Domino’s aiming for digital delivery

YOU don’t typically associate the pizza industry with innovation.

YOU don’t typically associate the pizza industry with innovation. Pizza is one of the most popular meals in the world, with a design that has endured for centuries. Yet innovation is at the heart of Domino’s Pizza (ASX: DMP). Such is this focus on improvement that it is being considered more as a technology company than a chain of pizzerias.

You see, Domino’s Pizza is a digital leader of food delivery in Australia, with nearly 60 per cent of domestic sales made online. This share is expected to increase, as the company has recently announced that “big technology launches” are planned in the next financial year.

Consider what the future would be like if 100 per cent of Domino’s Pizza orders were made online. Could Domino’s one day become a truly virtual player, no longer requiring storefronts?

First, we should explore the basics of the traditional pizza industry. Pizza is typically purchased on impulse or for convenience, and is always consumed upon purchase. When you’re hungry, waiting an hour for your food can be too long. Pizza chains would service this need by producing pizzas in a central location. A large store network provides scale benefits from the sourcing of ingredients, but the cost of producing the pizzas has stayed high due to the need for localised production.

If all customers eventually become comfortable ordering online, does this present an opportunity to innovate with the traditional storefront model? Could Domino’s consolidate its traditional store network into production centres?

Production centres have a lot of cost advantages over a network of small stores. The model would require fewer staff, as all orders would be centrally processed. Rents might be reduced as distribution centres do not need to be in highly visible areas, and with no storefronts the company would not need to invest in furniture and fittings to refresh the brand. This sounds appealing in theory, and may be a viable option to achieve earnings growth once Domino’s reaches the limits of it store rollout strategy. But there are two barriers that may limit this new model in practice.

The first is the need to deliver fresh, hot pizzas so drivers have a time limit. While a distribution centre may be able to service a wider area than a local store, distance constraints would still limit consolidation potential.

An extensive store network in highly visible locations also allows Domino’s to remain front-of-mind for impulse purchases. While customers may order online, in many instances this sale is generated by visual cues. How many times have your dinner decisions been influenced by what you’ve seen on the commute home from work? As such, the potential cost savings from production centres would have to be considered against the potential loss of “walk-in” sales.

The second barrier could be the mindset of consumers. Australians have been comfortable with the takeaway model for decades, but this has always been based on a clear understanding of where the pizzas come from. While customers who receive deliveries do not make contact with the pizza store, they know they can visit the nearest store and see the pizza being made. This level of trust is important, and is a key reason why Domino’s moved its “pizza make line” to the front of the store.

If Domino’s was to become a pure online player customers would need to be comfortable ordering from a production centre. There must be complete trust that the products will be prepared to the highest of standards. While the quality may improve in these centres where the environment can be more controlled, it may be a tough ask for the public to trust what goes into their bodies without a physical presence for confirmation.

At Montgomery Investment Management, we consider that Domino’s rightly trades as a technology company to reflect its growth opportunities. The company has been successful in transforming the buying patterns of its customers, and more sales are made online than via the physical store presence. For this innovative pizza maker, it is certainly an interesting future to consider.

Roger Montgomery is the founder of Montgomery Investment Management.