Memendu Showry & Indu Perepu. IUP Journal of Organizational Behavior. Volume 20, Issue 4, October 2021.
Introduction
On July 23, 2018, the board of directors of US-based pizza chain Papa John’s International Inc.’s (Papa John’s) adopted the ‘poison pill’ (also known as stockholder rights plan) to prevent the founder, John H Schnatter (Schnatter), from taking over control of the company. Schnatter, who owned a 29% stake in the 34-year-old chain, meanwhile, signaled that he was not going away without a fight. Patricia Glaser, Schnatter’s lawyer, said, “John is not going to go quietly into the night and watch the company he worked so hard to build fall off a cliff. He is going to protect shareholders and the company as much as he can.”
Earlier, on July 19, 2018, Papa John’s became the focus of media attention after an article in Forbes magazine termed the company’s culture as ‘toxic’ and detailed a number of deep-rooted issues involving Schnatter. The board had a tough time maintaining the company’s image after numerous allegations against Schnatter surfaced, relating to racist comments, sexual harassment incidents, inappropriate behavior, and scandalous conduct. The ‘poison pill’ move came as an attempt by the pizza chain to distance itself from Schnatter. Earlier, following some outrageous statements, Schnatter also lost his position as CEO, and later, as chairman of the company.
In July 2018, Forbes reported that Schnatter had cast a racial slur during a conference call. The report mentioned that Schnatter had used the ‘N-word’ and made other offensive comments during the conference call in May 2018. As a result, Schnatter had to step down as chairman. However, he later said that resigning as chairman was ‘a mistake’ and accused the board of failing to investigate the incident. Earlier, on December 21, 2017, Schnatter had to step down as CEO following his controversial statement against the National Football League (NFL) and anthem protests5. In November 2017, blaming the NFL players for the pizza chain’s lagging sales. Schnatter stated that the combination of declining NFL viewership and negative consumer sentiment associated with the league had caused sales to slump. He said, “The NFL has hurt us by not resolving the current debacle (players’ protests during the national anthem) to the players’ and owners’ satisfaction. Leadership starts at the top, and this is an example of poor leadership. NFL leadership has hurt Papa John’s shareholders. This should have been nipped in the bud a year and a half ago.” Reportedly, after his comments went public, the company’s shares fell by as much as 13%.
That fiasco grew worse with the surfacing of more allegations including Schnatter accusing media agency Laundry Service of extortion and litigation threats. The debacle highlighted the dangers of tying a company’s brand to its CEO and also left the company vulnerable to a takeover. In addition to falling sales, the stock price was going down, prompting marketing partners and consultants to break ties with the pizza chain.
To recover from the public-relations snafus, the company attempted to keep Schnatter as far away as possible from the business. Reportedly, the board evicted Schnatter from the company headquarters, asked him to stop making media appearances, and stay away from marketing activities. Although the board was trying to put an end to the entire episode with the poison pill, analysts had a different view. They estimated that not only would sales decline, but employee and franchisee commitment to the brand would also plummet. Chris O’Cull (O’Cull), Stifel analyst, said, “We believe the company is in a precarious position – needing a strategic savior but struggling to find one willing to underwrite a transaction given the brand damage.”
With the company adopting a poison pill and Schnatter gearing up for a fight, it would be interesting to see whether the company would be able to regain its reputation and bounce back or whether things will take a turn for the worse.
Background
Schnatter started his entrepreneurial venture at the very young age of 8, when he founded a grass-cutting company with his younger brother. At 12, he started a gutter-painting startup. At the age of 15, he started working as a dishwasher at Ricky’s Sub Pub, a pizza restaurant in Jeffersonville, Indiana. There, he eventually started making pizzas. That experience inspired him to open a pizza restaurant of his own. After completing his studies, Schnatter started managing his father’s pub, Mick’s Lounge, which was running at a loss. Schnatter did not like the bar business but loved running the business. Finally, in 1984, he started selling pizzas out of the back of the bar. In 1985, the first Papa John’s restaurant was opened in Jeffersonville. In 1986, Papa John’s sold its first franchise. In 1991, the pizza chain opened its 100th restaurant in Clarksville, Tennessee. The firm went public in 1993 and was listed as “PZZA” on NASDAQ. It focused on quality and hence ranked high in customer satisfaction among national pizza chains (Refer to Exhibit I for core values of Papa John’s). In 1995, it was ranked 10th on Forbes’ list of the nation’s 200 best small companies. In 2001, Papa John’s became the first national pizza company to offer online ordering. After that, the company’s sales grew exponentially with online sales growing by more than 50% each year on an average. In 2008, Papa John’s hit the $1bn mark in e-commerce sales, becoming the first company to achieve cumulative online sales of $1bn. In less than two years – by 2010 – it surpassed $2bn in online sales.
