise owners. Papa Johns had lowered the number of corporate-owned stores by about 5 percent in recent years in an effort to lower its lease payments. Leasing building space gave Papa Johns the flexibility to move locations quickly with minimal cost, should a profitable location turn bad.

Papa Johns also leased the trailers used to distribute ingredients from the commissary centers to the retail locations, typically on an eight-year lease agreement. By leasing the trailers, Papa Johns was able to manage its shipping logistics and costs in a structured manner while not being required to maintain the trailers as they aged.

As Papa Johns started to grow, Schnatter recognized the importance of sharing his passion for pizza with others in his company. The Operation Support Service and Training (OSST) Center was created and was actively engaged in the training and development of team members. In order to instill his passion into his new franchisees and corporate employees, Schnatter had them complete a management training program at the OSST Center when they started with the company. The aim of this training was to help franchise owners be successful and to instill in them a firm understanding of the Papa Johns culture. Making franchisees feel like they were in a partnership with Papa Johns facilitated a level of buy-in that the company believed was seldom found in restaurant chains.

Throughout Papa Johns tremendous growth during its first 10 years of operation, its marketing programs targeted the delivery area of each restaurant, primarily through direct mailings and direct store-to-door couponing.

From its beginning, Papa Johns had been active in community affairs, from supporting local sports teams with fundraising opportunities to offering college scholarships. Papa Johns had awarded more than $5 million in college scholarships. Papa Johns actively supported the National FFA, Cerebral Palsy K.I.D.S. Center, and Childrens Miracle Network, to name only a few. Papa Johns executives believed that giving back to the community was good business.

Papa Johns had entered into numerous marketing partnerships over the years. For example, Papa Johns aligned with Coca-Cola to offer only Coke products in its stores. When Papa Johns added a pan pizza to its menu, it enlisted the aid of former Miami Dolphins quarterback Dan Marino. At the time, this was the most intensive new product launch ever undertaken by Papa Johns. Another combined effort for Papa Johns involved coordinating with eBay for a limited edition Superman pan pizza box. In Kentucky, Papa Johns and Blockbuster video combined efforts in a take dinner and a movie online in which the customer would receive a free 30-day trial of Blockbuster Online with an online pizza purchase at papajohns.com.

By using a combination of internal and external resources, Papa Johns was determined to not compete with its competition on price. Focusing on a quality product, active participation in the local communities in which it operated, and product branding enabled Papa Johns to hold its own with the other pizza chains. Papa Johns had worked to create a product branded in such a way that customers came to expect the very best pizza; and they were willing to pay a premium price. Papa Johns was committed to holding firm on the quality and prices of its pizzas.

* This case is adapted from a report prepared by Rebekah Meier, Wade Okelberry, Odie Washington, Chad Witcher, and J. C. Woelich.

Case 23: Papa Johns International, Inc.: Growth Challenges*

Papa Johns International was a classic American success story. Founder John Schnatter had started selling pizza out of a makeshift kitchen in a small lounge in Indiana, and in a little more than a decade had built a business that included more than 4,000 locations. After a slowdown in growth following the 2008 economic crisis, Papa Johns had returned to its pre-crisis pattern of opening more than 200 stores per year. Such ambition was not without challenges. The U.S. economy had changed over the two decades that Papa Johns had been in business due to an aging population and to the severe economic crisis that faced the nation starting in 2008. The economy had been particularly challenging for firms serving food and drinks. Though clearly profitable (see Exhibit 1), Papa Johns had enjoyed relatively incremental growth in the new century. Despite the challenges, the leadership at Papa Johns believed that the company had developed some important advantages that could be leveraged for high growth in either the United States or international markets or perhaps even in activities that went beyond pizza. The question facing Papa Johns executives was which path would produce rapid but profitable growth.

