How a pizza joint became a tech giant

The digital business model

Never before in history have the largest global enterprises required so little tangible capital to generate enormous profits. These new digital business models are, in theory, infinitely scalable with very little incremental capital. For example, if Google, Facebook and Microsoft decided to return all their excess cash and non-core investments to shareholders via a special one-time distribution, the collective tangible capital left in their businesses would be modest. Yet the lack of tangible assets from a traditional accounting viewpoint would have virtually no impact on their earnings power. Free cash flow would still be enormous and growing.

Financial reporting, which was designed to approximate the previous tangible era, has become less useful for investors today because the fundamental nature of capitalism has changed. Indeed, a recent article in the Harvard Business Review made a bold claim that, “accounting earnings are practically irrelevant for digital companies. Our current financial accounting model cannot capture the principle (sic) value creator for digital companies: increasing return to scale on intangible investment.” Directionally, the importance of intangible assets will only grow over time, relative to tangible assets. The essential raw material of more capital that was so critical for growth throughout the modern business era is becoming far less important.

The intangible benefits of technology-driven competitive advantage go far beyond the handful of ubiquitous online giants. Consider the restaurant business. This industry is very fragmented and most have historically been resistant to new technologies. Yet, Domino’s Pizza Inc. (NYSE: DPZ), the world’s largest pizza chain, often refers to itself as a “technology company” because it has become a key success factor for the company.

This pizzeria’s incredible turnaround started after Patrick Doyle became CEO in 2010 after some troubled years. He led efforts to completely overhaul its pizza recipe, root out poor franchisees and, most importantly, invest for the future and aggressively embrace technology to make ordering more efficient and customer friendly.

The fundamental improvements of the business have been nothing short of stunning. Domino’s same-store sales, or sales from stores open at least one year, have risen in the U.S. market for 28 consecutive quarters at an average increase of 7.4% since 2010, which is well above all large peers. Today more than 60% of its orders come digitally, and the firm is targeting 100%.

The stock rose from below $9 per share in 2010 and has soared to more than $260 at the time of writing, an order of magnitude greater than its pizza chain peers. Domino’s is a wonderful example of the benefits of embracing technology as a competitive differentiator. Today, almost every successful restaurant operator is (or should be) trying to emulate some aspects of Domino’s extraordinary model.

Closer to home, a few Pender mandates owned Panera and one still owns Starbucks, in part because these companies also make forward-looking investments in technology as a competitive differentiator. We remain on the lookout for more well run, traditional businesses, which also see themselves more as “technology companies” in their space and are investing ahead of their peers. As we have seen, it can make a big difference and lead to a long runway of outperformance!

Felix Narhi, CFA, is Chief Investment Officer and Portfolio Manager at PenderFund Capital Management. He works alongside David Barr, Pender’s President, in setting the direction of Pender’s overall investment strategy. This article first appeared as part of the Pender June 19 Manager’s Quarterly Commentary. Used with permission.

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