In 2010, Papa John’s outpaced two larger rivals, Pizza Hut and Domino’s, to enter into an agreement with the NFL as the official pizza sponsor for the Super Bowl XIV. The three-year agreement through the 2012 season of the NFL and Super Bowl XLV, XLVI, and XLVII was the largest deal in history for Papa John’s. As a sponsor, the pizza chain used NFL logos and trademarks, including the NFL shield logo, in its marketing. In 2012, the revenues of the company witnessed a 10.2% increase and reached $1.3bn compared to $1.2bn in 2011.
By December 2014, Papa John’s restaurants were operating domestically in all 50 states and in 36 countries and territories.
The revenues of the company continued to soar year after year (Refer to Exhibit II for the details of revenue). The shares hit an all-time high of nearly $90 in December 2016. By 2017, Papa John’s had become one of the largest pizza companies in America with 5,199 restaurants in operation, consisting of 743 company-owned and 4,456 franchised restaurants. In March 2017, Schnatter featured on the Forbes’ World’s Billionaires list for the first time.
The Downfall
The company’s pizza was more expensive than those of its competitors. With consumers willing to pay a little more for the company’s slogan, “better ingredients, better pizza.” Papa John’s had long prided itself on maintaining a ‘premium’ position. Year 2017, however, was a challenging one for Papa John’s. The sales of the pizza chain were declining. Experts attributed the fall to the company’s declining pizza quality and the rapid expansion of better-quality pizza chains.
The restaurant chain lost a quarter of its market capitalization owing to quality issues. The third quarter earnings of the company were disappointing. The North American same-store sales, a key measure of the company’s operations, grew at 1.5% for 2017, instead of in the expected 2% to 4% range. Diluted Earnings Per Share (EPS) also fell short of analysts’ expectations. EPS grew by just 3% to 7% against the projected 8% to 12%.xiii In less than 24 hours of the company releasing its third-quarter financial report, the net worth of Schnatter fell by $70mn. The worst damage was caused by Schnatter blaming the NFL players’ protest for the sales drop (Refer to Table 1 for more on National Anthem protest).
On November 1, 2017, in addition to blaming the NFL players and the league leadership, Schnatter also said, “You need to look at exactly how the ratings are going backwards. Last year the ratings for the NFL went backwards because of the elections. This year the ratings are going backwards because of the controversy, and so the controversy is polarizing the customer, polarizing the country.”
The media were quick to criticize Schnatter’s statements. He was widely accused of racism and for making bad quality pizza. David Roth, journalist at Deadspin, said, “Papa John’s pizza tastes like unusually salty upholstery and the way long-distance bus travel feels.” While some people on the right rallied to support Papa John’s, others took the opportunity to roast the chain. White supremacists who came to Schnatter’s defense further stirred the disturbance, Adrian Solfrom The Daily Stormer wrote, “This might be the first time ever in modern history that a major institution is going to be completely destroyed explicitly because of public outrage over their anti-white agenda.”
The chain also faced a backlash from progressives for blaming the players’ protest for lower sales. Other pizza brands also slammed Papa John’s by insulting the quality of the chain’s pizza. According to the other brands, it was the quality and not NFL players that was to be blamed for the sales slump. While Pizza Hut said it did not see any impact of the protest on business, DiGiorno Pizza took a dig at Papa John’s tweeting “Better Pizza. Better Sales”.
Papa John’s was quick to dissociate itself from the white supremacists and condemned the website’s endorsement. Peter Collins, senior director of public relations at Papa John’s, said, “We condemn racism in all forms and any and all hate groups that support it. We do not want these individuals or groups to buy our pizza.”
Market experts, however, opined that the controversy was unlikely to inflict any longlasting damage on the company’s corporate image or even profits. Lakshman Krishnamurthi, a marketing professor at Northwestern University’s Kellogg School of Management, asserted, “People get upset and the outrage lasts for a week. These kinds of things blow over”.
