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Selling pizza to the Germans proving tough for Domino's

By Neil Maidment and Victoria Bryan

LONDON/FRANKFURT (Reuters) - Can a British food chain with U.S. origins sell Italian pizza to the Germans?

Domino's Pizza (LSE:DOM) is sure it can, but two years after launching a drive for explosive growth across Germany, Britain's biggest pizza delivery firm accepts that expansion will take longer and be harder than first expected.

"It's been about resetting expectations, taking a little bit of medicine and getting on with growing it," Domino's Chief Executive Lance Batchelor told Reuters.

Crucially, big shareholders of the London listed company - a master franchisee of U.S. group Domino's Pizza Inc (NYS:DPZ) - agree that there is a gap in the German market and it is a prize worth waiting for.

Domino's has halved its original target of 400 stores by 2020, and pushed its break even forecast for the German business back as much as two years to 2017.

The company is thriving in its home market and has almost trebled profit in six years to 50 million pounds, feeding a core army of teenagers and young adults.

Its German growth has stumbled chiefly over a rise in minimum pay for restaurant staff that is unexpectedly being applied to pizza delivery firms.

It also took a while to grasp German preferences for Italian-style thin crusts over the cheese-laden, deep pan pizza popular in Britain, and for steadily low prices over promotions.

Batchelor believes that armed with better knowledge of Germany's worker-friendly pay structures, a menu tailored to local taste and experienced franchisees to run its stores, the company can deliver in a market under served by big chains.

Not that there is any lack of pizza outlets in a country that acquired a passion for pizza from Italian migrant workers after World War Two.

A single busy street in western Berlin offers a choice between Cafe Pasta Pizza, Pizzeria Senza Nome, Porto Fino, Venezia, City Pizzeria or Mr Pizz. And now Domino's Pizza.

Pizza often heads Germany's favourite food lists. Its top four pizza delivery brands achieved total turnover growth of 180 percent in the last decade, according to trade magazine Food Service.

Margins are also rewarding. German market leader Joey's says its stores can offer a pre-tax profit margin of 10-14 percent.

In 2012 Domino's comparable margin was 8.4 percent on sales in the UK and Ireland, its core market, where it sold the majority of 61 million pizzas last year.

That kind of demand, coupled with its ambitions for Germany, a country with 14 million more homes than Britain, helped Domino's shares hit an all-time high of 710 pence in June.

News that the recipe for success was going to be more complicated has since pulled them down to 582 pence.

But Anthony Cross, special situations fund manager at Liontrust AM, one of the 20 largest shareholders in Domino's, said he would be patient while it gets the German formula right.

"(It's) the right menus, the right properties and a better understanding of the vagaries of national employment costs, taxes etc. Through trial and error they will get the right formula and when cracked, the roll out will succeed," he said.


Domino's biggest headache is pay in the most populous state, North Rhine-Westphalia (NRW), where the company has 17 of its 25 German stores. Minimum hourly pay for hotel and restaurant workers has just risen there to 8.50 euros, up from the average 6 euros paid by Domino's.

The jump, which could be replicated elsewhere given growing calls for a nationwide minimum wage, will mean higher costs and a slower roll-out as stores take longer to make a profit.

"I think we were overly bullish in the spring of 2011 when we talked about hitting break even in 2015 - we needed everything to go right in order to hit that and the NRW labour change is the straw that broke the back of that," Batchelor said.

"Germany is seen as one of the top growth opportunities in the world for Domino's," Batchelor, a former submarine warfare officer with the Royal Navy, said. "(But) building another UK is not going to happen overnight."

Still, 200 stores in its first nine years will be over double the rate Domino's achieved in the UK in that time.

The slowdown to 10-12 openings over the next couple of years is more in line with a steadier approach adopted by local rivals, who face similar issues over pay levels but have had longer to grow used to them.

"Welcome to Germany!," Joey's managing director Karsten Freigang told Reuters as he spoke about staff costs.

Joey's took 25 years to get to 206 stores and is opening 10-15 a year. German No.2 Hallo Pizza has 174 after 24 years.


Another challenge is that Germany has more independent stores fighting for customers, Joey's boss Freigang said.

Sales at pizza delivery chains in Germany reached $509 million (316 million pounds) in 2012, while independents racked up $693.6 million, according to Euromonitor. That stands against $1.213 billion for the chains and $515 million for the independents in Britain.

Domino's says there's room for everyone. To gee-up German sales at its 25 stores, it is handing its 15 poor performing directly-managed stores over to its expert franchisees.

Most of these managers, who pay to use Domino's brand and ingredients, and then hand over a percentage of net sales, have honed their skills in Britain, and their German stores have fared much better than Domino's 15.

That approach reflects its set-up in the UK, where all Domino's stores - 790 and rising - are run that way, and Domino's hopes the formula will work again.

(Additional reporting by Emma Thomasson in Berlin and Sinead Cruise in London; Editing by Anthony Barker)