Introduction

Patrick: [00:03:05] My guest today is Zack Fuss, an investor at Continental Grain, a 200-year-old family-owned business that is focused on investing and operating businesses through the food and agriculture ecosystem. Prior to his work at Continental, Zach was an analyst at Tiger and at Citadel. This is a must-listen for those interested in any aspect of the food ecosystem but also for those trying to understand value chains more generally. In our conversation, we cover where profits tend to sit in a specific value chain, how legacy food businesses are creating their second act as digital businesses and explore what makes Domino's Pizza so interesting and special. I hope you enjoy my conversation with Zack fuss.

The Food Ecosystem

Patrick: [00:03:40] Zack, I think an appropriate place to begin is with sort of how the ecosystem breaks down. So if someone's new to this area, what are the key sort of components? You can break it down however you want, value chain, supply chain. You give us the right taxonomy for thinking about this. What are the meaningful areas that you think it's important to develop special expertise in?

Zack: [00:04:03] Think about the value chain. At the top, you have large producers, industrial farms, they interact directly with companies like a John Deere or a Cargill. And you go all the way downstream just like energy assets. So you go from the soy and the corn and the animal protein to the producers, to the processors, like Tyson Foods. And they sell into the distributors and the restaurants, so a Sysco and a Performance Foods and a US Foods who sell to a McDonald's and a Burger King and a Chick-fil-A who sell to people like you and me. And everything in between that ecosystem, the grocery stores, you have the cold storage businesses. It's just such a rich ecosystem with so much change and dynamism. The reason that we find it to be so interesting is because at the end of the day, people are going to need to eat. And the form factors with which they eat and how they do so and where they get their food are going to continue to be different. But we're talking about in the US, a $1.5 trillion market between food at home and food away from home. And there's just so many places in the value chain you can play as a function of that.

Patrick: [00:05:12] Who makes the money in this ecosystem? Or maybe a better way to ask the question is what do you feel are the best and most defensible businesses in the food chain?

Zack: [00:05:22] There is a pretty interesting construct that I like to think about when evaluating these businesses. The law of conservation of attractive profits and how it impacts wherever we interact in the value chain. When I think about the last decade, the world has probably come to accept Marc Andreessen's thesis that software is, in fact, eating the world. I think we probably don't spend enough time contemplating what the implications are for the value chains of these legacy industries that we participate in. So as I said earlier, we sit at the intersection of consumer goods, logistics, infrastructure, restaurants, and food retail, upstream to downstream, and throughout the life cycle of businesses. Technological advances in some way, shape, or form impact all of our businesses. We're involved with public and private businesses and sleepy industries like protein and animal feed and fast food. As well as more disruptive and early-stage ones like nitrogen fixation and restaurant point of sale technology. So the spillover between the two hypothetically provides some canaries in the coal mine per se.

Clayton Christensen Wright is widely recognized for his work on the innovator's dilemma. But I think in the context of current business analysis, he probably deserves more attention for his work on the law of conservation of attractive profits as I mentioned which is as relevant today as it was 20 years ago. Start with the idea that throughout a value chain a certain player captures a disproportionate amount of the economics. There's a reason that McDonald's is a $200 billion business that trades at 20 times EBITDA. And Tyson is a $35 billion business that trades at eight times EBITDA. And Sysco is a $50 billion business that trades at 13 times EBITDA. They all participate in the same value chain. The value they capture for their investors is inherently different based upon which aspects of the value chain have become more commoditized. So if you think about chicken production, it's almost definitionally a commodity. If you think about food distribution on the local level, it's a very rich business, original oligopoly with the benefit of route density. It's more capital intensive to scale and it's somewhat constrained by its local markets. Fast food, McDonald's as an example, is an international licenser of its brand as a franchise business, it's a lead gen business, it's a landlord with massive scale benefits. So as a 75-year-old consumer-facing brand, they capture a disproportionate amount of the profit pool. It's almost obvious which are the least commoditized players in that value chain and which are the most differentiated and those capture a disproportionate amount of the economics.

Patrick: [00:07:50] Can you say more about other examples you've seen of this same concept? This law of the conservation of attractive profits or just other things you've observed in or outside of food. And sometimes it's good to bounce around examples to make the point of studying a specific chain and figuring out what is driving the most attractive businesses.

Zack: [00:08:11] I think we'll stay on the topic of restaurants, just given the context of the conversation. Today, food delivery is kind of a canonical example of the disruption that's reorienting a value chain. On the technology side, we have an exceptional operator with deep pockets all looking to carve out a portion of the food away from the home profit pool. There are incumbent players that are embracing that and also others that are fighting back. But there's this vast pool of participants looking to get their share. You have aggregators like a DoorDash or an Eats or a Postmates. You've got third-party logistics companies, ghost kitchens, digital-only locations, technology providers like an Ola or a ChowNow. You've got dark kitchens like CloudKitchens incumbents, Chipotle and Starbucks who are opening digital-only stores. Conventional wisdom was always that restaurants historically are "bad businesses". That if you consider the margin structure of a restaurant, which is probably food costs of 25 to 30% and labor costs of 25 to 30%, and rent costs of five to 10%. At the end of the day, best-case scenario, you're left with 10 to 15% margins if you're a strong operator.

So in the event that you decide to outsource your delivery and lead generation to a third party, like an Uber Eats or DoorDash and they're looking to take 20 to 30% on top of that. And in the event that it's replacing or cannibalizing your current sales, it's a bad economic trait. But I think what we've learned is lead generation is a great business. Logistics, historically not but if you want the lead generation business, you're kind of forced into the logistics business. So you better do at breakeven or better. This is just such a great and timely example. If you look at the DoorDash S-1 that was recently filed, they're tracking towards $3 billion in sales and a 50% share. And I think we can say with confidence that in certain markets and at a certain basket side, both the restaurants themselves and the aggregators, the delivery providers can both make money. And in urban areas specifically, if you have enough route density or drops per trip, take rates can be lowered. So a scale economic share type dynamic between the restaurant and the aggregator where everyone is participating in a larger profitable, delivery can hypothetically be done at a very positive contribution margin. What we continue to learn within all of these profit pools is that if enough people want something, there are ways to figure out an economic model to do it very profitably. But over time, it's kind of that Barksdale bundling and unbundling and modularizing and commoditizing different parts of the profit pool. And as different aspects of the supply chain integrate, segregate, and desegregate, that's where disproportionate amounts of the profit pool are often captured.

So a scale economic share type dynamic between the restaurant and the aggregator where everyone is participating in a larger profitable, delivery can hypothetically be done at a very positive contribution margin. What we continue to learn within all of these profit pools is that if enough people want something, there are ways to figure out an economic model to do it very profitably.

Patrick: [00:11:05] I'd love to step back for a minute and just talk about the behavior of, I'll call them legacy businesses, non-technology businesses given what's happened in the world. And what you've learned about what the best in breed and sort of the worst in breed have done or are doing to react to the way the world has changed. So if you think about like a Nike, that's done an unbelievable job, maybe not a technology company but adopting technology and adopting the direct to consumer mindset for the benefit of its business. What have you seen in similar fashion in the food world? Which again, it's one of my favorite things to think about and talk about because we all eat, we all know it, and it's fairly straightforward. There is ingredients, they come together, they're sold under brands. It's not that complicated a thing and it's not really tech-heavy but the world has changed. So just say a bit about what you've learned about, I'll call them older school industrial businesses and the best way that you think those kinds of businesses are acting today.