Exhibit 1

Papa Johns, Inc., Income Statement and Balance Sheet, 20092012

In millions of USD (except for per share items)	2012	2011	2010	2009
Income Statement
Revenue Other Revenue, Total Total Revenue Cost of Revenue, Total Gross Profit Selling/General/Admin. Expenses, Total Research and Development Depreciation/Amortization Interest Expense (Income)Net Operating Unusual Expense (Income) Other Operating Expenses, Total Total Operating Expense Operating Income Income Before Tax Income After Tax Minority Interest Net Income Before Extra Items Net Income Income Available to Common Excl. Extra Items Income Available to Common Incl. Extra Items Dilution Adjustment Diluted Weighted Average Shares Diluted EPS Excluding Extraordinary Items Diluted Normalized EPS	1,342.65 1,342.65 970.71 371.94 186.50 32.80 0.36 52.48 1,242.85 99.81 98.39 66.00 61.66 61.66 61.66 61.66 0 23.91 2.58 2.59	1,217.88 1,217.88 892.10 325.78 160.92 32.68 1.75 43.42 1,130.87 87.02 84.79 58.47 54.73 54.73 54.73 54.73 0 25.31 2.16 2.21	1,126.40 1,126.40 817.29 309.10 157.13 32.41 38.46 1,039.65 86.74 83.31 56.06 52.58 52.58 52.58 52.58 0 26.47 1.99 1.84	1,078.55 1,078.55 774.31 304.24 170.69 31.45 24.12 983.33 95.22 84.19 57.48 53.73 53.73 53.73 53.73 0.14 27.91 1.93 1.51
Balance Sheet
Cash and Equivalents Cash and Short-Term Investments Accounts ReceivableTrade, Net Total Receivables, Net Total Inventory Prepaid Expenses Other Current Assets, Total Total Current Assets Property/Plant/Equipment, TotalGross Accumulated Depreciation, Total Goodwill, Net Long-Term Investments Other Long Term Assets, Total Total Assets Accounts Payable Accrued Expenses Notes Payable/Short-Term Debt Other Current liabilities, Total Total Current Liabilities Long-Term Debt Total Long-Term Debt Total Debt Deferred Income Tax Minority Interest Other Liabilities, Total Total Liabilities Common Stock, Total Additional Paid-In Capital Retained Earnings (Accumulated Deficit) Treasury StockCommon Other Equity, Total Total Equity Total Liabilities and Shareholders Equity Total Common Shares Outstanding	16.40 16.40 44.65 49.22 22.18 12.78 18.05 118.63 487.96 291.30 78.96 31.63 438.41 32.62 60.53 10.43 103.58 88.26 88.26 88.26 10.67 18.22 36.17 256.89 0.37 280.90 356.46 458.05 1.82 181.51 438.41 22.24	18.94 18.94 28.17 32.39 20.09 10.21 13.19 94.82 445.71 263.81 75.08 27.06 390.38 32.97 44.20 3.97 81.13 51.49 51.49 51.49 6.69 15.03 30.39 184.74 0.37 262.46 294.80 353.83 1.85 205.65 390.38 24.02	47.83 47.83 25.36 30.09 17.40 10.01 14.14 119.47 424.69 239.32 74.70 25.34 417.49 31.57 42.83 1.79 76.18 99.02 99.02 99.02 13.48 33.20 221.88 0.36 245.38 240.07 291.05 1.01 195.61 417.49 25.44	25.46 25.46 22.12 22.12 15.58 8.70 12.16 84.00 402.06 214.09 75.07 28.95 393.73 26.99 54.24 5.85 87.08 99.05 99.05 99.05 8.17 22.55 216.86 0.36 231.72 191.21 245.34 1.48 176.87 393.73 26.93

Firm History and Background

By using fresh dough and superior-quality ingredients, Schnatter believed that he could make a better pizza than others. When Schnatter opened his first Papa Johns in 1985, his expectations were not very high. The first Papa Johns was a sit-down restaurant. Schnatter learned that he wasnt very good at the sit-down restaurant when he tried to serve too many different items. He paid careful attention to what customers liked and did not like and adjusted his menu accordingly.¹

The company grew rapidly, opening eight stores during its first year of operation. Papa Johns generated revenues of $500,000 in its first year.² In January 1986, Papa Johns sold its first franchise. The company remained private until the initial public stock offering on June 8, 1993, under the symbol PZZA. Papa Johns total revenues for the year ending in December 1992 were close to $50 million, having roughly doubled in size every year since 1986. After going public, the company experienced an accelerated domestic growth in the number of restaurants and opened its first international restaurant in 1998. International growth was aided by the 205-unit acquisition of Perfect Pizza, the quality leader for pizzas in the United Kingdom.

