Transcript edited for length and clarity
Brian Kenny: The hamburger. It's as American as apple pie, which means that it's actually European. Both foods trace their origins to Europe and were likely brought here by early colonists or later waves of immigrants. So, the hamburger may not have been invented in the US, but it was certainly perfected and popularized here, in large part due to the arrival of fast food restaurants. White Castle opened its first restaurant in Wichita, Kansas in 1921, selling hamburgers for five cents. They set the standard for fast food production that McDonald's and others adopted 30 years later.
In the decades since, the industry and its practices have evolved exponentially. Competition is fierce and margins razor thin--except for one player. Today we'll hear from Professor Gary Pisano about his case entitled Pal's Sudden Service--Scaling an Organizational Model to Drive Growth. I'm your host, Brian Kenny, and you're listening to Cold Call. Gary Pisano's teaching and research focus on strategy, innovation management, and manufacturing, among other things. He also advises CEOs at leading companies around the world, and he probably likes hamburgers as well. Gary thanks for joining us today.Gary Pisano: Thank you. I do like hamburgers.
Kenny: Did you eat some Pal's hamburgers in the making of this case?
Pisano: I did. I have to say I'm not a person who eats a lot of meat. I don't eat fast food. So, when I went down there they asked me to sample some of the food, and I happily did, and I was pleasantly surprised. It was actually quite good.
Kenny: Being from the northeast, Pal's isn't a chain that I'm familiar with. I think a lot of people might be hearing about them for the first time, but clearly a lot of people have enjoyed their for food over the years and they've done very, very well. How does the case begin? Who is the protagonist and what's on his mind?
Pisano: The case protagonist is their CEO, Thom Crosby, and it begins with Thom trying to think about the future path for this organization and particularly how much to grow. They have 28 stores. All but two are drive-through. They've been quite successful and now have the capital to expand much more if they'd like. They’ve had a slow-growth strategy, so they haven't grown for the sake of it. They grow when they've felt they've been operationally ready to grow. They're privately owned. That's why they could do that. So, there's very deliberate growth strategy, about one to two new outlets per year. The case begins where he's thinking, is it time to accelerate the growth to go up to between 25 and 50 new stores over the next five to ten years?
Kenny: How did you hear about them?
Pisano: I was working on a research study with a couple of collaborators here at HBS and elsewhere, and we had been doing research on the effect of teaching on your own performance: If you teach people to do things does it help you do better?
"If you were to do a standard strategy analysis of the QSR industry you would quickly come to the conclusion this is a terrible business to be in"I believe it was Brad who came across an interview with Thom Crosby, and a key part of what Thom talked about was their model at Pal's, where leaders are expected to teach, and so we said, “Aha.” This might be an opportunity to examine what we've studied by and large in lab settings, and understand how this “leaders as teacher” model plays out in reality. We contacted Thom and he was very open to us writing a case, and we learned … there's more to Pal's than just the leaders as teachers.
Kenny: Where do they sit in the landscape of quick service restaurants, that sector, and how it shapes up?
Pisano: Well, it's quite competitive as you know. If you were to do a standard strategy analysis of the QSR industry you would quickly come to the conclusion this is a terrible business to be in because its rivalry is intense. Barriers to entry are quite low, particularly now--think about new formats like food trucks. So, if you've got $20,000 you can kind of get into that business in some fashion. [Consumers have] easy substitutes. You don't have to eat fast food, you could pick up things at the grocery store. There's lots of other convenient ways to eat and very often if you're talking about suppliers, these big food suppliers have a lot of bargaining power, and the customers are very price sensitive.
Put all this together in a kind of standard, traditional competitive strategy analysis and you conclude this has got to be a terrible business. Particularly for a smaller player like Pal's. Maybe I can understand how McDonald's gets some scale, but how does a Pal's do so well? So that I found intriguing, as one who also teaches operations about how they use their whole operating system as a way to gain advantage and create considerable value and capture value in a sector where, in essence, the environment is quite hostile from a competitive point of view.Kenny: How did Pal's evolve?
Pisano: Their first store was [was in the mid-1950s] and I think they were inspired by (McDonald’s founder) Ray Kroc. But you know, the difference was they had two stores for the first 20 years--it was really a local drive-thru restaurant. When Thom became CEO, I guess about 15, 18 years ago, it was slow. It continued to grow but again we're talking one to two stores (per year). So, they're up to 28. Put that in perspective; I think McDonald's has 35 thousand globally... So, you talk about the difference here and the scaling and the scalability.