Zack: [00:12:06] Yeah. I mean I think that in a lot of ways, it's that classic example of distribution of a product. If you think about downstream food players, like restaurants, those with the strongest footprint in the best areas that can "distribute their products most effectively in the most timely nature", tend to win. Those that embrace technology, tend to win. Areas of the market where there's a more interesting push and pull between those that are willing to adapt and Henry Ellenbogen of T. Rowe calls it second act. Management's ability to innovate in such a way where they can capture whatever technological innovation or disruption is facing their industry, leverage that to become a more successful, more dominant player. I think if you consider grocery as an example, it's a really fluid and interesting dynamic playing out. As we alluded to grocery plays in that $1.8 trillion food at home and food away from home industry. The trends go back and forth but we're trending towards about 55% of food consumed away from the home and 45% at home, it's probably flipped due to the pandemic.

Grocery, typically a very low margin, high turnover business. Traditional grocery store has something like 40,000 SKUs, many of which are perishable and others that have very low turnover. And if you consider a $100 basket of groceries, the retailer keeps, I don't know, $2 to $4. It's not an easy business by any means but it's a massive category. So despite low margins, you still have this enormous profit pool to go after. Two to 4% of $800 billion is still a 20 to $30 billion annual profit opportunity. And so you have this battle between the upstarts and the incumbents. You have the Walmart, the Kroger, the Costco, the Albertsons of the world. You have Amazon on one hand and then you've got this longer tail of more focused, more digitally enabled businesses, like a farmstead in the US or a picnic in Europe. They're all doing very different things in order to capture this opportunity and time where share is going to shift between incumbents and upstarts. Or maybe the incumbents are going to continue to capture their disproportionate amount of share because they're willing to embrace changes in technology. For grocery stores, like restaurants are also located in highly trafficked areas with strong access points and require a fairly big footprint. Probably, I don't know, 70 to a 100,000 square feet. So they face pretty significant real estate costs. Buy online, pick up in-store is having its moment throughout consumer. But the reality is having human labor walk the shelves of a conventional grocery store to pick and pack your order comes at a very high cost. What's going to have to happen over time is more of the traditional grocery store is going to become industrialized. It's going to become more like a fulfillment center. So today maybe you walk into a grocery store, 80% of it is walked by shoppers. In the future, it becomes 60%, 40%, 20%. And the center of store items probably come completely commoditized and fulfilled through something like order ahead. And what I would postulate is as we observe this evolution of the store footprint, we get more dark stores or de facto warehouses and less desirable real estate. And much like Amazon uses its fast fulfillment centers to fulfill its online orders, a grocery store is going to operate in the same way. And so that's just one example of how technology and the way with which customers are acquired are disrupting legacy industries throughout food.

Source: ACV

Patrick: [00:15:41] Maybe say just a bit more about that term, I think you said dark stores, just exactly what you mean by that. And it makes me think of ghost kitchens, it makes me think of this just shift from real estate being the thing that matters for prime receiver onto this more competitive frontier in the digital sphere. Say a bit more about those two trends, maybe dark stores or ghost kitchens, and what you see and have learned there.

Zack: [00:16:03] Dark stores and cloud kitchens are kind of two derivatives of the same thing. You lower your rent costs and you use the savings from those rent costs to fund other value-added services. The reality is that a legacy grocery store requires the consumer themselves to pick and pack the items. Now when you shift that labor cost onto your own people, it requires an incremental wage cost. The idea of a dark store is that you shift location somewhere where you have less costs that can fund the cost of delivery, the cost of fulfillment. And over time, you no longer need the footprint in these high traffic areas but instead kind of serve as a cognitive referent for your customer. The idea of going to Kroger's no longer driving to the store but instead you're popping up on your phone, you're reordering the 80% of items that are occurring in nature. And maybe the 20% of items that are more discerning as a customer, you'll go and get yourself from a local or an independent provider. Cloud kitchens are really no different. We've talked from the past about businesses like Domino's, which are effectively the original cloud kitchen.

Understanding Domino's Pizza

Patrick: [00:17:10] Can you say more about Domino's? Just describe the sheer scope of Domino's. How many stores there are across the world, where they're located. I think probably everyone will understand what a store looks like but we'll explore that in a bit of detail in a second too. How many of these things are there? How much in sales does Domino's do around the world annually? Give us a sense for the scope of the business.

Zack: [00:17:31] Domino's is a restaurant system that does $15 billion in sales, about half in the US, half internationally. They have 17,000 restaurants, around 6,000 in the US, 11,000 globally. And they sell anywhere from three and a half to four million pizzas a day. So we're talking about a lot of food here.

Patrick: [00:17:50] What's the key differences between the nature of the ownership of the franchise ownership in the US versus international? Do they look similar? Do they look different?

Zack: [00:18:00] It's an important nuance. I like to take a step back and think about Domino's as really three businesses in one. It's a restaurant with a captive delivery arm. A lot of people refer to it as kind of the original ghost kitchen. It's a supply chain business because they own and distribute all the cheese sauce and dough to their restaurants. And maybe most importantly, to answer your question, it's a brand manager, a franchisor. There are nuances between the US and the international system. So in the US, 95% of the restaurant owners are former Domino store-level employees, so they either worked or managed the store. Internationally, the franchisees are institutional master franchisors. It's another level or layer that's helping to manage the brand. What that means is there are franchisees which are less institutionalized internationally that work under the master franchisors. And most of the large established ones are public companies. So you look at a Domino's Pizza Enterprises, which is the Australian franchisor, that's a $6 billion market cap company. You look at Domino's London, which is the United Kingdom franchisor, that's a $2.5 billion company. You look at Alsea, which is the Mexican franchisor, that's a $3 billion company. Jubilant Foods, a $4 billion company. So there is an incredible amount of wealth being created throughout the Domino's ecosystem. And even in the US if you were to look at the profitability of the restaurant owners, cumulatively, they probably do about a billion dollars in EBITDA. That's worth six or $8 billion alone. What's so amazing about the Domino's business model is it's really creating more value than it captures in a lot of ways.

So you look at a Domino's Pizza Enterprises, which is the Australian franchisor, that's a $6 billion market cap company. You look at Domino's London, which is the United Kingdom franchisor, that's a $2.5 billion company. You look at Alsea, which is the Mexican franchisor, that's a $3 billion company. Jubilant Foods, a $4 billion company. So there is an incredible amount of wealth being created throughout the Domino's ecosystem.

Patrick: [00:19:37] There's so many follow-up questions to each of those points. Maybe since we talked a bit about the franchisees already, we'll stick with that for a second. Just talk us through what it feels like to be a Domino's franchisee. Let's say opening your first restaurant for the first time. Let's say you were a former manager, you now want to be an owner. What does that look like and feel like from a dollar standpoint, from a timing standpoint? What does it require that they do? And why is it such a popular thing for former employees to do this? and why is it such a popular thing for former employees to do this?