This domestic and international growth continued unabated until 2001, when it decreased dramatically leading to a 1 percent contraction in domestic growth in 2003. Since 2003, growth has been positive and relatively stable, and Papa Johns executives believed that there was significant opportunity for domestic unit growth. Papa Johns was among the highest return on invested capital (ROIC) in the restaurant category. While domestic growth was anticipated to be stable, international opportunities were significantly large and promising. Papa Johns had 350 domestic restaurants and 1,100 international restaurants that were contractually scheduled to open over the following 10 years.³ Exhibit 2 shows the historical growth of Papa Johns restaurants including projected growth through 2017 and Exhibit 3 reports the current international locations of Papa Johns restaurants.

Business Structure

Papa Johns had five major reportable segments of its business: domestic restaurants, domestic commissaries, domestic franchises, international operations, and variable interest entities. Domestic restaurants were restaurants that were wholly owned by Papa Johns in the contiguous 48 states. Domestic franchises were restaurants in which Papa Johns had licensed to franchisees for a franchise fee. These franchisee restaurants, as well as company-owned restaurants, were supported by domestic commissaries that supplied pizza dough, food products, paper products, small wares, and cleaning supplies twice weekly to each restaurant. There were 10 regional commissaries that supported domestic restaurants and franchises.

An important part of Papa Johns strategy revolved around the central commissary. It allowed Papa Johns to exercise control over the quality and consistency of its products.⁴

The commissary system was frequently cited by industry analysts and company officials as a key factor in the success of Papa Johns. The system not only reduced labor costs and reduced waste because the dough was premeasured, but it maintained control over the consistency of the product. The centralized production facility supplied all of the Papa Johns stores with the same high-quality ingredients for their pizza. One of the most important aspects of this system is that it allowed Papa Johns to start up more stores because it did not require the purchase of additional expensive equipment for each store. Part of the companys strategy was to expand into new markets only after a commissary had been built that could support the growth and geographical expansion of restaurants.⁵

Papa Johns was rated number one in customer satisfaction among all pizza chains in the American Customer Satisfaction Index for nine consecutive years from 1999 to 2008. As Schnatter had remarked in a 1997 interview, We keep it simple, consistent, and focused. We dont keep changing what we are doing.⁶ Papa Johns president, U.S.A., William Van Epps, echoed this emphasis.

Papa Johns core strategy was to sell a high-quality pizza for takeout or delivery. Its focus on using the highest- quality ingredients to produce a high-quality pizza was communicated in its motto; Better Ingredients. Better Pizza. Schnatter considered it a sign of success when Pizza Hut sued Papa Johns over the assertion that it had better ingredients and, therefore, a better pizza. Papa Johns was ultimately successful in proving it used fresher ingredients and was, therefore, able to continue using its slogan. Papa Johns stated goal was to build the strongest brand loyalty of all pizzerias internationally. Early on, Schnatter also introduced a signature bonus that served to signal the quality of the product: Each pizza was accompanied by a container of the companys special garlic sauce and two pepperoncinis.

Technology, Menu Enhancements, and Company Growth

Papa Johns had long strived to be on the cutting edge of the use of technology. The company made ordering pizza even more convenient with the introduction of online ordering in 2001. It was the first pizza company to offer online ordering. Papa Johns online sales grew exponentially in the first decade of the 21st century with growth rates of more than 50 percent a year not unusual. In November 2007, Papa Johns led the way, once again, by offering text message ordering.⁷ More than 20 percent of all Papa Johns sales came online or via text. Papa Johns was also using both the internet and mobile technologies to make potential customers aware of current promotions and to allow them to easily order a pizza from virtually anywhere.

In October 2006, Papa Johns introduced online ordering in Spanish in an attempt to meet growing customer needs and expectations. In 2012, Papa Johns became the first pizza chain to offer online ordering in Canada.

