Podcast Summary
Exploring the Complex Food Ecosystem and Investing Opportunities: Navigate the intricate food ecosystem using comprehensive data and analysis from organizations like Canalyst. Partner with established investment firms like MITIMC for resources and support. Identify profitable areas within the value chain for successful investment opportunities.
The world of investing, particularly in the food ecosystem, is a complex and dynamic web of interconnected components. From large producers to industrial farms, processors, distributors, restaurants, and grocery stores, each part plays a crucial role in the value chain. Institutions like Canalyst, with their comprehensive public company data and analysis, help investors navigate this intricate ecosystem and react more quickly to market changes. For new and small investment funds, partnerships with established organizations like MIT Investment Management Company (Matimco) can provide valuable support and resources. And as the food industry continues to evolve, understanding the value chain and identifying where profits tend to sit can lead to successful investment opportunities.
The Law of Conservation of Attractive Profits in the Food Industry: In the food industry, some players capture larger profit pools due to their unique positioning in the value chain, such as McDonald's with international brand licensing, lead generation, and scale benefits. Understanding which aspects of a value chain are least commoditized and which are most differentiated can help identify attractive businesses.
Throughout various industries and value chains, certain players capture a disproportionate amount of profits due to their unique positioning. This concept, known as the law of conservation of attractive profits, is particularly relevant in the food industry, which is a massive market in the US worth over $1.5 trillion between food at home and food away from home. McDonald's, Tyson, and Cisco, for example, all participate in the same value chain but capture different levels of profit due to the varying commoditization of their respective aspects of the value chain. In the food industry, fast food chains like McDonald's capture a large profit pool due to their international brand licensing, lead generation, and massive scale benefits, while chicken production and local food distribution are more commoditized. Currently, food delivery is disrupting the value chain, with various players vying for a piece of the profit pool. This includes aggregators like DoorDash, logistics companies, technology providers, and even incumbents like Chipotle and Starbucks opening digital-only stores. Understanding which aspects of a value chain are least commoditized and which are most differentiated can help identify the most attractive businesses.
Adapting to technological innovations in the food industry: Restaurants and grocery stores must embrace technology and adapt to changing consumer trends to remain competitive and capture a share of the large profit pools in the industry.
In the food industry, particularly for restaurants, outsourcing delivery and lead generation to third parties like Uber Eats or DoorDash can be economically unfavorable if it leads to replacing current sales or results in high fees. However, lead generation is a valuable business, and if done efficiently, delivery can be profitable for both restaurants and aggregators. In urban areas with high route density, lower take rates are possible, leading to a larger profit pool for all parties involved. Traditional food businesses, including restaurants and grocery stores, must adapt to technological innovations and disruptions in order to remain competitive and capture a share of the large profit pools in the industry. Companies like Walmart, Kroger, and Amazon are battling it out in the grocery sector, which has low margins but a massive potential annual profit opportunity. Embracing technology and adapting to changing consumer trends are key for success in the food industry.
Traditional food businesses adapt to changing consumer preferences: Legacy food businesses like grocery stores and restaurants face challenges from technology and changing consumer behavior. They respond by adopting new models like dark stores and cloud kitchens, which reduce costs and improve order fulfillment.
Technology and changing customer preferences are disrupting traditional industries, particularly in the food sector. Legacy businesses, such as grocery stores and restaurants, are facing significant challenges as consumers shift towards online ordering and pick-up options. To remain competitive, these businesses are exploring new models, such as dark stores and cloud kitchens, which reduce real estate costs and allow for more efficient order fulfillment. For example, Domino's, with its $15 billion annual sales and over 17,000 restaurants worldwide, is a prime example of a business that has successfully adapted to these trends by operating as a restaurant, supply chain business, and brand manager all in one. Dark stores and cloud kitchens allow businesses to lower labor and rent costs, enabling them to fund delivery and fulfillment. In the case of Domino's, 95% of its US restaurant owners are former employees, while internationally, franchisees are managed by institutional master franchisors. These shifts in business models reflect the evolving nature of the food industry and the increasing importance of digital presence and efficiency.
Domino's Franchise Business Model: Remarkable Unit Economics: Former employees can invest $250,000-$350,000 in a Domino's store, generating $1,100,000-$1,200,000 in annual sales, 3-6% growth, $125,000 average cash flow, 30%+ cash on cash return, and a 2.5-3 year payback. Domino's high returns come from pizza's 80% gross margin, delivery services, and technology investment.