Kenny: I think the case points out that between stores number three and four at Pal's there was ... a 20-year hiatus.
Pisano: Almost all the growth has occurred in the last 20 years, and again we're still talking about a fairly small player and that's what raises the kind of salient issue in the case which is, can they continue to take it to the next level? They've created something pretty special there. They're doing well financially. They've got a unique HR system and unique operating system. The whole question for the students to grapple with is, does it scale?
Kenny: And they've got a really unique approach to managing each individual store. Can you talk about the owner-operator model?
Pisano: A few things they do differently, and I think one is the owner-operator model. The vast majority of quick-serve restaurants are franchised and the way franchised works is you sell a right to use the brand and you sell the “know how,” the intellectual property if you will, the processes, but to an independent investor who appoints their own management and they have to follow the rules. That's the way traditional franchising works. The advantage of franchising is you don't put out the capital. That's how you grow quickly. Pal's doesn't franchise. They are owned, all of their own stores. They put in charge of each store somebody they call an owner-operator.
Now, the owner-operator doesn't really own the store. They're employees, but the way they empower the owner-operator and the way they compensate them, it's as if they own that store… They look for and recruit these people, somebody who could be the CEO of their own business. And so the owner-operators are completely responsible for their store operations. Other than setting the menu and setting prices, they determine staffing, they determine how the place operates. They determine even, I think, the wages they pay. The compensation model is unique, After deducting for some kind of corporate charges and some required investment, the profit is theirs to keep. So, they don't have a salary. When they first start they get some guaranteed minimum salary but after after a couple of years it's basically that their salary is the profit of the business.Kenny: Works out pretty well for them?
"A Pal's owner-operator makes between two point five and ten times the industry average"
Pisano: Works out pretty well. A Pal's owner-operator makes between two point five and ten times the industry average for a QSR store manager.
Kenny: I saw that and thought, gee, maybe I should become an owner-operator. But then I saw the interview process that they put the owner-operators through. Can you talk about how rigorous that is?
Pisano: They go through an incredibly rigorous process. Thom interviews each one of these people multiple times. I think he said the minimum was 12. And the maximum was 22. He requires them to read books. He doesn't tell them to read the book. He leaves the book on his desk and he waits to see if they pick it up. If they don't pick it up or don't notice it, they aren’t invited back. He wants curious. He takes the whole idea of the learning organization incredibly seriously. Everybody talks about the learning organization but I have to say, 80 percent of the time, that's lip service.
This is not lip service. He wants these people to be engaged and he's really looking for their attitude as well as their aptitude. They follow a similarly rigorous process when they recruit new people into what they call their Leadership Development Program. These people go through an extremely extensive interview process. They meet all the other owner-operators. Again, to see that they are a good cultural fit for the organization. They select incredibly carefully.Kenny: The process seems to work when you talk about the longevity of the owner-operators. They don't leave. That's a career choice.
Pisano: Very low turnover, and again this is an industry which has high turnover at all levels. They have low turnover even at the staff level relative to the industry, but also extremely low at the owner-operator level. These are very coveted positions. We met some of the people going into their Leadership Development Program. They were all college graduates. One woman had been in the Navy, was trained in nuclear engineering. They called this their golden opportunity program. They see this as an opportunity to become entrepreneurs, to be in their own business, but as part of this broader organization…
Kenny: Certainly counter to all of the impressions that you might have of working in a QSR restaurant, they treat their employees really well, but it's not easy.
Pisano: I think they have created a very attractive environment that fits into the broader system, the culture there. I think the key to their system and why they do well is, well, if you kind of break it down, how are they profitable? Volume is everything in this business. You've got to be able to get people through quickly. This is a fixed-cost business. Pal's is not going to do better on the variable cost in terms of buying their food less expensively. Where they're going to do better is being able to get high revenue per square foot and get people in and out. This is particularly important because meal time only comes at certain times of the day. So, if there's a long line, it’s not like they are going to come back later. It’s called quick serve, right? They’re going to leave.
