The Challenges Facing the Increasingly Crowded Pizza Segment

The Challenges Facing the Increasingly Crowded Pizza Segment

We’re currently seeing a whole host of pizza chains (from the household names like Domino’s and Pizza Hut to the rapidly-expanding fast-casual players) racing toward the same finish line. The sheer amount of pizza restaurants is a signal that some likely won’t finish the race, falling by the wayside as more competitive chains forge ahead.

Over the next few years, the pizza industry in the US is likely to experience lower growth than the foodservice industry overall (while Food Away From Home sales have grown, on average, 6.2% annually over the past three years, the pizza industry is expected to experience a CAGR of 4.6%). So, is the pizza boom over? Not exactly, though we’ll see a lot of changes on the horizon.

SOME PREDICTIONS

• The weaker concepts and chains will be gobbled up or lose share as the segment continues to grow crowded. (For every Cici’s and Sbarro pizzeria that closed, we’ve noted 1.2 Domino’s pizzerias have opened.)
• The biggest players will continue to unveil innovative ways to order, forcing independent operators to increase their investment into tech (but not without putting plans in place to ensure its efficacy).
• Labor, rent, and commodity costs will force chains to enact plans farther in advance than they have historically.
• Seismic shifts in technology and convenience will see pizza chains compete against non-traditional players and segments. Change will occur at a much faster pace than ever before.

Below, we outline a handful of hurdles facing pizza chains today, and how restaurants can best begin to tackle them.

NEW CONCEPTS ARE CROPPING UP ALMOST DAILY, BUT GROWTH WON’T BE ENOUGH TO SUPPORT THEM ALL

Like the Better Burger segment, the pizza market is becoming crowded with a slew of similar concepts. A potential pizza industry bubble doesn’t mean pepperoni and cheese pies will go away. Nor will Domino’s, Pizza Hut, or Blaze fade into obscurity any time soon. But with some fast-casual concepts growing at rates of more than 100%, and newer players continuing to pick up funding (Blaze, for instance, touts investors including LeBron James and got a recent infusion of capital from private equity firm Brentwood Associates), cannibalization is naturally on the horizon.

Those in the most danger will be the independent pizzerias not keeping up with modern technology, as well as chains not offering anything unique enough to distinguish them from the pack. The shift from independent operators to pizza chains in just a ten-year window is striking (in the last decade, American independents have lost 21% market share in terms of sales and 19% market share in terms of units to chains) — but it’s likely to grow at an even more rapid clip.

Historically, pizza chains saw huge shares of revenue being driven by delivery or carry-out. But gone are the days when the only two delivery options were pizza and Chinese food. The danger of competitors has grown and a slew of tech-savvy, energetic concepts have emerged. As a result, share is no longer just being stolen by “the big guys,” but from entirely new segments, a range of restaurants with mobile apps, and third-party delivery apps. As delivery expands and more convenient options become ubiquitous, innovation will continue to take a toll on low-tech operators.

But just because the US market doesn’t necessarily need another pizza restaurant (unless it’s incredibly distinct), doesn’t mean there’s no untapped opportunity. Emerging markets (including the Gulf Cooperation Council, Brazil, China, India, some parts of Africa, and other parts of Asia with booming populations and fragmented foodservice) offer enormous potential. Of course, there are international players, as well — 800 Degrees, for instance, has outlets in Dubai and Tokyo as well as the US — but there remain numerous opportunities around the globe.

THE PIZZA INDUSTRY APPEARS IMPENETRABLE

As of 2016, 46% of the U.S. pizza market share was concentrated in the hands of eight companies (as we illustrated in a previous post, on the importance of restaurant tech). To those looking to expand a concept, or invest in a concept with the intent of growing it, the segment might seem near-impossible to break into — and, for many, it is. But even the newer, smaller players can carve a niche for themselves — provided they undertake the proper planning necessary to do it the right way.

The chain with the largest share of the segment in 2016 was Pizza Hut (14%), but this doesn’t illustrate the whole picture. Pizza Hut grew at 3% CAGR over the last five years, so it’s actually been losing share to fast-growing companies like Little Caesar’s, Domino’s and Papa John’s. Meanwhile, concepts that haven’t been as quick to turn to technological innovations (Cici’s Pizza and Sbarro, for instance) have seen share shrinking, with negative growth of 4% and 11%, respectively. In other words, we’ve noted an almost one-to-one tradeoff of new Domino’s stores replacing old Cici’s and Sbarro stores. In fact, for every Cici’s and Sbarro pizzeria that closed, 1.2 Domino’s pizzerias have opened.

AUV ATV pizza chains

The bulk of pizzerias see within $0.6 million and $1 million in Average Unit Volume. On the high end, California Pizza Kitchen has an AUV of $2.8, explained largely by a higher check average. Cici’s and Sbarro sit on the opposite end of the spectrum, characterized by low ATV (and high traffic) – a model that doesn’t appear to be as successful as it once was, considering both chains saw negative growth over the last five years. Domino’s, Papa John’s, and Pizza Hut, meanwhile, compete at similar values of Average Transaction Value and traffic.