The Domino's pizza franchise business model creates significant value throughout its ecosystem, with remarkable unit economics that offer high returns to franchisees. For a former employee looking to open their first Domino's store, the investment can range from $250,000 to $350,000, with an average store generating $1,100,000 to $1,200,000 in annual sales and growing 3-6% every year. With an average store cash flow of $125,000, the potential franchisee can achieve a 30%+ cash on cash return or a 2.5-3 year payback. Domino's unique position to offer such high returns is due to the nature of the product they sell and deliver. Pizza has a higher gross margin of 80% compared to a burger joint's 65%, allowing Domino's to fund their delivery services and invest in technology. The returns are higher than most competitors, with Domino's offering more than McDonald's, Burger King, Dunkin', or Wingstop, which typically have cash on cash returns in the high teens to low thirties with a 4-5 year payback. The delivery business model also enables Domino's to take advantage of lower-cost real estate locations. Overall, the Domino's franchise ecosystem's strength comes from the unit economics' truly remarkable value creation, making it an attractive opportunity for former employees to become store owners.
Domino's Pizza: A Tech-Forward Company with a Powerful Unit Economic Model: Domino's Pizza's tech-forward approach, unique business model, and focus on experimentation have led to increased same store sales, profits, and customer satisfaction.
Domino's Pizza is a tech-forward company with a powerful unit economic model for standalone stores. This is evident in their ability to adapt to platform shifts, such as the transition from dial-in orders to digital channels, and their focus on allowing customers to order through various devices and platforms. Domino's also has a unique business model where they create the business once and sell it multiple times, with similar order processes and the use of the same oven for various menu items. This model eases operational burdens and allows for economies of scale, leading to higher same store sales and profits. The franchisees' willingness to open more stores due to the profitability of existing ones results in lower delivery times, increased customer satisfaction, and further sales growth. Domino's investment in their stores drives this cycle of growth, making them a tech-forward company with a strong focus on experimentation and adaptation in the fast food industry.
Domino's Success: Business Model & Product Improvement: Domino's success stems from their innovative business model, focus on product improvement, and control over the delivery process. Transparency about product issues led to consumer trust and product innovation, making them a leader in the pizza industry.
Domino's Pizza's success is rooted in both their innovative business model and their focus on product improvement. The company's flywheel effect, which includes opening new stores to increase sales and lower delivery times, and the scale benefits of a multi-store system, contribute to the system's profitability. However, in 2009, Domino's acknowledged their product needed improvement and publicly admitted their pizza tasted like cardboard. This transparency led to consumer trial and product innovation, making the company a leader in the pizza industry. Another unique aspect of Domino's business is their control over the delivery process and refusal to partner with third-party aggregators. This allows them to maintain a strong relationship with customers and protect their proprietary information. Despite competition, Domino's continues to grow, demonstrating the power of their business model and commitment to product quality.
Domino's Pizza's Success from Decentralized Business Model and Adaptation: Domino's success comes from its decentralized business model, where franchisor and franchisees have aligned incentives, allowing for efficient resource use and scalability. The company's ability to adapt to changing market conditions, like the rise of aggregators and the importance of delivery, through innovations like Ghost Kitchens, keeps it competitive.
Domino's Pizza's success can be attributed to its decentralized business model, where the franchisor and franchisees have aligned incentives, allowing for efficient use of resources and scalability. This strategy, which can be thought of as a "software in a box" model, has proven to generate significant returns. Another interesting aspect of Domino's history is its adaptation to changing market conditions, such as the rise of aggregators and the increasing importance of delivery. The company's innovation, including the creation of Ghost Kitchens, has kept it at the forefront of the food and restaurant ecosystem. Additionally, the private equity model has proven to be effective for businesses like Domino's, allowing for efficient operations, productivity, and scalability. Overall, Domino's serves as a compelling case study for businesses looking to build a successful, scalable model.
Dollar General's Preferred Developer Program: A Mutually Beneficial Relationship: Dollar General's unique development strategy, combined with brand recognition and scale economics, sets them apart in retail industry. Founder-led retailers focus on fundamentals, leverage counter positioning, process power, cornered resources, scale economics, network density, and branding for persistent supernormal returns.
