Portfolio: Bain Capital and Domino's Pizza Japan

In 2011, Domino's Pizza Japan announced that it would be opening its next store on the moon. Appearing in a commercial, dressed in a full astronaut suit, Dominos Japan CEO Scott Oelkers tells the camera: "Perhaps you think we're foolish to take on such a challenge and perhaps we are foolish. It takes courage to accept a challenge to make your dreams come true."

Famous for his offbeat marketing stunts as well as his business savvy, Oelkers may not have been serious about setting up the pizza chain's first ever lunar base, but this novel campaign demonstrated that he is very serious about brand building. Oelkers' appointment as CEO was the first of a number of changes introduced by Bain Capital when, in 2010, it acquired 100% of Higa Industries, Japan's oldest pizza delivery chain operator and Domino's master franchise in the country.

The company was purchased from three main shareholders. These included Duskin, a listed company that owns Japan's Mister Donut chain, and Daiwa SMBC Capital, a direct investment arm of Daiwa Securities Group, each of which held a 44% stake. The remaining 12% was held by Matsuo Ernest Higa, the company's owner and founder.

The deal was born out of a long-time relationship between Higa and a Bain managing director in Japan. Higa wanted to step down and was looking for a way to transition the business to new owners.

"He felt because of that relationship and our global experience in the restaurant sector we would be the logical buyers," explains David Gross-Loh, managing director with the private equity firm. "He wanted to ensure there was a good home for the business after he left, so we went into exclusive discussions with him that resulted in the deal."

The value of the deal wasn't disclosed but industry sources at the time revealed Higa Industries was valued at about JPY6 billion ($66.5 million), representing around 6x EBITA.

Higa had been with the company for many years so Bain's first challenge was to come up with a new leadership team. It opted for a hybrid approach, bringing in some of its own people and having them work in partnership with the existing management. The goal was to professionalize how the business was run.

Oelkers was an obvious choice for CEO, having previously performed the same role for Domino's in Taiwan where he oversaw the opening of around a 100 stores. Even more remarkable was his successful marketing strategy and the personal television appearances that saw Domino's "top of mind" awareness in Taiwan jump from just 3% to 55%.

While Bain had previously invested In Dominos International in the US, few comparisons could be drawn with the Japanese market. Pizza, though popular in Japan, is much less of an every-day purchase. Broadly defined, consumers are divided into two groups: heavy users, typically younger people, ordering pizzas online in the low to medium price range; and families willing and able to pay a premium for a better product.

An arms race

In Japan, the typical suburban family of four accounts for a large segment of the market. And with smaller homes and less space, much more money is spent on food, apparel and other discretionary items - this is opportunity most Japanese pizza firms have been tapping into.

At the time of investment, Domino's was Japan's third biggest pizza delivery company after Pizza La and Pizza Hut. The company had positioned itself as a specialty purchase at a very high price point with some of its top-end pizzas costing as much as JPY5000 ($50). A host of luxurious toppings were available, including Kobe beef and foiegras. Domino's was not alone in taking this approach; Pizza La and Pizza Hut operated in a similar way.

"There was room for improvement relative to how the market was structured before," says Gross-Loh. "The competitors have been in a sort of "me-too" mode where the basis of competition was who can come out with the most creative pizza - lobster, shrimp, truffles. It was an arms race of toppings."

While the premium segment remains important to this day - Domino's continues to produce top-end pizzas - the company has also sought to develop its consumer base by expanding the menu and introducing some lower priced products. For example, Domino's started producing lighter, less ingredient-heavy pizzas as an alternative to the gourmet variety.

"That's one thing that has changed over the last five or 10 years; in an ever budget-conscious Japan, people are looking for value," Gross-Loh adds. "So by providing more value we have been able to drive up frequency."
The next step was to crank up marketing efforts and build up the brand. In order to increase Domino's market share, the marketing team had to be really creative, offer a raft of promotions and taking full advantage of internet and mobile technology.

Aside from supposed plans to establish a store on the moon, Domino's also launched a competition where the winner received a part-time job paying $25,000 per-hour and tasked with delivering a pizza the farthest distance ever - based on the Guinness Book of World Records. The existing record, set by a Domino's franchise in the UK, saw a pizza travel from Fulham in London to Sydney, Australia.