Zack: [00:20:04] So I think the reason the Domino's franchise ecosystem is so strong is because the unit economics are truly remarkable. So if you are a former employee that wants to open up their own store, you're going to pay a franchise fee, which is a nominal amount, but cumulatively to open up your store, it's going to cost you anywhere from 250 to $350,000. An average store in the US does about 1.1 to $1.2 million in top line. And if you look at the same-store sales growth in those businesses, they're growing anywhere from call it three to 6% in every given year on a same-store sales basis. Because pizza is such a profitable category, the average store can do about $125,000 in cashflow. And so on a $300,000 investment, you're returning $125,000 without debt. So if you were to borrow from a bank in order to finance the build-out of your store, you're looking at a 30% plus cash on cash return or two and a half to three-year payback.

Patrick: [00:21:03] Can you talk about why Domino's is in a unique position they're able to offer such incredibly high returns to its store owners? And maybe just put those returns in perspective. Is there anything that offers a higher cash on cash return to a potential franchisee and what are some of the more normal numbers in something like a Burger King, say?

Zack: [00:21:21] The reason that Domino's is inherently more profitable has a lot to do with the nature of the product that they're selling and delivering. Pizza is a very low cost of good cuisine. If you were to look at a pizza restaurant versus a burger joint, for instance, pizza generally starts with an 80% plus gross margin. The cost of dough, cheese, and sauce are just not that high. As opposed to a burger, which is dealing with the expense of protein. That business is going to be starting at like a 65% gross margin. So if you consider the spread from that perspective, they're already at a competitive advantage. And what they do with that incremental margin is it affords them the ability to fund their delivery. The reason that Domino's has been so successful is because they lead with delivery. They've also invested heavily in the technology stack in their restaurants. Any potential franchisee is going to look at their restaurant and return economics in comparison to the other opportunities out there. You look at a McDonald's or a Wingstop or a Chick-fil-A or a Taco Bell, most burger joints, they're going to have cash on cash returns probably in the high teens to low twenties. So a four to five-year payback, which is still very healthy as displayed in the size and scale of a McDonald's or Burger King system. If you look at Dunkin, for instance, you're looking at like 25 to 30ish percent return. So it's still very healthy, depending upon the region.

The only thing I've actually seen that's better is a Wingstop. If you look at that stock price chart you can see kind of how unit economics really drive returns 40 to 50%. Their business model is quite similar, except the difference with Wingstop is they historically haven't had delivery, but if you consider the footprint of their stores, and another reason that Domino's is competitively advantaged, because Domino's is a delivery business, they can take lower-cost real estate as well. So they don't need to be at the busy intersection or in the strip mall where there's a lot of foot traffic, they can go to more BNC type locations. And so you have the higher gross margin, you have a lower cost of rent, and that kind of all boils down to a much more powerful unit economic for a standalone store.

Patrick: [00:23:21] One of the things that everybody talks about with Domino's is they call it a tech company. You describe many of the things that it is. You didn't say tech company yet. I'm curious for your take on that common trope that really what's driven their results is that they're a tech company in disguise.

Zack: [00:23:34] Yeah. They certainly have the returns of a tech company, so I can see why people lead with that. There are a couple of things they've done that show that they are a technology-forward company. I think they deserve a ton of credit in appreciating and reacting to platform shifts. So for instance, historically pizza was a dial-in business so that would people pick up the phone and call, and then the internet helped to accelerate and facilitate internet orders. And then as mobile became more relevant, they made sure that you could order on your mobile. Today, 65 to 70% of their orders come through digital channels. So mobile or internet. And the other thing that they are really focused on is allowing you to order wherever you may be as the customers. You can order through Alexa, you can order through Google Home, you can order through your iPhone. They even went as far as allowing all these hotspots where you can order to Central Park, for instance. So they're certainly tech-focused.

The other thing I think is important, and the reason that their relationship with their franchisees is so powerful, is because it's more fragmented and less institutionalized, especially in the United States. They can work with their franchisees to implement new types of technology that may be more challenging for someone like a Yum! Brands or a McDonald's who are dealing with more kind of private equity-type sponsor oriented owners. Back when they were turning around the product of their business, back in the mid 2010s, they also made sure that all of their stores run a unified point of sale system. What that means is that Domino's corporate in Michigan has visibility into the unit economics, the sales, the store-level data, and that helps them to inform decisions about where to open new stores, what products to trial, how to push on certain initiatives, how to price their product. It's certainly not a technology company, but they are more tech-forward. And they show a higher propensity to experiment than most of their kind of fast food, quick service peers.

Patrick: [00:25:25] I lost track of the kind of same-store idea. You started to walk down a typical store, how much it costs to start one, where the sort of top-line sales are more than a million dollars in sales, 80% gross margin. So relatively low cost of the dough and the cheese and the sauce and the toppings, et cetera. What are the other key aspects of same-store economics that you think are worth noting, whether that's labor or equipment in the store, what else is relevant for a store owner?

Zack: [00:25:52] There are a couple of things. It kind of is a really interesting business model in that you're creating the business once and you're selling it multiple times. Every Domino's store has pretty similar order process flow if you consider kind of the way that that eases the operational burden on its employees. So the preparation and cooking process for every menu item, whether that be pizza, pasta, wings, desserts, actually uses the same oven. And based upon different points of entry, all the food products complete their cooking at the same time, and then are ready to be picked up by the delivery person and dispatched to the home. It's almost like a system engineer's dream in the way that these businesses that work. And then the question is, okay, how are they driving same-store sales to their stores? So for a medium, large, two-topping pizza, they've charged 7.99 for as long as I can remember. And so as they gain incremental scale, they have the benefit of passing that scale economics onto their customer. There is this really interesting kind of feedback loop in their businesses where they invest more in the stores, it drives higher same-store sales. Because they have higher same-store sales, the stores are more profitable. Because some stores are more profitable, the franchisees are willing to open up more stores. And because the franchisees are willing to open up more stores in their designated region, that means that delivery times are going to be lower. And if delivery times are lower, that means that the customers are going to be more satisfied and order more pizza. And on and on and on you go. And they've actually formalized that strategy to something called fortressing. So for instance, if a franchisee has two stores in a market and that markets starting to show the stores are at capacity, Domino's will inform that franchisee that they should open up another store in that region. If you consider the flywheel that we just referenced, as stores generate more sales, they can lower their delivery times by opening up an incremental store, which makes the whole region more profitable. And then you have the scale benefits of a multi-store system that is ordering higher amounts of goods. And as they're ordering more cheese, dough, and sauce, they're getting fixed cost leverage on their stores and the entire system is more profitable. The reason we can see that that's working is the average franchisee in the US has six or seven stores doing about 150,000 in EBITDA per store, or a million dollars in their entire system. Going from a Domino's employee to a business owner of six to seven stores doing a million dollars, you can appreciate the wealth that's being created throughout the system.

Source: Domino's Pizza

Patrick: [00:28:15] I realize we've gone a long way without actually talking about something interesting about the product in this case, which is the pizza. Obviously, they make stuff other than pizza. One of the most interesting timeline points in its history, I think was in 2009 or 2010, when the then CEO basically went on TV and said, "We know our pizza sucks." This is like disruptive innovation in taste or something. Talk about that episode because we've talked about the brilliant system that is Domino's and the technology and the engineering and the distribution, but we haven't actually talked about pizza. And I think that's an important episode.

