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FRANCHISES

The Next Big Thing
 

Profile of a start-up drive-through pizza franchise.
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Fast and focused, Pizza Now! is bidding to be the next McDonald's

Philip Goldman taps the steering wheel. Then he checks his watch. "Can you believe how long this is taking?" he asks.

Almost a minute has passed since he leaned out of his car window and ordered a regular 95¢ hamburger. "This is unbelievable," he says, shifting a bit. Just as he finishes speaking, a hand juts out from the booth next to him; behold the awaited delight. "Finally," says Goldman. And to think he wasted nearly 90 seconds waiting -- roughly 30 seconds more than he planned.

Goldman's restlessness arises less from a personality quirk than from a zeal for market research. After all, both the hamburger stand from which he now roars away and his own venture, Pizza Now! Inc., seek to exploit a perpetually growing niche: impatient people. Goldman anticipates that both his franchisees and his customers will be fidgety. His franchisees, he asserts, could recoup their original investment in four short years. And Pizza Now! plans to lure consumers by transforming pizza into the speediest of fast foods. Goldman claims that his company will make good on the early, now abandoned, promises of such giants as McDonald's and Burger King.

That fast-food's elders have lost some of their zing is as plain to see as the burger that Goldman clutches. Today's visit to a thriving Rally's Inc. franchise roughly two miles from Pizza Now!'s first and only unit, in Phoenix, supports his belief that McDonald's and its ilk have strayed far enough from their original recipe to make them vulnerable to low-end competitors. Battling soaring costs, the fast-food giants have tried to leverage expenses by expanding their menus and hours. The result? Increased prices and slowed service, Goldman claims.

Armed with such anecdotal ammunition and with research showing that about 60% of all fast-food consumers whisk their food off premises, a generation of diehard restaurant fundamentalists has sprung up in the past five years. Five-year-old Rally's -- with 1990 sales projected at about $60 million and the #5 slot on the INC. 100 ranking of the fastest-growing small public companies -- has led the Big Mac attack. Rally's small units offer limited menu items, minimal seating, and two drive-through windows, making them as bare as a 1950s McDonald's and nearly as cheap.

Rally's may be the most formidable proponent of what Goldman terms "the resimplification of fast food," but plenty of others want to crawl through the same window of opportunity. Back in 1988 Goldman had also turned his mind to burgers, after failing with four Cincinnati fast-food chicken outlets. But a six-week national tour convinced him there were already too many players positioning themselves as the back-to-basics alternative to burgers.

Then he consulted Gregg Pancero, a friend and the owner of four Italian restaurant franchises. It's too late for burgers, Pancero agreed, but why isn't anyone trying drive-through pizza?

Goldman was intrigued. Pizza Hut Inc., which had invented a fast six-inch pizza, still did most of its business during dinnertime hours. If Goldman could speed the process up, he could position pizza for the $3.50-and-under lunch crowd that flocked to Rally's and its kind. There ought to be room, he figured: as of 1989 pizza represented one of the fastest-growing segments of the food industry. And off-premise consumption of fast foods had grown 23% since 1985.

Put simply, Pizza Now! offers one of the nation's most popular foods conveyed through two of the most popular means: drive-through, which should comprise the majority of sales, and delivery. "Drive-through is really our niche and our competitive advantage," says Goldman. "But to optimize the return on investment, we have to have delivery."

Goldman's career has been seasoned by both tremendous success (he built up 28 Arby's franchises with $17 million in sales) and abject failure (the now-defunct Marco Pollo chain of chicken outlets "cost me a ton of money"). The 46-year-old intends to stay in touch with the market as he grows. Even so, he ambitiously figures on opening nine company-owned units by the end of next year and selling at least 50 franchises during the same time span. And, yes, he is well aware that McDonald's may roll out pizza nationally later this year, and that Pizza Hut is toying with drive-through service.

"Look, I wasn't about to invest a million dollars of my own without knowing that I had a good shot," he says. "I've learned that the Midas touch is a bunch of bull. But we do have something innovative here. I'm sensitive to what is out there. Our product is more consistently high quality, and it's more accessible. So I don't know what they can do to us.