Dollar General, the largest discount retailer in the US, operates with remarkable efficiency and speed in opening new stores through a preferred developer program. This program allows local developers to find, permit, zone, and build stores to Dollar General's specifications, resulting in a mutually beneficial relationship. Dollar General's unique development strategy, combined with their brand recognition and scale economics, sets them apart in the retail industry. Another key takeaway is that many of the best retailers are founder-led and highly focused on the fundamentals of their business. They leverage counter positioning in smaller markets, process power through efficient operations, cornered resources, scale economics, network density, and branding to create persistent supernormal returns. These retailers' success is a testament to the power of physical retail models, which have been driving growth and innovation for decades.
Competing against large incumbents: Focus on unique value proposition and empower customers through digital tools for success in today's business landscape
In today's business landscape, the best companies are those that embrace change and competition, particularly against large incumbents. This is in contrast to historical trends where young companies could compete by focusing on narrow niches or specific use cases that larger companies couldn't match. However, with large companies now adopting similar strategies and technologies, it's essential for younger companies to be focused and nimble. The ability to provide a hyper-relevant product or service and empower customers through digital tools can lead to strong economic outcomes without the need to become the next Amazon. Instead, companies should aim to be the best in their specific area and focus on creating a profitable, productive business model. The pandemic and the shift towards online shopping and pick-up services have further highlighted the importance of adaptability and the ability to expand beyond physical storefronts. In summary, while it may be more challenging for new companies to compete against incumbents, those that can focus on their unique value proposition and empower their customers will still have the opportunity to succeed.
The power of storytelling in business growth: Effective storytelling helps small businesses compete against larger competitors and gain consumer attention in industries like food, even as trends like alternative proteins disrupt traditional markets. Public markets favor younger, speculative businesses, but incumbents still hold advantages.
The power of storytelling and the narrative created by businesses plays a crucial role in their growth and success, even in industries that may be considered less disruptive. The franchise model is a prime example of this, but even small, focus businesses can win against larger competitors by effectively telling their story. The trend towards alternative proteins, such as plant-based and lab-grown options, is a notable example of this, with companies like Beyond Meat receiving significant market attention and consumer adoption due in part to their unique stories and innovative offerings. The public markets have become increasingly receptive to younger, speculative businesses, creating a reflexive cycle of media attention, consumer awareness, and trial. However, incumbent consumer packaged goods companies still hold a significant competitive advantage due to their size and spending power. Other interesting trends in the food industry include the growth of alternative proteins and innovative companies in the private markets.
Ingredients and Social Issues Shape the Future of Food Industry: Mushrooms, probiotics, prebiotics, and alternative ingredients are shaping the food industry. Social issues like food distribution and sustainability are driving ecommerce, egrocery, and technological advancements.
The food industry is experiencing significant changes driven by novel ingredients, social debates, and technological advancements. On the ingredient side, there's a focus on mushrooms, probiotics, prebiotics, and alternative ingredients. However, a pressing social issue is the distribution of food to areas where it's needed most, despite the ability to produce food cheaply. Ecommerce and egrocery are seen as potential solutions to this problem. Additionally, there's a growing focus on sustainability in the food ecosystem, particularly in production, packaging, and distribution. Looking outside the US, there are notable trends such as the success of private label food in Europe through businesses like Aldi and Lidl. These companies offer lower costs to consumers and higher margins for themselves by disintermediating part of the value chain. China is also a roadmap for technological trends, with super apps and micro fulfillment centers being adopted. COVID-19 has significantly impacted the food industry, with lasting changes including a shift to online ordering and curbside pickup, as well as an increased focus on local and regional supply chains. The pandemic has also accelerated the adoption of automation and robotics in food production and distribution. These trends are expected to continue even after the pandemic subsides.
Adapting to the New Normal in the Food Industry: Restaurants need to innovate and monetize through delivery, order ahead, subscription products, and dynamic pricing. Grocery retail is consolidating and adopting technology for ecommerce to compete. Companies are rethinking strategies and focusing on customer experience to stay competitive.
The COVID-19 pandemic has significantly impacted the food industry, with temporary and permanent changes. While Americans' love for eating out is likely to continue, restaurants need to adapt and find new ways to monetize their businesses through delivery, order ahead, subscription products, and dynamic pricing. On the other hand, grocery retail is consolidated and deep-pocketed, requiring technology adoption to compete. Ecommerce is becoming the norm for grocery shopping, and incumbent brands are expected to regain their dominance due to their scale advantages and distribution power. The pandemic has forced companies to rethink their strategies and innovate to stay competitive. The store as a software that is iterated and perfected is an appealing concept, with Best Buy being a notable example of a company that successfully adapted to the digital age by matching prices and focusing on customer experience.