Zack: [00:28:45] The company released a pretty viral video of consumers, essentially boiling down to the fact that their pizza tastes like cardboard. The age-old debate of product versus distribution. It became very clear that Domino's was a distribution company that wasn't focusing enough on their product. They refocused on the formulation, they improved the crust, they improved the pizza, they improved the sauce. I kind of like the heuristic that Rory Sutherland offers that you want someone in your business that's willing to do something that the CFO will tell you is a terrible idea. I think coming out and saying that the product tastes terrible is generally not a typical marketing strategy. But if you consider the virality and the consumer trial that helped to catalyze, people were reinvited back into the business and started to trial the product and they improved it. That was one of Patrick Doyle's kind of best innovations, but really the most powerful, because I think anyone that is loosely aware of the Domino's story today fully appreciates the fact that they kind of came out 10 years ago and said, flat out, "We stink."

Patrick: [00:29:45] I want to go back to this idea of ghost kitchen. Again, maybe you can describe that concept for those unfamiliar and why Domino's may have been the first ghost kitchen. But maybe more interesting is that they don't, at least in the US, operate on the, what we'll call the aggregators. The Uber Eats, the DoorDashes of the world. You can't order Domino's through that. You have to order direct. They control the delivery. Talk about those two key aspects.

Zack: [00:30:07] So as we spoke to earlier, pizza almost definitionally is a better product for delivery. It delivers well, but more importantly, the economics of a pizza delivery drop are really powerful. So if you consider a business, as we've referenced, that starts with 80% gross margins versus 60%, that 20% differential on the margin is what funds their ability to deliver pizza. So let's consider a $20 order of Domino's, two medium three-topping pizzas. 20% provides you with $4 to essentially fund that delivery cost and a delivery person can do, I don't know, call it four to six deliveries per hour. Although as an aside in Japan, apparently they can deliver a pizza in less than two minutes, which is pretty impressive.

Patrick: [00:30:50] Insane.

Zack: [00:30:51] The engineering of these businesses are really truly remarkable. If you're doing five deliveries an hour, $4 per delivery, you have $20 to spread across that hour of work for your delivery person. They've been very adamant about not sharing their data with the third-party aggregators, with GrubHub and DoorDash and Uber Eats, because they really value that relationship they have with the customer. And it's also proprietary information that they feel like their restaurants are kind of being shortsighted in sharing that information, but it wasn't easy. I mean, I love the concept of a mode attack, and I think that they kind of proved that through the last three or four years where you had some very deep pocket investors funding the operating losses of DoorDash or an Uber. When you're dealing with competition that's uneconomic, it's very difficult. You definitely saw competitive impact on Domino's business, despite the fact they're growing their same-store sales through the pandemic. It was just really a year and a half, two years ago where same-store sales decelerated because of the competitive impact from those aggregators. But they kind of stuck to their strategy of maintaining that relationship one-on-one and driving sales to their stores and acquiring customers themselves. There are scale benefits in being a franchise system because all your franchisees contribute to the advertising pool. So it just became a function of them spending those advertising dollars in a more efficient and productive manner. And I think that ghost kitchen example is an interesting one. They're essentially stores that were created for delivery. And I think that if we consider the food and restaurant ecosystem, as delivery becomes a more competitive category, it's going to force Domino's to really innovate and stay on the leading edge, and ghost kitchens, the reason that they work, is because you're able to spread the rent costs across multiple restaurant concepts. And beyond that, as we were talking about earlier, they're in less desirable real estate locations. And so the rent per square foot is just less, which leaves more room for delivery. But Domino's was kind of a first-mover on that.

Patrick: [00:32:46] What do you think are the most portable aspects of Domino's current or historical business strategy that could be, at least in some interesting way, applied to other industries or other business concepts?

Zack: [00:32:58] Yeah, so I think that one of the most important is the decentralization of their business. In technology companies, people are way more cognizant of the ecosystem or the marketplace. I think you could make an argument that Domino's is in of itself a marketplace. You essentially have aligned incentives with your franchisees and that when they do well, the franchisor does well as well. And that's important because they're creating value and the franchisees, working on behalf of their own businesses to go and create value for themselves. In many ways, it is kind of that software in a box model that people like to talk about. Domino's created the business once, and then they're selling it multiple times. The restaurant is the form factor, but the technology and know-how, and process power of the business are what really drive the returns. And I think that for any business if you consider the returns on capital requisite in the business model, what it comes down to is how much cash can you generate for any single store. And once you prove that out, you can go and scale that business infinitely. So it's about showing that the unit economics work and then demonstrating the ability to scale.

Patrick: [00:34:03] One thing I didn't ask at the beginning is if there's anything other than a recipe redesign in 2010 that you think is interesting about Domino's history. It's been around a long, long time. Some of the scary aspects of trying to think about competing against the Domino's or some similar store network or restaurant network that has thousands and thousands of stores, as just a brand-building exercise it's really hard and expensive and takes time. Is there anything else from Domino's history that you find interesting and relevant as people think about other businesses today?

Zack: [00:34:32] The company was started by two brothers in Ann Arbor, where the company is still headquartered. They started with one restaurant and then actually started franchising quite quickly. The trend of late has actually been to start with company-operated units, prove out the economics, and then start to franchise. I think operators would probably sit on both sides of the debate as to which is the better process. And it was family-owned until from the 1960s until 1998, where the company sold most of the business to Bain Capital. It's interesting, all these QSR businesses have either been taken private or spun off of larger enterprises. So for instance, Yum! Brands came off of Pepsi. Dunkin' was also taken private by Bain. Wingstop was a sponsored back company. And so there is something about the efficiency and productivity and scalability inherent in the private equity model and also the leverage, but we'll leave that there, that makes these really good businesses for private equity to own. And then ironically, this morning, we learned that Dunkin' brands is looking to be acquired by Inspire Brands, which I actually think is something that if you're going to study Domino's, you need to be cognizant of what Inspire is building, which is a portfolio company of Roark Capital. And under that, it's Arby's and Buffalo Wild Wings and other fast food concepts. In the family, as an example, is something that's very difficult to compete with.

Best-In class Retailers

Patrick: [00:35:51] Where else have you seen this concept of build once, sell many times?

Zack: [00:35:56] So I think in the physical world, you see it a lot in restaurants and retail. There's some crazy impressive retail businesses. I think Walmart is one of the most fantastic examples. And more recently we've seen it with a businesses like Dollar General. Dollar General is the largest discount retailer in the US behind the likes of Walmart. It generates $30 billion of sales across 17,000 stores. I mean, there are 3000 more Dollar Generals in the US than there are McDonald's. They're typically found in rural areas, focused on towns of 10 to 20,000 people, markets that are probably too minor for Walmart, on big roads, grocers to bother with. They're adding a thousand stores a year. So that's like three stores a day. At this point, I think 75% of Americans live within five miles of a Dollar General. So I don't know if you're familiar with their stores. Their footprints are relatively small. They're around, call it 7,500 square feet, so slightly bigger than a convenience store, but really tiny compared to a Walmart Super Center at over 100,000 square feet. And it carries about 10,000 items as opposed to a Walmart, they have a hundred thousand separate SKUs. And within that tiny footprint, they're generating $2 million in sales and can be staffed with six or seven people. So really, really great businesses, but what's unique about Dollar General and the way they go to market, and what I think is the most under-appreciated facet of their business, is the way that those thousand stores a year get built with such speed and efficiency.