"After all," he adds, tossing away the hamburger wrapper, "what is McDonald's doing about Rally's?"

Nary a person alive, Goldman will grant, has ever craved drive-through pizza. "But," he adds, "it's an entrepreneur's job to stay a step ahead." In fact, Goldman's grand marketing strategy requires him to grab a defensible foothold in the market before anyone else.

One way Goldman hopes to lure both consumers and franchisees is by emphasizing the proven quality of the pizza. By using the same sauce and dough Pancero uses, he can point to a track record. "People will say that one pizza is definitely better than another, and you rarely hear that about hamburgers," theorizes Goldman. "I can create a distinguishable difference, flavorwise, and that gives us a hook." (But has he? For the results of INC.'s informal taste test, see "Time Is on His Side," page 6.)

No such duodenal dialectic will take place, however, unless Goldman can convince consumers to give Pizza Now! a try.

Since opening his Phoenix unit in November, Goldman has been mailing out 5,000 direct-mail pieces a week to homes in his three-mile-radius delivery area.

Pizza Now!'s larger pizzas cost about the same as Domino's, and the $1.59 individual-sized pizzas run about 40¢ cheaper than Pizza Hut's and, for that matter, about the same as a McDonald's Quarter Pounder. Although the local Pizza Hut franchise has been meeting Goldman's prices during special promotions, it still doesn't offer the mini-pizza all day at his price, or in three minutes. Nevertheless, Goldman's mailings don't hammer away on price or time. Instead, he touts quality, characterizing Pizza Now! as The Fresh Choice and extolling the virtues of its "zesty" tomato sauce and "handmade and freshly baked dough." In doing so, he hopes to earn some pricing flexibility, heading upmarket from his pizza peers.

The design of Pizza Now!'s tiny 600-square-foot structure itself constitutes a marketing tool. Goldman's generous description of the copyrighted shape is "asymmetrical," but the modular structure looks more like a breakfast-cereal prize that the assembler got too frustrated to finish. The eyesore is also an eye-catcher: some 49% of the customers Goldman has surveyed say they just happened to be driving by when the structure caught their attention (in contrast, about 36% were lured through direct mail).

The unit currently conducts about 1,400 transactions a week, up from its earliest days, but far from its peak of more than 2,000. Goldman expected the figure would drop 20% after six weeks or so as a novelty. It dropped more, he says, because renovations to the mall surrounding his unit have cut down on parking -- bringing fewer of the harried young families, hurried students, and ravenous businesspeople he hopes to attract.

But as hard as Goldman works at enticing consumers, he seems almost to discourage potential franchisees. Drop him an inquiry, and he shoots back a detailed three-page questionnaire. To gain market penetration swiftly, Goldman intends to target only experienced restaurateurs. Pizza Now!, he stresses, is not for the retired car mechanic.

Given the price tag, even a retired auto executive might have difficulty coughing up the required capital. Pizza Now! may be a cheap undertaking compared with the arched enemy -- a McDonald's unit can chomp through about $1.6 million, Goldman claims, before anybody eats -- but it still requires an investment of around $325,000, not including the land.

Goldman counters sticker shock by claiming that franchisees can look forward to a speedy payback. By investing $325,000, a franchise can generate sales of $520,000 or so. Because the cost of the facility is so much less than a standard fast-food unit, the net margin before depreciation and taxes rises to a robust 15% (see "Financials," page 4). That translates into a four-year payback, probably half the payback period of a major-chain fast-food unit.

Not that Goldman expects franchisees to open just one unit; he wants franchisees to commit to at least five. "Instead of spending $1.6 million to open one giant fast-food restaurant, they can open three Pizza Now! units," says Goldman. "That way, they spread the risk."

But the relatively bare-bones entry fee isn't the only way Goldman minimizes downside risk. The prefabricated modular unit offers two clear advantages. First, it allows the unit to get up and running within 30 days from the time permits are issued, cutting by about one-third any carrying costs. And if the unit should fail, the operator can tow the entire structure to a new location or to a new owner and can probably recoup some 85% of the original investment -- including $75,000 in equipment, a $13,000 point-of-sale system, and the $135,000 modular unit itself.