Retailers and restaurants offer value-added services and experiences: Invest in franchises with strong returns on capital, efficient dining experiences, and operational control, such as Chipotle and Domino's.
Retailers and restaurants are shifting their focus from just selling goods to offering value-added services and experiences to compete in today's market. This includes services like insurance, buy now pay later applications, and comprehensive omnichannel approaches. The best example of this is Chipotle, which has maintained strong unit economics and operational control by offering a high-value, efficient dining experience. For those looking to invest in franchises, it's essential to consider the unit economics, including the cost to build and expected annual cash generation, and the payback period. Brands with strong 4-wall margins, like Domino's and Chipotle, are particularly attractive. Ultimately, the goal is to find franchises with strong returns on capital that can differentiate themselves from the competition and maintain operational control.
Investing in a Franchise or Starting a New QSR: Factors for Sustainable High Margins and Strong ROI: Consider royalty fees, real estate ownership, brand health, differentiation, and trends when investing in a franchise or starting a new QSR for sustainable high margins and strong ROI.
Investing in a franchise or starting a new quick service restaurant (QSR) involves careful consideration of various factors to ensure a sustainable high margin structure and strong return on investment. The franchisee pays a royalty fee to the franchisor, reducing the restaurant level margin. The number of stores one can own depends on whether they own the real estate or not. It's crucial to invest behind a healthy, growing brand, as the advertising pool contributes to the system's success. For new QSR concepts, differentiation is key, focusing on cultural relevance, rich gross margins, digital adoption, and experimentation with lower rent costs and better product quality. The long tail of cuisine in the US makes it challenging to find an entirely new concept, but trends toward ethnic and flavorful concepts and the success of businesses like Cholula indicate opportunities in this area.
Technology and data integration in businesses: Profit pools and investor returns: Understanding the impact of technology and data on profit pools and returns is crucial for investors in the rapidly changing business landscape, with permanent capital providing an advantage in the evolving competitive landscape.
The integration of technology and data in businesses, whether in the food industry or beyond, raises questions about the creation or destruction of profit pools and who benefits from it. The increasing use of automation and software in various industries, driven by the widespread availability of advanced technologies and the vast amounts of customer data accessible through smartphones, poses challenges for investors. While these developments can lead to significant improvements for consumers, it is essential to understand whether the returns on investment for businesses will be substantial enough to justify the costs. Additionally, the competitive landscape is evolving, with permanent or semi-permanent capital becoming an increasingly valuable asset in the market. Crossover funds, which manage both public and private assets, have an inherent advantage due to the insights gained from their private investments and the ability to take a longer-term view. Ultimately, staying informed and connecting the dots across various markets and industries is crucial for investors in this rapidly changing business environment.
Continental Grain's hybrid model and industry expertise add value as investors: Continental Grain's unique hybrid model, flexible capital base, and industry expertise enable them to identify defensible businesses and connect the dots between them, while Fenimore Asset Management utilizes Canalyst for data comprehensiveness, ease of updating, and time-saving analysis.
Continental Grain's hybrid model of operating and investing, combined with their flexible capital base and industry-specific expertise, allows them to add value as investors by identifying defensible businesses and connecting the dots between them. This compounding of knowledge and competitive advantage is harder for typical asset managers to compete with. In addition, Fenimore Asset Management uses Canalyst to free up analysts' time from manual data collection and analysis, allowing them to focus on deeper, qualitative analysis and engagement with management teams and companies. The comprehensiveness and ease of updating of Canalyst's data are also significant time-savers for the firm.
Customization in Data Analysis with Canvas: Canvas empowers analysts to build custom modeling templates, saving time and enhancing analysis for better insights and informed decision-making.
Canvas, a financial modeling tool, recognizes the importance of customization in data analysis, even when the data itself may have become a commodity. By allowing each analyst to build their own modeling template within the spreadsheet, Canvas ensures that insights are developed based on unique perspectives and methodologies. This functionality is particularly valuable as models are maintained and updated, as each analyst can create templates specific to their preferred industry data. This customization results in time savings and more effective analysis, ultimately leading to better insights and informed decision-making. For those interested in learning more, consider signing up for the Inside the Episode email newsletter at investorfieldguide.com/forward/bookclub. Each week, the newsletter condenses key ideas, quotations, and recommendations from the podcast episodes.