People won’t stop eating pizza, but there will be consolidation, with weaker players getting gobbled up. A lot of chains in the mature part of the life-cycle are already ripe for consolidation. For private equity firms looking to invest in a restaurant concept, the opportunity abounds. There’s also an increased need for firms to help rehabilitate and improve those mature brands that have not kept up with the times. Through the proper investment (plus help from a seasoned expert), firms can provide the necessary capital and management insights required to reimagine a future for an older brand, and seed relevance within the increasingly competitive pizza category.

COMMODITY, LABOR, AND RENT COSTS WILL RISE

The restaurant industry faces a slew of challenges, including the fluctuating costs of commodities and rent and labor inflation. There was a period of time when commodity costs were relatively low. Pizza chains will be especially impacted by higher dairy, wheat, and flour costs.

Futures markets anticipate an 8.3% increase in the price of milk from now until June 2019 and a 13% increase in the price of wheat, as of July 2020. For some, commodity price increases will be manageable in the overall context of a business. But for others, the impact will be felt in a deeper sense (though proper planning can provide a better cushion).

Even if rising costs aren’t yet impacting chains, restaurant companies should plan ahead — we expect to see rent and labor costs spike within the next five years. Rising wages and lower unemployment rates will prove especially potent for the industry. Minimum wage hikes have already taken effect in more than a two dozen states and municipalities, with plenty more expected to follow suit soon enough.

PIZZA CHAIN TECHNOLOGY IS GROWING AND BECOMING A REQUISITE PART OF THE INDUSTRY

We’ve written before about how tech is killing off independent chains — but even some well-known, yet dated, chains are at risk of falling into irrelevance.

pizza chain technology mobile order drones Apple watch

For decades, restaurants grew accustomed to the notion that they were the convenient choice — stealing share from grocers and growing fat and happy in the process. In recent years, some grocers have redeemed that share and other, even more convenient options, have crept in, too.

The speed and breadth of communication is such that the modern consumer has a need for instant gratification, leading to mounting pressures for restaurants to provide convenient delivery options and launch digital-ordering platforms.

For still-burgeoning concepts, success will start with defining a brand’s purpose and promise, and ensuring every touch point of service goes back to that purpose. Startups will be forced to confront a hard truth: Do they offer something that a journalist would deem nationally-newsworthy? Even the most brilliant concept can fail, particularly if it tries to solve a problem that doesn’t exist, and lose simple truths of hospitality along the way. As great as technology is (and as important as it will continue to be), a tech-heavy chain that doesn’t offer the most engrained aspects of service — speed, convince, quality, etc. — won’t resonate with consumers. Even a single-location restaurant can attempt to microwave too much, too quickly, placing ego over EBITDA in the pursuit of quick success.

SEISMIC SHIFTS (IN TECHNOLOGY, CONVENIENCE, AND MORE) WILL OCCUR AT AN EVEN MORE RAPID PACE

Today’s business environment is a survival of the fittest. The weakest chains and concepts will have a limited life span; poor planning could spell the difference between distinct and extinct.

We’ve seen the fate that awaits those who take a wait-and-see approach. While Amazon continues to dominate the retail industry, companies like Sears and JC Penney have suffered. Many restaurant chains (particularly those in the pizza segment) will face similar challenges. Those who wait too long risk missing the path toward recovery.

retail versus ecommerce

The most dramatic reshaping of the industry to happen in decades will occur over the next five years, and complacency will be a death knell for restaurant concepts. Restaurant guests don’t expect chains to innovate as rapidly as Apple, but they are growing more and more accustomed to convenience and the tools that enable it.

On the one hand, chains have to work from the inside-out — a holistic approach that our firm has long touted. On the other hand, though, working from the inside out requires an outside-in approach. Restaurant chains must start with looking at their own company: their promise, their people, their processes. But if they really want to understand why they’re struggling, they must start at the widest, most global levels, determining which forces are bearing down on them and how they’re being re-shaped as a result.

The world doesn’t need another pizza place. What it does need is something new — a unique promise and positioning strategy that will resonate with consumers. Chains that can bake that unique promise into their pies, and top it off with all of the non-negotiables (convenience, service) will be rewarded with a larger slice of share.

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ABOUT AARON ALLEN & ASSOCIATES:

Aaron Allen & Associates is a leading global restaurant industry consultancy specializing in growth strategy, marketing, branding, and commercial due diligence for emerging restaurant chains and prestigious private equity firms. We work alongside senior executives of some of the world’s most successful foodservice and hospitality companies to visualize, plan and implement innovative ideas for leapfrogging the competition. Collectively, our clients post more than $100 billion, span all 6 inhabited continents and 100+ countries, with locations totaling tens of thousands.

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