Obviously, each unit's location is crucial to its performance. Goldman plans to retain approval of every site, checking that such factors as the traffic count meet his strict guidelines. When a big hamburger chain locates at a mall, its lease often precludes the developer from flirting with another burger flipper. But few leases mention drive-through pizza. "That creates a lot of opportunity for us," says Goldman.

While Goldman claims that he is counting on industry word of mouth to attract franchisees, he has already approached and signed up two franchisees on opposite ends of California. Both are former colleagues from Arby's and are busily scouting sites.

It is 11:10 a.m., and the five-member Pizza Now! crew is carrying out its duties like a drill team. During a yearlong tryout in Indianapolis in 1988, Goldman spent $175,000 figuring out how to make pizza quickly. He broke the process down into simple, repetitive tasks. "This is how you do it in a small space," he says, pulling a pizza from the oven. "A large space lets you be sloppy."

Working space consists of a stingy 425 square feet. The standard Pizza Now! formation includes one or two cooks stationed at the pizza table, an order taker at each of the two cash registers, and a puller who boxes and cuts the pizzas as they emerge from the conveyer oven. In the next room are a dispatcher and a handful of drivers, practically sitting on four phones and a fax machine.

Ohio restaurateur Gregg Pancero, a minority investor in Pizza Now!, introduced Goldman to conveyer ovens. Unlike traditional deck ovens, where pizza needs frequent shifting to compensate for hot and cold spots, these ovens feature preset and preprogrammed temperatures and times. After receiving an order, the pizza maker builds the pizza and then simply places it on the appropriate conveyer belt.

As a trade-off to provide speedy service, Pizza Now! offers only three kinds of six-inch pizzas within the three-minute pledge: cheese, pepperoni, and a five-item deluxe. The pizzas actually emerge from the oven in about a minute, but, says Goldman, "we're easing consumers into believing that. If you say 'pizza in a minute,' it sounds like it's something other than freshly baked." Custom concoctions, such as a classic anchovy-pineapple combination, require a couple of minutes to build and nearly six to bake.

To preserve freshness, Goldman doesn't bake the pizzas beforehand and freeze them. The dough arrives from Cincinnati every six weeks. Based on anticipated demand, pans of sized and shaped dough are moved from freezer to refrigerator to thaw. From there they are pulled out, sauced, and baked. During slow periods the pizzas are kept in warming ovens for up to 20 minutes -- "a more controlled atmosphere than heat lamps."

To achieve crucial efficiency, Pizza Now! relies on tailored software. Among other capabilities, it keeps a tab of what is sold each hour; the operator decides how many and what kind of individual pizzas will be needed between noon and 1:00 p.m. this Monday based on demand during the same time last week. Goldman discards about 20 six-inch pizzas a day, roughly 5% of production.

Because the facility is so cheap, Goldman expects operators to spend more lavishly on food such as fresh mushrooms. Goldman admits that, at 27%, his food costs -- the silent killer of many an eatery -- are higher than he would like. As more units open up, he expects to shave a couple of percentage points, though it's unlikely he'll match the 23% range he says the giants generally achieve.

No matter how you deliver it -- through a window or by truck -- pizza's margins, like the product itself, hold up handsomely. On average, pizza provides a pretax margin of about 25%. Delivering a pizza cuts into that margin a bit, but the difference is not all that significant because most drive-through customers buy individual pizzas, which cost $1.59. The minimum delivery order, on the other hand, is $5. So, says Goldman, the gross profit may be higher with delivery, but "you can generate a lot more dollars faster with drive-through." Goldman wants Pizza Now! units to maintain a three-to-two ratio of drive-through/carry-out to delivery. "It's not just that we want to maximize efficiency," he says. "Drive-through is our competitive edge. And that's easy to communicate."