Pal's has worked really hard at designing a system which gets you in and out really fast and they track religiously the cycle time of the cars coming in and out. They call it Wheels Stop to Wheels Start. If you think about it, it's strictly drive-thru by and large. All but two of the stores are just drive-thru. From the time the wheels of a car stop to the time they start they want that to be almost like an assembly line. Every 18 seconds. That's what they're shooting for, regardless of the order. They've designed everything to be really fast. But a key part of that is having extremely high quality, because errors slow you down. That's particularly problematic in a layout where you have a single file of cars. If one order is held up or you got somebody's order wrong, that just causes the queue to back up. That’s why they're so obsessive about the quality, and the case points out that they have one error every 3,600 orders. That, the average for the fast food industry is one every 15 orders. So, that shows you how they're doing.Kenny: Amazing.
Pisano: They check, but that checking is another two, three seconds and then if it's wrong it's going to add more time. This is that obsession [on] quality. That's easy to talk about but hard to do, and that comes down to a very high degree of process discipline. You get that through culture. This starts with people and it starts with culture.
Kenny: We did a podcast with (HBS Professor) Jan Rivkin about Lego, and we talked about the fact that it took Lego, I don't know, eight years to decide to add a green Lego. Here, it took Pal's three years to decide to add bacon to the menu because any little thing that you put into that process that requires a different set of practices could throw a wrinkle into the whole thing.
Pisano: Absolutely. So, they want to have total control over their processes. They document their processes in detail. There's a spec for everything and again, the spec doesn't just say you put mustard on the bun. It's that you put mustard a quarter inch from the edge of the bun or the amount that a hotdog bun should opened--the right angle so you don't break the hinge. By having a limited menu they have a limited number of processes and they train everybody in every process. Before you're allowed to make French fries you have to be certified, and then re-certified periodically.
"Before you're allowed to make French fries you have to be certified, and then re-certified periodically"
Kenny: I was interested in that. What do they call it? Recalibration?
Pisano: Calibration. You go through a process where you have to demonstrate that you can do the process a hundred percent right. They call it their Triple 100, a hundred right, a hundred percent of the time, at one hundred percent volume. Every several months they recheck you again to make sure you're capable of doing that.
You’ve got to keep the operation simple. One of the ways you keep it simple is you don't add menu items to it too often because you could add processes. There is this dilemma here between how static you keep the menu to keep the operational efficiency up but do you run the risk of becoming stale. Now, that hasn't happened. They seem to have a very loyal customer base but unlike, say, a McDonald's, which does add things quite frequently, they're choosing not to do that. It's a great example of a company with a clear understanding of their strategy and sticking to it and understanding what the trade-offs are and willing to tolerate what those trade-offs are. I think that’s a hallmark of excellent strategy.Kenny: I also found it interesting that, I think it was Thom ... who had the insight that they're not in the food service business. They're in the manufacturing business.
Pisano: That's right. This is a great example where it's a so-called service industry. It would show up on our GDP as service but as Thom points out, look, they take raw materials, they convert it into a finished physical product that people take away and eat. That's manufacturing and they came to that recognition about 20 years ago. Once they did, they began to design and manage all of their processes like they were a factory, and they say that works really well for them.
Kenny: You discussed the case yesterday with some Executive Education students. What's the reaction like?
Pisano: I really enjoy teaching the case and it's a bit of an eye-opener. The general managers, Thom and the owner-operators, they're the heads of HR so they take HR very seriously. And it’s an eye-opener for students to realize what it takes to create such an organization … trying to understand what does that mean in terms of the dilemma of growing? It does make it harder to grow, and this is an organization which, rather than setting an arbitrary growth goal of saying, we need 50 new stores a year and then do whatever it takes to get (there), they kind of work backward and say, what's the key resource here? The key resource is the talent of our people and the leaders. So, what's our capacity to generate new leaders? They open stores when they have a new leader ready.
Kenny: Really excellent insights from an unexpected place, I'd say.
Pisano: Absolutely, but there's a lot of interesting things going on in the food world. I have lots of other food cases that I'm working on that I enjoy doing and I enjoy eating.
Kenny: Gary, thanks so much for joining us.
Pisano: Thank you. This was my pleasure.
Kenny: You can find the Pal's Sudden Service case along with thousands of others in the Harvard Business School case collection at hbr.org. I'm Brian Kenny and you've been listening to Cold Call, the official podcast of Harvard Business School.