Papa Johns also extended its menu. In January 2006, Papa Johns announced that it was adding dessert pizzas to its carryout and delivery menus. We created Papas Sweetreats in direct response to consumer demand, said Catherine Hull, Papa Johns vice president of strategy and brand marketing.⁸ In July 2008, Papa Johns introduced another permanent addition to its menu: Chocolate Pastry Delight.

Menu additions and new ways to order did not signal a change in strategy, according to company executives. Nigel Travis, president and CEO of Papa Johns, stated in the company annual report 2007, our stated strategy from a year ago remains unchanged. We will continue to focus on quality, growing the brand globally, and competing aggressively. It has proven the right course in a challenging economic time and has the opportunity to be even more successful as the economy rebounds. Papa Johns targeted restaurants in the international arena as the companys primary source of long-term growth. Papa Johns saw its use of innovative marketing, product offerings, and industry-leading technology as a major advantage over its competitors.⁹

Papa Johns outlined its company strategy in one annual report as follows; Our goal is to build the strongest brand loyalty of all pizzerias internationally.

Papa Johns strategy for accomplishing this goal centered on five key activities. The first was a commitment to using high quality ingredients in its menu items. The second was operational efficiency from using commissaries and centralizing procurement. A commitment to training and development of its employees and franchise members was the third key activity. Marketing constituted the fourth key to Papa Johns strategy. Papa Johns marketed nationally through television, print, direct mail, and digital activities. The company also emphasized community-oriented marketing at the restaurant level. Such activities were often directed at schools and sports activities. Building a strong franchise system was the final key element of Papa Johns strategy. The company sought to attract franchisees with either restaurant or retail experience and then sought to develop franchisees through a variety of training and development activities.

Cost Management and Operational Support Systems

Papa Johns subleased retail locations to franchise owners. Papa Johns had lowered the number of corporate-owned stores by about 5 percent in recent years in an effort to lower its lease payments. Leasing building space gave Papa Johns the flexibility to move locations quickly with minimal cost, should a profitable location turn bad.

Papa Johns also leased the trailers used to distribute ingredients from the commissary centers to the retail locations, typically on an eight-year lease agreement. By leasing the trailers, Papa Johns was able to manage its shipping logistics and costs in a structured manner while not being required to maintain the trailers as they aged.

As Papa Johns started to grow, Schnatter recognized the importance of sharing his passion for pizza with others in his company. The Operation Support Service and Training (OSST) Center was created and was actively engaged in the training and development of team members. In order to instill his passion into his new franchisees and corporate employees, Schnatter had them complete a management training program at the OSST Center when they started with the company. The aim of this training was to help franchise owners be successful and to instill in them a firm understanding of the Papa Johns culture. Making franchisees feel like they were in a partnership with Papa Johns facilitated a level of buy-in that the company believed was seldom found in restaurant chains.

Throughout Papa Johns tremendous growth during its first 10 years of operation, its marketing programs targeted the delivery area of each restaurant, primarily through direct mailings and direct store-to-door couponing.

From its beginning, Papa Johns had been active in community affairs, from supporting local sports teams with fundraising opportunities to offering college scholarships. Papa Johns had awarded more than $5 million in college scholarships. Papa Johns actively supported the National FFA, Cerebral Palsy K.I.D.S. Center, and Childrens Miracle Network, to name only a few. Papa Johns executives believed that giving back to the community was good business.

Papa Johns had entered into numerous marketing partnerships over the years. For example, Papa Johns aligned with Coca-Cola to offer only Coke products in its stores. When Papa Johns added a pan pizza to its menu, it enlisted the aid of former Miami Dolphins quarterback Dan Marino. At the time, this was the most intensive new product launch ever undertaken by Papa Johns. Another combined effort for Papa Johns involved coordinating with eBay for a limited edition Superman pan pizza box. In Kentucky, Papa Johns and Blockbuster video combined efforts in a take dinner and a movie online in which the customer would receive a free 30-day trial of Blockbuster Online with an online pizza purchase at papajohns.com.

By using a combination of internal and external resources, Papa Johns was determined to not compete with its competition on price. Focusing on a quality product, active participation in the local communities in which it operated, and product branding enabled Papa Johns to hold its own with the other pizza chains. Papa Johns had worked to create a product branded in such a way that customers came to expect the very best pizza; and they were willing to pay a premium price. Papa Johns was committed to holding firm on the quality and prices of its pizzas.