Leftovers are even more of an indigenous American culinary tradition than pizza, so it's perhaps fitting that Goldman has paid homage to the principle in financing his company. So far, most of the $1.7 million he has spent has come from savings he amassed before his calamitous foray into fast-food chicken. There was a Japanese steak house, which he sold, and there were those 15 years at Arby's. Gregg Pancero has added his own $250,000 or so for a sliver of equity. Goldman won't say how much deeper his own pockets are, but he admits, "I don't have as great an access to capital as I would like. I'm a restaurateur. I am not a financial guy."

Given that, Goldman says he will suppress his more ambitious streak and grow slowly, using cash flow to finance his own expansion and choosing franchisees very carefully. "Maybe one of the franchisees will want to become a joint-venture partner," says Goldman. "But I'm not going to start looking at their financial qualifications ahead of their experience. You can self-destruct if money starts becoming more important than the quality of the concept."

Goldman has developed the Pizza Now! concept with an eye toward fast-food history. So perhaps it's fitting to draw on the past for some insight into the challenges ahead. Back in the mid-1960s there were four fast-food restaurants in the Cincinnati area called Barney's Drive-In. Oddly enough, the owner of them was not named Barney. His name was Philip Goldman.

What happened to Barney's Drive-In stands as a cautionary tale for these early days at Pizza Now! By the late 1960's McDonald's, Burger King, and others were well-heeled enough to compete fiercely. By 1969, recalls Goldman, "I started looking for something else to do."

Now, jump ahead to the fall of 1990 -- or sooner -- when McDonald's will decide whether to roll out its own pizza nationally, adding 10,000 new pizzerias. McPizza would be available only after 4:00 p.m. and would cost more than any drive-through competitor. And McDonald's huge promotional budget would likely lift pizza sales everywhere -- for a short time. After that, well, no one who knows the business would append the word benevolent to this particular giant.

If McDonald's doesn't cut into Goldman's niche, there are plenty of others who could. After all, nothing about Pizza Now! is terribly tough to copy; the cooking technique, the siting strategy, and even the special software take simply money and ingenuity to develop. What's to prevent Pizza Hut from attacking Goldman head-on, or at least sideswiping him with an ad campaign promoting its fresh ingredients? "A lot of people may have this idea," concedes Goldman. "But the difference between me and them is that I am doing it."

True, getting there first counts for something. But getting big fast is what's required to complete the equation. And, as Goldman admits, he doesn't have much access to capital. Nor does he have reserves of experienced management. The two members of his management team were barely born when he first got into the restaurant business. "Our money has to go into building restaurants, not people," he says. It's worth noting that Rally's launched its training school even before cutting the ribbon on its 10th unit. There are other questions. Is Pizza Now! filling a market need, or is it just something new? And consumers aren't the only group Goldman has to fret about. Those who have $325,000 to invest may not want the kind of active involvement Goldman envisions.

Still, during a recent sunny -- as always, in Phoenix -- lunchtime, eight people are sitting outside, munching individual pizzas. Four more are at the take-out window. And a van is just swinging into the drive-through lane. "Tell me there isn't a market for this," says Goldman defiantly. "I'm not going to put Domino's out of business and I don't want to be the next McDonald's. But if we do what we do well, there will be room for us."

His comparatively skimpy resources, Goldman asserts, may give him the biggest advantage of all. "The other companies are selling something else at the same time," he says. "For me, it's not like, 'Let's test this and drop it if it doesn't work.' We'll test it, massage it, cajole it, and figure out its strong points. We'll make this work."

* * *

Research assistance was provided by Leslie Brokaw.


EXECUTIVE SUMMARY

THE COMPANY:
Pizza Now! Inc., Phoenix

Concept: Resimplify fast food, offering consumers speed and value with a franchise chain of drive-through pizza restaurants promising fresh pizza in three minutes or less

Projections: Nine company-owned and 50 franchised units operating by end of 1991; estimated income per franchise unit before taxes and depreciation: $75,400 on sales of $520,000

Hurdles: Beating competition from established chains including McDonald's, which may roll out pizza later this year; attracting experienced franchisees to a low-yield-per-unit concept