They have what's called a Preferred Development Program. It's essentially a programmatic joint venture that they have with local developers who find them sites, permit them, zone them, and build the stores. The developers themselves who are independent of Dollar General have entire teams of people dedicated to building Dollar General stores. And they've created this ecosystem of preferred builders around them who develop their stores to specification for them. Dollar General Will enter into a 15-year lease at five to 6% cap rate. And the developer will take that rock-solid contract and flip it to a real estate investor, to a REIT. Because Dollar General is standing behind a developer, that developer can get cheaper financing, materially cheaper than what an independent builder would get. So for them, we'll put in $800,000 to a million dollars and turn around and sell it to real estate investor for 1.3, 1.4 million. So a really healthy business that's related to Dollar General, but has nothing to do with their core competency of selling consumables. For a non-tech company, Dollar General exhibits a stunning number of Helmer's seven powers, that set of conditions to create potential for persistent supernormal returns. There's counter positioning in that they're located in rural markets that are too small for a Walmart or a conventional grocer to find attractive. Actually, Walmart opened more than a hundred of these rural small-format stores a couple of years ago, but the concept was shuttered and dozens of them were sold to Dollar General. There's this process power in their development strategy that we just talked about, which is unique and gives them this ability to open up stores at such an insane velocity that people can't compete with them.

There's this cornered resource because Dollar General stands behind its developers, and despite the fact that they're non-affiliated, they can borrow at a lower cost and they have access to capital and a talent pool that can stand up stores quicker and cheaper than anybody. They've got the benefit of scale economics and being a $30 billion business. And the network density that comes with that means that they get more productivity and more velocity in the stores. Now they can drop more pallets per visit in a more concentrated area, realizing leverage on those fixed costs. And finally branding. The brand perception, lower search costs for consumers who trust the Dollar General brand and know that it's symptomatic of something that has convenience and low prices. And they continue to shop more, which enables them to improve the shopping experience, strengthen the brand further. So it's this really powerful retail model. And we spend a lot of time talking about those digital businesses that can create something once and sell them many times. But the reality is it's been happening in the physical world for as long as American capitalism has existed in the physical world for as long as American capitalism has existed.

Patrick: [00:40:04] I love the concept of physical versions of this great business model. Anything else that you've learned about the absolute best in class retailers of any kind? Things that are shared in common across the leadership of those businesses, best practices for how they do so well on either a store by store basis or more generally across the entire business. What else have you learned about the absolute best in retailing?

Zack: [00:40:26] I would say one of the key takeaways is that they are in many cases founder-led and they are maniacal about the first principles of their business. So if you think about a business like Walmart, it's just kind of the archetype of the American retail business. The reality is that for the first 30 or 40 years of Walmart's business, the four wall margins were really healthy and they were incredible merchandisers, but the business on a consolidated basis wasn't generating cash, which is funny as we look today and complain about some of these high growth businesses being non-free cashflow generatives, but the difference being that on the four wall level of the store, they knew to the penny how profitable these businesses were. I alluded to it earlier, but I think some of the best operators have the ability to leverage that second act. I think we're seeing it play out more and more today, given the implications of the pandemic combined with that concept of increasing returns to scale. The reality is that the best businesses now are going to face cheaper rent in that if they are a traffic-driving retailer and as buy online pick up in-store becomes a competitive alternative to online delivery, it's going to drive people to the store, which is a higher contribution margin shopping event.

I would say one of the key takeaways [from best in class retailers] is that they are in many cases founder-led and they are maniacal about the first principles of their business. So if you think about a business like Walmart, it's just kind of the archetype of the American retail business.

They can hire more efficiently by leveraging digital tools and I think another facet of it is embracing technology rather than trying to compete or avoid it. And they're going to be able to borrow at cheaper and cheaper rates to hurt down market competition or compete with them. I think incumbents today are becoming increasingly difficult to compete within a lot of ways that Amazon inspired a class of high quality, well-positioned companies to take on that day one approach that Jeff Bezos extols. It's the old, your margin is my opportunity. And so it forces companies that historically may not have tried to move up the value chain to actually invest behind their businesses to stack as courage. It's that point, that diffusion of innovations, where your growth starts to stagnate and you need to find the best way to either harden your economic mode or compete in a new market. And if you consider the advantages that a company like a Home Depot has, they haven't closed stores in nearly a decade, but they're starting to do acquisitions like a Home Depot supply. And a business like Chipotle, that's leading it to its digital capabilities and now rather than being constrained by the four walls of their restaurant are going to be able to expand that to their greater delivery area and take something that probably would have been kept at the couple million dollars a unit volume and expand it further. It's something like Disney introducing Disney Plus, and going direct to consumer and Walmart piloting a subscription offering. It's abundantly obvious to me that today the best businesses are those that are willing to embrace change and compete. And that classic innovator's dilemma is not impacting them into the same extent that it has businesses in the past.

Patrick: [00:43:26] One of my favorite topics is the ability to compete against large incumbents through market and business history. To historically young companies have been able to earn incredible returns, say in the venture markets or the early-stage markets, because they pick some narrow, whether it's counter positioning, like you mentioned, with dollar general or some extremely specific use case to just be able to do it better than the big incumbents can. And that was often a road to riches that you could attack these big sleepy or slower-moving giants. But it seems like today the giants are more than ever enabled by all the same things that make younger companies successful in the past. So, because I know you do some private investing and look at younger companies, earlier stage companies. What's your view on that landscape? Is the prognosis that it's going to be harder for new companies than it was in the past to compete against incumbent big public companies because those public companies now have so embraced these changes?

Zack: [00:44:20] I think what was most appropriate to think about here is that you can't run in every race at the same time. I think the reality is that narrow and focused businesses will still be able to compete. I think there are certain subsets of the market where mental models or heuristics that we find to be more attractive given those dynamics on the one side of things, businesses that provide some sort of social signals, it's a niche brand that's hyper relevant and hyper-focused. I think that part of the challenge or the aspirations to become the "Next Amazon," but the reality is that you can have a very, very strong economic outcome without becoming a restaurant concept with 10,000 stores. There's a way that you can have a 100 really profitable, highly productive restaurants and be a better business than in 1000 restaurants system that requires constant maintenance CAPEX and massive brand spend. I think on the other hand, businesses that empower are going to continue to be successful. I think that that's why the franchise model is so powerful. The reality that if you build a business once and it's profitable and the unit economics work, but I also think on the other hand, it's important to consider that some of these businesses that are considered to be sleepy or less disruptive are now themselves becoming the disruptors. We joke about Walmart in that if they were to change the way that they talk about their business to GMV and to daily active or monthly active users, it would probably be treated as a different industry. The way in which businesses tell their story and the narrative that they create helps to become and scale up over time. I think that the competition that is facing them is cognizant of them, but small and focused, as you said, still has the ability to win. There's a reason that a business like Sweetgreen has started from a small concept by three Georgetown grads to a real business today. There's the public markets are becoming increasingly receptive to younger and more speculative businesses and there is a reflexive nature and going public and getting your name out there. I think that the art of storytelling is just as important today as it's ever been in helping you to get up that curve of consumer adoption.