Another of Domino's more innovative campaigns emerged earlier this year in the form of a mobile app featuring HatsuneMiku, a popular Japanese anime "vocaloid" or computer generated singer. The app is used to order pizza but includes an augmented reality photo feature that allows the user to point his or her phone camera at a pizza box and see the HatsuneMiku avatar dancing on it. Oelkers appeared in a TV spot advertising the app as part of the campaign.

"The next big thing is that we will start doing national TV advertising," says Gross-Loh. "Pizza La has always been a heavy TV advertiser and we have not, so this can give us a decent-sized boost."

Expansion will also come through the store network. When Bain acquired Domino's, it had around 175 stores, but they were concentrated in Japan's two largest cities, Tokyo and Osaka. The company was effectively missing out on 65% of the population.

Furthermore, it hadn't opened a new branch in years, because it was such a capital intensive exercise and a new store typically doesn't see payback for around six years. The first thing Bain did was to significantly reduce the capital expenditure required to open a new outlet, in part by standardizing the equipment used across the network. By doing this Domino's managed to reduce the payback period to three years.

The company then looked to expand the number of Domino's Japan franchisees by giving store managers the opportunity to open their own outlets in an "employee-to-own" program.

"By changing the economics and making this into an entrepreneurial opportunity for people to start their own business we really got the new store engine humming," says Gross-Loh. "We still think there is potential for 600-700 stores in Japan so we are early into the growth potential."

Through this approach Domino's has entered cities such as Nagoya, Kobe, Kyoto, Fukuoka and Sendai, which had hitherto been untouched. The company now boasts 250 stores nationwide with around 42 of the 75 new outlets opened since 2010 being franchises. There are plans to further penetrate second-tier urban centers.

"The fact that Domino's wasn't in Nagoya before is mind boggling," says Gross-Loh. "It is a giant city - it is not like we are expanding in rural areas - and we are still targeting stores with address counts of 50,000 to 60,000 apiece."

In addition to opening new stores, Domino's expanded its carry-out service. By offering this convenient alternative to customers and saving on delivery costs, pizzas could be discounted further. New stores are now being planned with a view to accommodating carry-out. This means eschewing traditional back-street locations in favor of stores on main thoroughfares.

The combination of aggressive marketing and rapid store growth appear to have had their desired effect. According to company research, the number of new customers coming to Domino's Japan has grown from around 120,000 a month to more than 160,000 and the figure is still rising. In terms of same store sales (SSS) growth, Dominos compares favorably with its competitors in Japan's overall restaurant market; 8% growth compared with 3.9% for McDonald's and -2.3% for KFC. The company has also stolen second place in the pizza delivery market from Pizza Hut.

Smiling ear-to-ear

The next stage was to focus on the company's bottom-line, which turned out to be a more challenging aspect of the value-add process. In the early days some glaring inefficiencies were visible, especially in terms of managing store labor.

"There wasn't a scientific scheduling tool to match labor in the store against order patterns," explains Gross-Loh. "So we introduced a number of tools so managers could make accurate forecasts and that had really big improvement." This meant staff cuts were minimized by having more people working at peak times and fewer at quiet times.

Domino's then took steps to ensure its workers were suitably motivated through the launch of an employee incentive program. There were previously no sales-driven incentives for store managers who were judged mostly by labor used and by labor as a percentage of sales. The metrics by which productivity was judged were changed to make employees much more sales driven.

"That didn't really exist in the stores, in fact it didn't really exist in most retail chains in Japan and that has been a real transformation," says Gross-Loh. "It generated a ton of enthusiasm - people were smiling ear to ear when they got those first bonus payments."

When Bain invested in the company it anticipated a holding period of around 4-5 years. Although still in year three, the PE firm isn't ready to exit but has been mulling its options. A trade sale is possible with plenty of strategic investors likely to be interested in acquiring a ready-made foothold in a high-value market.

But Gross-Loh refuses to rule out a public market farewell. "I think the company is big enough and growing fast enough that it could be a good IPO candidate," he says. "We have grown the top line by 10-11% a year and tripled profits during the three-year holding period, so for Japan that is a pretty exciting IPO story."

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• Topics
• North Asia
• Consumer
• Buyouts
• Bain Capital Asia
• Japan
• Consumer
• buyout