THE FOUNDER
Philip M. Goldman, President and CEO
Age:
46

Family: Single, three sons

Source of idea: Friend in the restaurant business

Personal funds invested: $1.7 million

Equity held: 97%

Salary: Zero

Workweek: 70 to 80 hours

Education: Left Clemson College after three years

Outside directors: No

Other businesses started: Kabuki Japanese Steak House, sold in 1975; Marco Pollo International, liquidated in 1986

What I'd do if I weren't doing this: Run a bed-and-breakfast in Santa Fe


FINANCIALS

Pizza Now! Franchisee Pro Forma Operating Statement (Freestanding Restaurant)*

SALES $520,000

Cost of goods sold

Food purchases (27%) 140,400

Other 36,400


GROSS PROFIT
343,200

Percent gross profit 66%


OPERATING EXPENSES

Labor and benefits 145,600

Royalty fee (4%) 20,800

Advertising (5%) 26,000

Ground rent 25,000

Utilities 15,000

Delivery expenses 6,500

Miscellaneous 28,900


TOTAL OPERATING EXPENSES
267,800


*The above analysis is based on INC. estimates.

NET PROFIT BEFORE DEPRECIATION & TAX 75,400

Percent net profit before depreciation & tax 15%

Depreciation 43,642

NET PROFIT BEFORE TAX 31,758

Percent net profit before tax 6%


WHAT THE EXPERTS SAY

OBSERVER
JOHN CORRELL

Restaurant consultant specializing in pizza; founder of Pizzuti's, a two-unit restaurant chain in the Detroit area offering one-minute drive-through pizza, which he sold in 1984

Goldman seems to have done some good research on the drive-through industry. But I'm dubious that he can avoid the low-quality stigma that one-minute pizza has.

Attempting to position the product a notch above the competition is a very good marketing idea. But can he pull it off? Ultimately, pizza quality is not a matter of ingredients but of perception. When you take a product and push it through a drive-through window, the quality perception goes down. Goldman doesn't want to go deeper into delivery because of the competition, and that's smart. But how long before drive-through is full of intense competitors? Twenty-four to 36 months, maybe. It won't take Pizza Hut and Domino's long. And McDonald's is not too shabby, either.

So the only way he's going to survive is by outmarketing them on a neighborhood basis. He'll have to do a slightly better job than the rest at being customer responsive. And he needs to understand the importance of creating management and training systems. Rally's isn't successful because it has a better-looking box or burger. It all comes down to execution. When the competition gets fierce, that will be key. If he can pull this off, he's a pizza marketing genius.

COMPETITOR

LEO KELLEHER

Chief financial officer, RioStar Corp., which owns a controlling interest in Bambolino's Italian Kitchen, a 15-unit chain of drive-through pizza and pasta restaurants in Houston and Lafayette, La.

We've gone down the exact path he is going down, and we would not do it again. Franchising, for example, can be a major distraction. Selling 50 franchises in the next year -- that is absolutely undoable. When you have a start-up concept, you are out there competing for franchisees. He thinks he'll somehow find the people who have the money; we didn't.

Even if he does, franchisees are looking for more upside than he can offer. Remember, there's nothing in the numbers for debt service. If the franchisee is getting $75,000 in cash flow, you've got to service his debt out of that for the first four to five years. After the debt service, he could easily be left with $35,000 on a $325,000 investment. Is that worth it? I don't think so. You could go get a $35,000 job at McDonald's. OK, so then you say, 'But it's not just $35,000, because you'll open a bunch of restaurants.' Then you are getting into multiunit management, and for that you need people who are very experienced. And all of this is assuming $520,000 in sales, which is overly optimistic.

There's tremendous competition in pizza, and there's not that big a market for drive-through. We went the route he's trying to go, and we got rave reviews about the taste, but it didn't seem to make that much difference. It's still a very price-sensitive market. And the big players are on television all the time. You have to prop up sales with a disproportionate amount of advertising. We managed to offer franchisees a total turnkey investment cost of $180,000 -- we built our units off premises, too -- and we found they could survive at $250,000 in sales. Still, only a few of our franchisees are really doing well; the rest of them we'll probably convert to company units.