Patrick: [00:46:39] You mentioned reflexivity, and this is a food question again around reflexivity. Say what your reaction was to watching burger replacement companies Beyond Meat, Impossible Foods, these sorts of businesses that I've sort of watched with amazement with no exposure to any of them, but just talk me through as someone from the food background, what it's been like to watch those companies and what you think the future might hold, not just for those businesses, but for that sort of trend generally speaking.

Zack: [00:47:03] It's amazing how receptive the public markets have been to a company like a Beyond Meat. I think it has close to a $10 billion valuation today. The reality is that American consumers are more cognizant of what they're putting in their bodies than they have been in the past. But on the other hand, the reality is that McDonald's has something like 13,000 stores in the U.S. that do two and a half million dollars in volumes per store. So there's certainly a dichotomy between the types of consumers that are thinking about how they're consuming. But I think alternative protein is something that's important. The reality is that the reason that a company like Beyond Meat got so much attention is because it's different and to speak to the reflexivity that you alluded to, it is interesting how fundamentals are impacted by market performance and that coming public at $20 a share, quintupling over the course of a month receives a lot of media attention. That media attention leads to more consumer awareness. More consumer awareness leads to consumer trial and you've almost had the ability to lower your acquisition costs by free media that came from a reaction to the stock price.

Many times the markets are right. I think that when things don't make sense, it makes sense to question why they're not immediately apparent to you. And I think that if you consider the protein industry in the U.S. and the size and scope of it, it's not unrealistic to think that you can carve out a small, but increasing portion of it that is "plant-based." And there are a lot of other businesses like a Modern Meadows that are doing things that are completely innovative, have the same biological makeup of a animal-based product that are going to be grown in a lab. I think if you kind of think to the future implications of that, look, something like ground meat that could be grown in a lab at the cost of which we can deliver it today, will be competitive. The reality is that we can produce ground beef today, something like 25 cents a pound and do it very profitably. And I think that inherently, it's going to be very difficult to compete with something that's so different on the cost curve, but there's certainly a subset of a market for it and as these companies become increasingly sizable, they're going to be able to compete. Now, the core question, right, is what do the large consumer packaged goods businesses like the Tysons and the General Mills of the world do to compete with these businesses and push back and regain their market share? They have the size and the scope to spend and unfortunately, so much of CPG retail is the ability to spend, to get your product in front of the consumer. Now they have to like it, but at the end of the day, that competitive advantage of incumbents is probably not going away.

Underappreciated Trends in the Food Industry

Patrick: [00:49:49] What are the wildest or interesting and maybe underappreciated trends in the world of food right now, whether in public or private markets that we haven't talked about yet?

Zack: [00:49:59] So I think there are a couple of things. I think on the more novel ingredients side, you have things like mushrooms and probiotics and prebiotics and alternative novel ingredients that people are going to experiment with. But on the other hand, I think that you have a very interesting social debate around why we can produce food so cheaply in this country yet so many people still go hungry? It's not due to the lack of production. I mean, as I had alluded to earlier, we can produce table eggs and chicken and beef and pork, at literally pennies on the dollar. Really, what it comes down to is distribution, how are we getting food to the places that it needs to be for the people that need it? And I think that e-commerce and e-grocery, as an example, are going to be very important applications of that because so much of the value chain today is captured by the landlords in the real estate. And so if you consider that over time, we can have more efficient operations and less waste, that food then could be reoriented and redistributed towards areas of the economy that need the help and the support. I think that if you consider kind of the ESG implications of the food ecosystem, a lot of it will be focused on the sustainability of production, packaging, and distribution. I think that there are a lot of promising developments there, and hopefully it will help to stem some of those problems.

Patrick: [00:51:22] What have you seen outside of the U.S. that's worthy of note? I always like looking to either different stage businesses, maybe public markets looking the early stage to see what's coming or internationally at other countries or other regions to see maybe things that are happening sooner or earlier there than they are here. Any lessons to share on the food vertical outside of the U.S.?

Zack: [00:51:42] Yeah, what's really interesting is the way that the supermarket landscape has evolved there versus here. They're probably two brands that you may not be intimately familiar with, but one is Aldi and the other is Lidl. Both have started to make inroads into the U.S. There are a lot more similar to a Trader Joe's type of business where 90% of what's in the store is private label. And what's amazing about private label food is that you can offer to your consumers at a lower cost, but get a higher margin for it. The reason is you're essentially dis-intermediating part of the value chain. The best example would be kind of a Costco in the U.S. is Kirkland brand is probably one of the largest independent brands in the U.S. but it's owned by Costco. These are grocery stores that lead with private label, as opposed to branded food. For whatever reason in Europe, the adoption of these types of business models have been a lot quicker than they are in the U.S. But both those businesses are making an effort to come here. I think the other thing is I always think it's interesting to look towards China as a roadmap for some of the technological and consumer-facing trends that may start to come into the U.S. In China they have their super apps, but I also think on the micro fulfillment center model, they're doing something really interesting over there where rather than having these gargantuan 100,000 square foot stores like a Walmart supercenter, they've got tiny little stores located throughout cities that are effectively micro FCs. One of them is called Miss Fresh, which is a business in China where the reason that grocery is such a low margin category is because of the labor intensity, the capital intensity, the competition and the real estate costs. Now, the only way that you can offset some of that is by increasing your inventory returns and having less SKUs. So if you can find a very small site that's not attractive for a prototypical retailer, and you can use it to fulfill local and regional delivery orders with super high velocity, maybe you have a 1000 SKUs. You have this really interesting economic model that frankly hasn't really been tried yet in the U.S. And I think there's a businesses like goPuff are starting to make inroads into that market. And it's going to be really interesting to see how that plays out in an environment in the US where historically real estate costs have been significantly more than those abroad.

Patrick: [00:54:04] Say a bit more at we've touched on it, obviously at various points here in terms of how COVID is affecting trends in the food world, but just go as deep as you can on that. What do you think is something very specific to this acute period of COVID, which hopefully is close to an end here with the vaccine results being so positive and what is just pure lasting impact that we will not turn back from. We won't revert back to how things were before COVID. Can you separate those two categories as you see them temporary versus permanent change as a result of COVID?

Zack: [00:54:34] There's the belief that much of the way that we consume food and where we get it will return to normalcy over time. I think that the reality is that we've historically been massively over-stored on restaurant counts. I don't know that that's necessarily going to change. I think that the reality is that restaurant tours know that they're not always in it for the money and they enjoy it. There's certainly things that we're going to need to do to change the industry. But the reality is that Americans like to eat out and I think we're going to continue to do so. But what I think that COVID has done is it's forced restaurant owners to realize that they need to figure out other ways to monetize their store base, whether that's through delivery or order ahead, or a subscription product or dynamic pricing like the former guests has mentioned on your show. But I think that restaurants are likely going to return and return with strength. I think e-grocery is something that's not going away. The reality is that we have a highly consolidated, very deep-pocketed grocery retail environment in the U.S. Kroger, Walmart, Costco, Amazon, Albertsons, then the long tail of retail competition, they're going to have to embrace technology. If you think about how e-commerce has evolved in the world of online retail, I think something like 60% of online commerce searches today are started on Amazon. And the question is going to be, when you go to do your local grocery shopping, where are you going to start your search? Is it going to be at walmart.com is it could be on Kroger? Is it going to be an app? So I think that that is going to be super dynamic.

