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Tags: papa johns founder | quality pizza

John Schnatter: Papa John's Will Fully Embrace Quality Again

John Schnatter: Papa John's Will Fully Embrace Quality Again
John Schnatter, right, founder of Papa John's International, Inc., rings the Nasdaq opening bell in New York. (Rob Kim/Getty Images/2014 file photo)

Wednesday, 08 March 2023 08:08 AM EST

Everybody loves pizza. The pandemic proved it. People were forced to stay at home for months on end, the government was handing out paychecks, and pizza delivery shops were soaring high with teeming business.

The artificial sale surges that pizza companies experienced finally came to an end in the past year or so. As a result, the realities of the current economy have set in for the sector, including the negative impact of inflation, supply disruptions and labor shortages, on top of rising utilities, insurance premiums and commodities.

Perhaps no other company in the pizza delivery business faces the headwinds of this new reality more than my namesake, Papa John’s International (PJI).

The release of the company’s disappointing Q4 earnings report – which sent Papa Johns (PZZA) stock tumbling – confirmed the concern I raised back in 2021. Although the company is still seeing some residual “positive” effects from the pandemic, the COVID chickens are finally coming home to roost.

I share this update with little enthusiasm. Some of my best friends are franchisees who have everything at stake in the performance of the company. While I have been away from day-to-day management as CEO since 2016 informally and 2017 officially, I wish nothing but success for the franchisees who have their livelihoods and life savings on the line.

But something is fundamentally wrong at the core of Papa John’s.

Among the Big Three pizza companies — Papa John’s, Domino’s, and Pizza Hut — Papa John’s beat out the competition in the American Customer Satisfaction Index every year except two from 1999 to 2019. Since then, however, Papa John’s has consistently lost to Domino’s and Pizza Hut when it comes to customer satisfaction, now having one of the lowest scores of any national brand – and no longer has the chance of winning local and regional pizza contests.

This drop in customer satisfaction has driven customers away, despite Papa John’s corporate leaders desperately trying to entice them back with national promotions. The typical food costs for these promotional items have been 38% to 39%. That’s devastating to franchisees – who rely on keeping food costs less than 29% – and it’s not even having the desired effect of driving traffic.

All of this leads to reasonable questions about the company’s plans moving forward. For instance, shareholders should also ask why Papa John’s is losing customers as quickly as it’s losing customer satisfaction, and why the company’s efforts to regain lost customers are failing. It’s truly terrifying to think that running a $6.99 national offer for a pizza would lead to lost customer counts, as transactions have recently been in the range of negative 5% to negative 10%.

Unfortunately for PJI, customers are not the only numbers declining. The company’s Q4 report shows that although same-store sales (“comp sales”) in North America were up 26% over a three-year period, North America comp sales in Q4 2022 vs. Q4 2021 were only up 1%. International comp sales, meanwhile, were down by over 3%. In fact, the company’s adjusted total revenues were up only $86 million in 2022 – which can be entirely attributed to increases in revenue in the commissary system driven by food cost inflation. The company was able to ride the COVID wave for a while, but the lockdowns are over, and the pizza industry is returning to normal.

The company also appears to be falling far short of its goal for new store openings. Although it still insists it will hit its projection of 1,400 to 1,800 net new units over the period of January 2, 2022 to December 31, 2025, the company struggled to open new stores (on a net basis) for most of last year —62 in Q1 2022, 47 in Q2 2022, and a meager 18 in Q3 2022. The Q4 report claims 117 net new stores in the final three months of the year, bringing the full-year total to 244 net new openings, but that’s still not enough. To gloss over this problem, I’ve heard reports that they’re threatening litigation against franchisees, forcing them to keep open stores that are losing money.

To hit the low end of its four-year projection of 1,400 net new stores, the company would have to average an unprecedented 385 net new store openings per year — more than one per day – over the next three years.

They’re only projecting opening 310 net stores in 2023, so to make their target, they’d have to open over 430 net units per year in 2024 and 2025. That’s a tall task just to get to the bottom end of their guidance – franchisees won’t be very eager to build new stores when customer transactions are headed in a negative direction. And remember, these are net new stores we’re talking about. Any store closings only make hitting their target more difficult, and they’ve already closed 273 stores since the beginning of 2021.

Earnings per share (EPS) of PJI are also declining. 2022 saw an adjusted EPS of $02.94 compared to an adjusted EPS of $3.51 in 2021, a decline of over 16 percent.

For those who may be asking what’s wrong here, there is an obvious answer. Papa John’s has lost its “point of differentiation” – the thing that makes it stand out compared to its competitors.

“Better Ingredients. Better Pizza.” was never just a slogan. It was a statement of principle. It was something that mattered when my leadership team helmed the company. We went to great lengths every step of the way to make sure that our ingredients were the highest quality so that the final product could out-compete any other pizza.

That’s no longer true. The company terminated the product and store measurement system we established years ago that maintained consistent product quality worldwide. Current management abandoned that commitment to quality. Another thing shareholders should ask, therefore, is: Why did we spend hundreds of millions, maybe billions, of dollars over decades (investing in product, people, training, and measurement systems) to build equity in a quality position that differentiates PJ from competitors only to lose that advantage by commoditizing the brand?

We built this company on quality, and without that differentiation, Papa John’s will be competing solely based on price – and they’ll be doing it against competitors who have thousands more stores, and the economies of scale that go with that size advantage. That’s not a recipe for success in my opinion.

The bottom line is that Papa John’s is an expensive stock in a value-driven market, and the company is struggling because quality and service have deteriorated to the point where customers are leaving at the very same time that inflation is destroying store unit economics.

While it’s universally true that everyone loves pizza, that doesn’t mean consumers will accept mediocre quality and substandard customer service from a major pizza delivery brand such as Papa John’s. Reestablishing the commitment to quality that has always differentiated the brand would be a great place to start to turn this ship around.

The sales bounce from COVID is over, but satisfying people’s love for quality pizza will always be a winning strategy. Unfortunately for Papa John's, it will be a long, expensive road to get back to the winning ways of its past – I should know, I’ve had to do it three times before.
Papa John Schnatter is the founder and former chairman and CEO of Papa John’s International (PZZA).

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Everybody loves pizza. The pandemic proved it. People were forced to stay at home for months on end, the government was handing out paychecks, and pizza delivery shops were soaring high with teeming business.
papa johns founder, quality pizza
Wednesday, 08 March 2023 08:08 AM
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