I hate to throw cold water on somebody else's idea, but we saw the same numbers he sees, and we drew the same conclusions. The sales are just not there. We're a couple years further down the road, and I would advise him to cut his losses and try something else.

FINANCIER
BRUCE RAUNER

General partner, Golder, Thoma & Cressey, a Chicago venture firm with an investment in several fast-food franchises with drive-through operations

It sounds like Goldman's got a lot of relevant experience, and it's nice that he's had a failure before. If you learn to be cautious but still optimistic, failure can be a good thing.

Still, I was troubled that his background is roast beef and chicken, not pizza. Gregg Pancero apparently is the one who really understands pizza, and our bias is that once you find people who are important to the success of a venture, make them full partners. Goldman should do more to make Pancero part of the team.

Goldman is trying to do major pioneering on several fronts, which is one reason we wouldn't want to invest. Pizza really is a dinner item; nobody's made it a successful lunch item. You can eat burgers while you're driving -- pizza you can't. And with pizza, there's a wide variety in tastes: while to some degree a burger's a burger, with pizza the crusts can vary, the sauce can vary, and it's hard to come up with a product that will appeal to a wide audience -- unless, like Pizza Hut stores, you're in a location where you're the only pizza around.

What's more, consumer perception of quick pizza is pretty negative; I wouldn't want to be fighting it. And I wouldn't want to bet a lot of money that Goldman will be the first to pull it off.

He's in Arizona and opening single outlets in northern and southern California -- that to me is very dangerous. Especially if you're pioneering: you've got to go for a cluster, focus on a market or two, become a well-known, proven performer there, then go elsewhere. He shouldn't be franchising yet, anyway. I don't think franchisee money should be venture money; you ought to have something that's demonstrated to be reasonably successful.

Bottom line, though, is how it tastes, and if your review is right and it's not any better than Pizza Hut, then the odds are pretty low that the company will succeed on even a modest basis.

COMPETITOR
RICHARD SHERMAN

Chairman and president of Rally's Inc., operator and franchisor of 230 drive-through hamburger restaurants in 24 states; former president, Church's Fried Chicken; former executive vice-president, Hardee's

He is in a crowded field -- just as we are -- but there's a significant opportunity because pizza has such a low food cost.

Goldman was known as a good Arby's operator, and he's somebody we respect. You can see by his commitment to the software and having it in place that he has thought about what is necessary to achieve speed. But his operating costs should be significantly lower, and he needs to pass that through his menu. If I were Goldman, I would want a business that could succeed without delivery, to keep the cost structure down. He might take out a register and some labor. And he needs to look at whether the menu is limited enough. Maybe he should offer only one size of pizza. I'd urge him to keep things as simple as possible.

His prices are not low enough. He ought to use price to get people to try his product. It's tough to communicate quality through the marketing clutter. If he wants me to go there, he has to give me a compelling reason. Drive-through is not enough. People don't like to admit it in marketing surveys, but they will go if something is a buck cheaper. I'd copy what Pizza Hut serves for lunch as closely and as legally as I could, and I'd be 25% cheaper.

If he looks at everyday lower prices and then gives people something extra, like "zesty" tomato sauce and better packaging, it could work. Phoenix is one of the most challenging markets in the country. If he can succeed there, he ought to be heartened.


TIME IS ON HIS SIDE

We're all for fast, but how does it taste?

It's unfair to compare Pizza Now!'s pie with the kind you get from your local old-country purveyor; as founder Philip Goldman will gladly point out, that version takes at least 20 minutes to make. Goldman's individual pan pizzas usually arrive in less than 60 seconds and set you back only $1.59. That in mind, the slightly stiff dough and somewhat chewy cheese seem like reasonable trade-offs.

The larger pizzas, which aren't as good a deal and take around seven minutes, taste about the same as any big-chain fare -- which is, Goldman believes, "perfectly acceptable."

And the competition? Pizza Hut's individual pan pizza tastes almost the same -- but can costs 40¢ more. Both Pizza Hut and Pizza Now! deliver satisfaction if you're in a rush, but neither has created a fast-food pizza for all time.

Last updated: Jul 1, 1990




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