I think that food delivery is not going away. I think that if anything, we've proven that the unit economics in many use cases can and will work, which has been questionable prior to this point. But I also think that on the CPG side of things, we went from an environment where CPG companies, so large consumer packaged good companies could count on 2% inflation, 2% GDP growth, a little bit of pricing power. So they were able to count on a 4 to 6%, top-line growth with really healthy margins. I mean, the operating margins of best-in-class CPG businesses were in the high teens, low 20s that changed over the course of the last five years as companies started to face competition from upstart brands. But the reality is that the scale advantages and the distribution that large CPGs have through the grocery channel is very difficult to compete with. And so I think the way that this plays out is that Gavin Baker had a fantastic post on the inherent advantages that incumbents have in an online world. I don't think that that problem is any different in the case of CPG. I think that the reality is that when it comes to auction costs for advertising, the Procter and Gamble and Kraft Heinz of the worlds are going to win. And the reality is you're not going to go to the third, the fourth, the fifth page on the Kroger app or the Amazon website in order to find what you're looking for. So I think that we're going to see a shift back as we have to some of these incumbent brands who are going to flex the dollar power they have to invest behind their brands and are likely going to be around for a lot longer than I think people in metropolitan areas tend to think.

Patrick: [00:57:43] What other stores have you covered and thought about that you find extremely outside of food, outside of the ones that we've talked about, which Walmart sometimes have food and tons of other stuff? I just love this concept of the store as the software that you build and iterate and perfect, and then multiply. It's just such an appealing way to think about this. Are there other stores that you find specifically fascinating? What do you find fascinating about them and what might be implied about what they've done to other kinds of businesses?

Zack: [00:58:16] I mean, I think if you consider that the turnaround of something like a Best Buy for instance, and obviously a large, very well-run public company, there was this irrational fear throughout the 2000s that they were going to be replaced by the likes of Amazon. And they had something called showrooming. It was the concept that you would walk into the store and because of the price transparency available via the internet, you would look up that 50 inch TV and you would purchase it online for cheaper. Best Buy realized this and they decided that they would start to match prices. There was this inherent creative disruption in their store where they realized we no longer can compete on price. So what we need to do is compete on convenience, compete on service. They offer the geek squad. There's something I like to refer to as moving up the value chain, where a store like a retailer historically has competed on the quality of the goods and the merchandise within that store, but there are value-added services that you can add. And Home Depot is no different. They shifted their focus from the do it yourself-er to the professional. A business like Target, who decided that they would need to reinvest billions of dollars into their store experience to offer as comprehensive and omni-channel approach as possible. So when you can layer on services and insurance and buy now pay later type applications, there's just so many other ways that you can monetize the customer that haven't been trialed in the past because incumbent businesses have become sleepy. And I think we're just in a competitive environment now where that's just no longer the case and these incredible retailers that are focused on maintaining the returns on capital that they enjoy are going to continue to innovate and find higher-margin service revenue that they can help innovate and find higher-margin service revenue that can help differentiate them from the everything store that is the internet.

Patrick: [01:00:08] What food store or restaurant that you've been to physically, are you the most interested in or impressed by?

Zack: [01:00:15] I mean Chipotle was a pioneer. Chipotle with their assembly-line approach, it's almost militaristic in nature. The reality is that Chipotle gives you the best value for your buck relative to any other store, and they do it at the best margin profile possible, which is amazing. Even before people were focused on food delivery and to go, which has become one of the most important aspects of any successful restaurant business, Chipotle had their second facility in the Back of The House, they had it so if you ordered ahead, or if you had a catering order, they could be producing whatever it was in the front of house at twice the capacity. So if you recall back into 2015, when the lines for Chipotle were around the corner at lunchtime in Midtown Manhattan, they were not only generating those orders that people had at the counter but also twice that in the back of house. So if you consider the natural operating leverage you get on just increasing that square foot productivity, you're going to be positioned very well to have super, super high returns on capital. It's interesting. There's been this pervasive trend in restaurants to franchise your stores. Most of the major US quick-service restaurant concepts are 90 to 95% franchise. The reason that you can not do that, you can maintain the operational control of your business, is because the unit economics you enjoy are so strong that it wouldn't make sense to outsource them because you want to capture those economics for yourself. Chipotle is an incredible restaurant. Ironically was owned by McDonald's until back in the day. They probably wished they held on to that one today.

Understanding Franchising Unit Economics

Patrick: [01:01:47] Maybe say a bit about the world of franchising. I don't think I've ever asked anybody in detail to describe. I'm going to ask the question from the perspective of the would be store owner. So if I wanted to invest as a person into a Domino's or a chain of them, or a McDonald's or a Wendy's or a Chipotle or whatever, talk me through my deliberation. If you were doing this, if you had a few million dollars, let's say to invest, and you wanted to go start doing this yourself, how would you approach the problem? What things would matter to you if you're thinking about each of these stores as a sort of product to you as an investor, walk us through that world, because I don't think I've ever explored that before.

Zack: [01:02:23] So ultimately with any franchise, the unit economics are going to be the most important. I know that that seems obvious, but I think that some people fail to recognize that different businesses have different return profiles and different brands and logos have higher and better returns. We spoke to Domino's, it's one of the best. What you want to know fundamentally is if I go and build a store, how much is it going to cost me to build that store and how much can I likely expect for that store to generate in cash every year. Really it comes down to the payback period, like any private investor. Some of them have really low costs and super low paybacks in terms of the time it takes to get your money back. Some of them have super high costs and longer payback periods, but the quantum of that payback is higher, given the upfront investment. At the end of the day, you want to have four wall margins that are really strong. We talked a little bit about the four-wall margins of something like a Domino's. A typical food store has best in class is above 20%, something like Chipotle. So you want to know that when you open that store, that it's going to have a sustainable high margin structure, and that you're going to get a strong return on your investment. Now, the way that the franchisee and the franchisor work together is that the franchisee pays the franchisor, call it 4% to 6% off of their top-line sales. So that restaurant-level margin I just talked about is going to be automatically reduced by the cost of that royalty. Then the question is how many stores can I likely own and operate over time?

As we talked about the Domino's example, the average Domino's franchisee has seven stores and does a million dollars in EBITDA. That's probably a 5 to $6 million business that they control. So it's a really, really interesting economic opportunity. Some of the most institutionalized franchisees, the people that operate and own the restaurants, they can have a couple hundred stores. So it's a really, really big economic opportunity for them. There comes down to the question of if you want to own the real estate or not, which is important. If you own your real estate, it's more expensive. You can engage in something like a sale lease back where you buy the ground, build the structure and lease it back to a real estate investor and take the cash proceeds from that business and re-invest it. But at the end of the day, what's most important is that you're investing behind a healthy brand as growth prospects, and that's because as the system grows, more money is contributed to the advertising pool and that advertising spend is shared across the entire system. So that's why you see these massively scaled quick-service restaurants that tend to have a loudest voice. And I think that drives traffic to your store and it becomes this feedback loop of success, where your store is doing more traffic, more profitable. You have more funds to open up more stores. Those unit economics that we spoke to, you continue to enjoy. But if you're investing behind a system that's decelerating, it's almost the opposite effect, as we spoke to about Papa John's. They went through a really rocky time where their founder made some comments that hurt the performance of the business and the franchisees suffered. So, you live and die with the strength of your brand.