* This case is adapted from a report prepared by Rebekah Meier, Wade Okelberry, Odie Washington, Chad Witcher, and J. C. Woelich.

The Restaurant Industry and Pizza Segment

The restaurant industry had historically been very attractive to entrepreneurs. Most of these new entrants opened single locations. The relatively low capital requirements made the restaurant business very attractive to small-scale entrepreneurs. Some of these businesses succeeded, but there was an intense amount of competition. There were relatively high fixed costs associated with entering into the restaurant business. These factors caused many of the new businesses to fail. However, for the businesses that succeeded, the payback on the investment could be quite high. After sales reached the break-even point, a relatively high percentage of incremental revenues became profit.

Restaurant analysts were generally amazed at how successfully Schnatter built Papa Johns. Michael Fineman, a restaurant analyst with Raymond James in St. Petersburg, Florida, stated, Heres an industry that appears to be mature and saturated, and here comes John Schnatter with his company Papa Johns. He has proven to be a fantastic visionary.¹⁰

Large restaurant chains, like Papa Johns, were able to realize economies of scale that made competition extremely difficult for small operators. Some of these advantages included purchasing power in negotiating food and packaging supply contracts, as well as real estate purchasing, location selection, menu development, and marketing.

Papa Johns operated in the highly competitive pizza restaurant market, where the cost of entry was relatively low and product differentiation was difficult. Other pizza chains tried to compete in ways other than Papa Johns emphasis. Some chains focused on being less expensive or having a broad menu. The meal options available for consumers were increasing both for convenience dining and at-home consumption. The quality of frozen pizza available at grocery stores had improved significantly in recent years. A broader trend was that restaurant and quick-service restaurant dinner occasions were declining, which was significant for pizza restaurants such as Papa Johns, which gained 70 percent of its sales from dinner orders. Declining restaurant and quick-service restaurant dining was attributed to an increase in at-home dinner preparation, linked to a decline in the percentage of women in the workforce.¹¹

The large number of restaurant types throughout North America made it unlikely that any firm would gain a competitive advantage by offering one style or type of cuisine. The one principle that made Papa Johns rare in the restaurant industry was its ongoing passion to offer the perfect pizza. Many companies claimed to place quality at the forefront of their business, but often the commitment to quality went no deeper than public relations and was not a core value.

Papa Johns commitment to the highest-quality ingredients created challenges in managing the supply of the foods that went into its pizza. The volatility in the price of cheese had been a major problem for Papa Johns. Cheese material costs contribute approximately 35 to 40 percent of Papa Johns restaurants food costs. In order to reduce the cheese price volatility, Papa Johns partnered with a third-party entity formed by franchisees, BIBP Commodities, Inc., whose sole purpose was to reduce cheese price volatility to domestic system-wide restaurants. This allowed Papa Johns to purchase cheese from BIBP at a fixed quarterly price. Profits and losses from BIBP were then passed on to Papa Johns.¹²

Rising costs challenged pizza restaurants in multiple areas. Labor costs, as well as food commodity costs, were rising in the industry. Although restaurants are experiencing cost increases for labor, utilities, and transportation, perhaps no other factor has prompted restaurants to increase their prices in 2008 more than food commodity cost inflation (S&P Industry Surveys [2008]). Rising energy costs had a dual impact on Papa Johns and its competitors. Food prices of products related to corn were increasing even more rapidly because of corns use as an alternative fuel. Fluctuating in-store utility costs and delivery driver fuel costs were an ongoing source of concern. In 2007-08, such costs had risen dramatically. Another potential threat of rising costs stemmed from legislation at the federal level as well as many states that mandated a higher minimum wage.

