Pizza wars: Big dough, small crusts and the Mexicana stand-off

If you ask Zain Mazloum, managing director of the iconic Melbourne restaurant Toto’s Pizza House, talk of a pizza war is nothing more than hyperbole, a load of baloney to borrow an American phrase.

“I don’t think there’s a pizza war,” says Mazloum, whose family has been in the pizza business for almost 34 years.

Mazloum, along with his father Sami and their business partners, is in the process of rolling out the first Toto’s franchise store, located in South Melbourne, with another slated for Richmond within the next few months.

Toto’s Pizza House fired up its oven in 1961 in the Melbourne suburb of Carlton and has been officially recognised as Australia’s very first pizza restaurant. It’s a mainstay among locals and tourists alike on the well-known Lygon St shopping and restaurant strip.

Mazloum’s father, Sami, bought the store from original owner Salvatore Della Bruna in 1982, complete with original recipes.

Mazloum says the two big players in the sector, franchise giants Pizza Hut and Domino’s, are rolling their dough in a very different market to smaller makers like Toto’s.

“We’re traditional, we’re authentic. I believe we’re doing the right thing. Our pizzas are much more expensive than Domino’s and Pizza Hut. We’re on the upper tier,” Mazloum tells SmartCompany.

“People pay the money and they love us. We’re pretty popular.”

If the $4 billion pizza sector is not at war then Pizza Hut and Domino’s have certainly been doing their best to turn up the heat in their battle for supremacy at the lower price end of the market. And Pizza Hut franchisees appear to have been the ones getting burnt.

The two pizza giants have engaged in a Mexicana stand-off on price that has left many Pizza Hut franchisees rolled and beaten, and now ready to have their day in court. A group of 288 Pizza Hut franchisees has initiated a class action against the Yum! Restaurants group, which holds the master franchise rights to Pizza Hut and also operates the KFC fast food chain.

The class action follows on from a failed court injunction bid by a group of Pizza Hut franchisees in July 2014 to stop Yum! Restaurants from implementing a “reduced price strategy” that sought to fight Domino’s increasing market share. The strategy soon saw Pizza Hut matching Domino’s on price with $4.95 pizzas. The fallout has reportedly resulted in more than 30 Pizza Hut franchisees going bust.

Mazloum has sympathy for the Pizza Hut franchisees.

“At $4.95 the only people making money are at the top, the franchisors, who are making 6-7% of the turnover of the store. The store owners have to pay rent, wages, and all the other big bills that come into a business,” he says.

Aside from Pizza Hut and Domino’s, the other big players in the sector are Eagle Boys, Crust Pizza, Pizza Capers and La Porchetta.

Eagle Boys has also experienced problems with its franchisees, with the number of its outlets falling drastically in the past few years from about 340 to 169. Meanwhile, La Porchetta was an acquisition target for Retail Food Group (RFG) last year, but RFG – which also owns Crust Pizza and Pizza Capers – took the deal to acquire the 70-restaurant chain off the table in November.

Read more: How I sold Crust Pizza for $41 million

Retail expert Brian Walker, chief executive of the Retail Doctor Group, says while the two big players have been engaged in a race to the bottom on price, chains such as Crust Pizza have carved out a niche for themselves in the gourmet end of the market.

“The pizza market broadly is broken into gourmet pizzas and then the non-gourmet, and Pizza Hut falls into that non-gourmet category,” Walker tells SmartCompany.

He says Pizza Hut’s gamble in going head-to-head with Domino’s depended on reducing price to hopefully lift volumes and, consequently, its share of the market. This can be a perilous path against a competitor like Domino’s that is willing to dig deep and serve up as good as it gets.

“They’re really in a volume price war, so their strategy to reduce their pricing has to have an offsetting increase in volume in order to make the same returns and grow market share. That’s the risk of the strategy,” he says.

Franchising expert Jason Gehrke says the class action will make it hard for Pizza Hut to attract franchisees, which might lead the chain to adopt a strategy that relies on more company-owned stores.

“I wouldn’t want to pre-empt the court but the fact it’s proceeding is a significant indicator of the seriousness of the issue,” Gehrke says.

“The courts have determined there is a case to hear and I think the outcome of this will be watched very carefully by many people in the franchise sector.”

Gehrke says the case provides a valuable insight for franchise networks about making sure franchisees and franchisors are in agreement when it comes to pricing and margins.

“There’s a lesson: be very wary about price-driven campaigns that don’t enjoy the support of franchisees or which cannot be proven to be viable for franchisees,” he says.

“I think that Domino’s really fired the first salvo in the pizza war but they had the opportunity to prepare for it well in advance, to ensure their supply chain logistics were capable of keeping margins within reason for franchisees, and that’s one of the big arguments in the Pizza Hut case is that their margins deteriorated to nothing.”

Walker says the smaller chains and stores that occupy the gourmet and middle ground of the pizza market should tread carefully or be caught in the crossfire between the big two.

He says these operators might be better off playing to their strengths rather than employing a risky growth strategy that looks at picking up customers Pizza Hut might have lost.

“It’s a dangerous space to play in that relies on a lot of volume and a lot of market position locations, it’s just a very, very different position. It’s like asking Armani to turn into Walmart,” he says.

Gehrke also says the price wars are best left to corporate outfits like Pizza Hut and Domino’s with “very deep pockets”.

He says smaller players in the sector would do well to stick with a strategy that taps into the increasing desire of consumers for healthier and more diverse menu offerings, a trend that is becoming apparent in other food and beverage sectors.

“Consumers want good value and consumer habits are that we’re buying more food prepared out of the home,” Gehrke says.

“I think that the price competition that has emerged in the pizza sector will emerge in other food sectors, particularly the ones that are becoming more crowded such as hamburgers and, to a lesser extent, coffee.”

Mazloum remembers walking into Toto’s as a young boy with his grandfather when his father had first expressed an interest in buying the restaurant.

“I went in there as an eight-year-old and I had a little bit of pocket money and I ended up buying a small pizza and a couple of soft drinks,” Mazloum says.

“Dad bought the place and basically instead of going to parties and that sort of thing I used to hang out with dad, he was working long hours, and I got to learn the industry and I fell in love with it.”

He says smaller operators need to keep the focus on quality because they will never be able to match the price volumes of the big chains or their marketing budgets.

“There are a lot of independent stores out there who are doing a magnificent job and they’re making not bad money,” Mazloum says.

“At the end of the day, when you go out to buy a pizza, do you want a quality pizza or a $4.95 pizza? Because at $4.95 I cannot work out how anyone is making any profit.”