Patrick: [01:05:30] Let's go at it from the other angle, which is if I wanted to partner with you and introduce an entirely new store concept. You mentioned a name earlier that I hadn't really heard of, which is Wingstop. The frame that you referenced it in was maybe it was the only one that was better than Domino's. So if you were thinking about, maybe we can use Wingstop as an example, but if you were thinking about creating a new QSR concept, what sorts of things would you think about as key aspects of differentiation versus what's already available?

Zack: [01:05:58] I think that at the end of the day for new concepts, you have to be culturally relevant. So I think there are certain areas of the food and agriculture ecosystem today, whether it be locally sourced or better for you, that are super powerful. You want to have very rich, gross margins that afford you the opportunity to invest in the store itself and the customer experience. And you also want to have an embrace of digital adoption and technology. The reason that these ghost kitchen concepts are so interesting is because hypothetically if you can lower your cost of rent and the cost associated with the front of house, but also take that money and invest it behind a better product, so for instance, give your customers more food or use higher quality ingredients, the value proposition of something like that is incredibly strong. So I think that what we're going to see with some of these new concepts is experimentation, whereas historically, the store itself has served as a billboard for the company. But if you can acquire customers online in an inorganic fashion, through online social media channels or digital apps, and drive trial of your products without having to front the cost of rent and the capital associated with a store build-out, I think that's something that's very interesting. And then I think, look, the reality is that in the United States, there's such a long tail of cuisine it's already available so the likelihood of picking a concept that doesn't already exist would be difficult, but I think certainly we're seeing more and more ethnic and flavorful concepts be trialed. And yet you look at something like Cholula, for instance, not that it's directly attributable to a restaurant, but that business was bought by a private equity investor for $200 million two years ago, and was sold to McCormick, the spice manufacturer and distributor, for 800 million just last month. So the reality is that trends like that are going to continue to take hold, and that's the type of opportunity that we would evaluate on the restaurant side.

Patrick: [01:07:59] In closing, Zack, what are you most interested in today that you still don't know much about? Another way of asking the question. And this can be in food or outside of food. I know obviously, we spent time on food, but I think you're interested in all businesses. What are those frontiers for you personally?

Zack: [01:08:14] I think the most interesting question is ultimately that classic red queen problem. It's the reality that there's newer and newer disruptive technology, but the question being does that mean that these legacy businesses and these disruptive forces are going to have impacts on profit pools that are durable, or are we just going to be running in place implementing new technology, but the incremental return on investment from that new technology doesn't yield anything to the ultimate end user? And I think that there is a number of questions in both food and non-food related industries where it's relevant. And I think that as an investor, it's tough to understand whether it's worth, for instance, automating an entire factory, or if the gains from that automation are just going to go to the consumer, which is great as a consumer, but not necessarily as compelling for an investor. So I consider that problem throughout the ecosystem of B2B businesses, B2C businesses and the businesses that we invest in, because I think that as we alluded to earlier, software is eating the world and automated technologies are derivative of that. And I just question whether that's going to create or destroy profit pools and who's going to benefit from it. And I think that's really interesting. I think as an extension of that, the reality is that billions of people have super computers in their pockets today, which means that we know more about our customers than we ever have before. How are businesses going to leverage the power of that information to customize solutions for their customers in a way that was not possible in the past? That visibility into the customer allows us to segment them in ways that we historically haven't been able to, and whether that's in food delivery or grocery or insurance or entertainment, the reality is that we now have the ability to see our customers in a way that hasn't been transparent in the past. And I think that's going to have profound implications in the competitive landscape for all businesses.

The reality is that billions of people have super computers in their pockets today, which means that we know more about our customers than we ever have before. How are businesses going to leverage the power of that information to customize solutions for their customers in a way that was not possible in the past?

Patrick: [01:10:12] I absolutely love that as a closing thought for a couple of final questions here. I know that now you're working at Continental Grain and you have a very interesting, unique and specific perch, which I think is what allows you to have all this insight into one specific vertical. As you look at it more broadly, because you came from the more traditional hedge fund world prior to Continental Grain, any thoughts on the changes in the dynamics of that competitive sphere? We know now that the major platform hedge funds that manage crazy amounts of money with incredibly smart portfolio managers and insane access to data and information, and it makes you think like, God, markets must be becoming more and more efficient. Do you think that's true? And any other closing thoughts on just the competitive landscape itself in public equities?

Zack: [01:10:57] Yeah, I mean, it's a fascinating concept. I think what we saw over time, we all, as equity analysts, fashion ourselves to be very strong business analysts, but ultimately if you consider the competition, the fragmentation, the competitive advantages of a "hedge fund", they're not necessarily great businesses. There's this inherent asset-liability mismatch between you as the investor that wants to take a long-term approach to the market and your LPs that in many cases require short-term lock-ups on their capital sometimes that are as short as three months in time. And I think what that's created is an implicit advantage for those that have capital that's permanent or semi-permanent in nature and their ability to take a longer view. I think that the reality is that the markets are largely efficient. If you're trying to compete with multi-multi billion-dollar asset managers for the next incremental data point, it's going to prove very difficult. But I think that the reality is that lots of people are coming around to the fact that crossover funds have an inherent competitive advantage, and they likely do. And that's because of the spillover between public and private assets. And if you consider the insights you get from your private assets and how they can inform the strategy of a public investor, and if you consider the conversations that we have with public company management teams and what they're seeing, the value is not so much created in the ability to analyze a business better than other investors, but it's really taking that active approach to the market, whether it be public or private, and connecting the dots. And I think at Continental Grain, where we try to focus our time and energy is we have the ability to invest throughout the life cycle of businesses, whether that be Series A gross stage opportunities or late-stage public companies. While their competitive landscape is inherently very different, the way that we can add value as investors is not only in identifying those defensible businesses that have higher rates of return that can redeploy capital, but in connecting the dots between them and making those introductions. So I think that having a hybrid model where you're both operating and investing and sharing within that ecosystem is something that compounds knowledge, but also compounds your competitive advantage as an investor. So the combination of a flexible capital base and industry-specific expertise is something that I think puts us in a very advantageous position. And I think that it's much harder for a prototypical asset manager to compete directly with something like that.

Patrick: [01:13:39] Well Zack, this has been so much fun. You've become my go-to person for asking questions about any of the topics that we've covered today. Lots of fun to do it with you here on the record and continue to learn. I think you know my traditional closing question for everybody, which is to ask for the kindest thing that anyone's ever done for you.

Zack: [01:13:55] It's clearly the sacrifices that my parents had made to get me the opportunity to do what I do today. My father has been working at the same hospital for four years. Working in investments is sometimes humbling, but really it's a privilege. I get the opportunity to learn every day. And that's because of the sacrifices that my mother and father have made. The reality is my father as a physician is saving lives and I'm allocating capital, and I'm forever grateful for what he does and continues to do at the ripe old age of 70, as I sit here and listen to management teams and re-filings for a living.

Patrick: [01:14:30] Fantastic stuff. The basics are always the best. I really appreciate that answer. Appreciate all the time. Thanks for doing this with me.

Zack: [01:14:36] Thanks a lot, Patrick.