Many companies, including Papa Johns, engaged in forward pricing to stabilize food costs. Forward pricing is a hedging strategy whereby a company negotiates with a supplier to purchase a certain amount of a product at a given price. Some supply contracts, signed by larger chains, can lock in less volatile food products for an entire year. Some of the products subject to the greatest variability, especially dairy products, can be locked in only for shorter periods.¹³

Of the $200-plus-billion restaurant market, the pizza segment currently held 6.7 percent of the market. Pizza Hut, a division of Yum! Brands, Inc., was the leader, followed by Dominos Pizza, Inc., Papa Johns International, Inc., and Little Caesars (a division of Ilitch Holdings, Inc.). Each was a large, nationally known pizza provider. These four accounted for 88 percent of the aggregate sales in the pizza chain restaurant segment; each was significantly larger than the #5 chain Chuck E. Cheeses (operated by CEC Entertainment, Inc.).

Papa Johns Looking Forward

Schnatter was optimistic about the future of Papa Johns. He wanted to see Papa Johns get back on the path of opening 200 to 300 stores per year. Over the following five years, he wanted to see Papa Johns reach the 4,000-store mark and, long term, he aspired to see 6,000 to 7,000 stores worldwide.¹⁴ Papa Johns also sought to reduce the number of company-run stores by turning them into franchising opportunities. At the end of 2012, Papa Johns operated 3,204 stores in North America and another 959 internationally. Papa Johns owned 20 percent of the North American stores but only 5 percent of the international stores, which were all in China. Franchising more of its current company-run stores offered Papa Johns some important benefits. Franchise royalties were based on a percentage of sales and not on a percentage of profits, which allowed Papa Johns to ensure a steady stream of revenue even in a difficult operating environment.

Papa Johns had several options at its disposal. Among them were international market expansion, increased domestic market penetration, and related diversification (primarily via strategic acquisitions). The case for international expansion was based on the conclusion that the U.S. pizza industry (and quick-serve restaurant industry in general) had matured and that the most significant growth opportunities were beyond U.S. borders. Pizza Hut benefited from a first-mover advantage in several, if not most, attractive international markets. With over 1,000 stores, Pizza Hut operated more stores in China than Papa Johns throughout the world. It operated more than 5,200 stores, more than five times the number of Papa Johns. Historically, Papa Johns international efforts centered in Mexico, Canada, the United Kingdom, the Middle East, and Asia. Some believed that Asian markets would generally favor quality-centered business models due to higher preferences for quality. Another favorable trend in these markets was a growing income base for the local population.

In building its international infrastructure, the company would need to cultivate new relationships and develop new skills. One critical element was the companys ability to continue to partner with local producers in order to maintain tight quality control and keep ingredients fresh. In terms of new skills, Papa Johns needed to develop the ability to modify its standard smaller carry-out restaurant blueprint. Looking at the success of firms such as McDonalds or Yum! Brands, Inc.s Kentucky Fried Chicken, there was persuasive evidence that international customers tended to view their eating-out experience as more of a formal dining event. Thus, the standard Papa Johns takeout restaurant model might need to be expanded to accommodate a sit-down dining area for patrons.

In addition to expanding internationally, Papa Johns sought to grow and maintain its domestic market share. Traditionally, restaurants did this by adding new menu items or introducing a value selection such as McDonalds dollar menu or Little Caesars Hot-N-Ready $5 pizza offering. For Papa Johns, these strategies presented the risk of overextending its menu and, consequently, reducing its overall brand quality or ability to charge premium prices.

Extending the companys co-branding efforts was another possible avenue for domestic growth. For example, Papa Johns partnered with firms such as Nestl to provide some of its dessert menu offerings. There were a vast number of co-branding opportunities that were, in theory at least, possible.

A third alternative for Papa Johns involved diversifying from pizza. For example, Papa Johns could develop or acquire an additional restaurant chain under a different brand. Such an approach would allow Papa Johns to compete in another restaurant category without fear of diluting its quality brand. Other competitors in the industry had operated chains in multiple categories. McDonalds, for example, had invested in Chipotle Mexican Grill and Boston Market before disposing of its investments in 2006 and 2007, respectively. Yum! Brands, Inc., operated Pizza Hut, Taco Bell, Kentucky Fried Chicken, and A&W. With the growing influence of the Hispanic population and culture in the United States, some believed that a Hispanic/Mexican-themed restaurant would allow the company to benefit from this trend without impairing the Papa Johns franchise.