Damage Control Moves
The sales and the stock price of Papa John’s which were at an all time high in December 2016, reportedly fell nearly 13% after Schnatter’s comments. Finding itself mired in controversy, Papa John’s had to apologize for the comments made by Schnatter blaming sluggish pizza sales on the NFL players’ protest. On November 15, 2017, the company tweeted a statement which read, “The statements made on our earnings call were describing the factors that impact our business and we sincerely apologize to anyone that thought they were divisive. That definitely was not our intention. We believe in the right to protest inequality and support the players’ movement to create a new platform for change. We also believe, as Americans, we should honor our anthem. There is a way to do both. We will work with the players and league to find a positive way forward. Open to ideas from all. Except neo-Nazis.”
On December 21, 2017, Schnatter stepped down as CEO of Papa John’s. The company announced that Schnatter in addition to retaining his role as chairman would also ‘pursue his personal passion for entrepreneurship, leadership development and education’ but did not provide a reason for his departure from the post Schnatter was replaced by Steve Ritchie (Ritchie), chief operating officer, on January 1, 2018.
In February 2018, Papa John’s severed ties with the NFL. The pizza chain and the NFL mutually agreed to terminate their sponsorship deal. Ritchie, the new CEO of Papa John’s, said, “While the NFL remains an important channel for us we have determined that there are better ways to reach and activate this audience. Thus we will shift our marketing for the broader NFL sponsorship to focus on our partnership with 22 specific NFL teams, a significant presence on league broadcast and digital platforms and on our relationships with many of the league’s most popular players and personalities.”
The NFL incident forced Schnatter to lie low, and Papa John’s toned down his prominence in advertisements. However, that change did not sit well with Schnatter. He personally hired a marketing agency to create ads featuring him that would air in key markets. According to sources, Fallon, a Minneapolis-based agency, was hired in mid-June to handle brand campaigns.
More Problems
On July 11,2018, Forbes reported that Schnatter had used the ‘N-word’ during a conference call in May. The conference call, which was arranged between Papa John’s executives and its media agency Laundry Service, was designed to be a role-playing exercise and was intended to help ensure that Schnatter would not make incendiary remarks and cause public relations flare-ups in the future. Schnatter, however, made snafus with his statement. Asked how he would distance himself from racist groups online, he said, “Colonel Sanders called blacks n-s.” Schnatter allegedly complained that Sanders (Colonel Harland Sanders, founder of Kentucky Fried Chicken) had never faced a public backlash for using the n-word. The news of the call came to light as Forbes magazine was conducting an investigation of the culture at Papa John’s. The day the news broke, the shares of Papa John’s fell by as much as 5.9%, erasing $96.2mn in its market value. Subsequently, Laundry Service parted ways with the company.
On July 12, 2018, PR agency Olson Engage too dropped Papa John’s as a client. In a statement, Olson Engage said, “We were hired to help their brand, franchisees and employees recover from recent controversies and connect with consumers in new and exciting ways. On the consumer front, we did precisely that through several programs that delivered very positive results. But we had significant recurring differences with their founder regarding the best way to address the controversies and restore and advance the brand’s corporate reputation for the good of their workforce and franchisees.”
Following the Forbes report, Schnatter admitted having used the N-word and apologized for it. He subsequently resigned as board chairman. Schnatter said, “News reports attributing the use of inappropriate and hurtful language to me during a media training session regarding race are true. Regardless of the context, I apologize. Simply stated, racism has no place in our society.” The very next day, the shares of the company soared 11%.
After Schnatter resigned, Ritchie posted an open letter asserting, “Racism and any insensitive language, no matter what the context simply cannot-and will not-be tolerated at any level of our company.” He also promised the company would take steps to rebuild trust from the inside-out. Further, Ritchie stated that the company had plans to retain an independent expert to audit its existing processes and policies surrounding diversity and inclusion and sending its senior management to its restaurants to hold listening sessions with employees.
With external pressure mounting, sports brands began distancing themselves from the pizza chain. The University of Louisville was reportedly evaluating the naming rights for its football stadium, which was known as Papa John’s Cardinal Stadium. Schnatter submitted his resignation as Louisville trustee soon after the N-word story came to light. Baseball teams, The Baltimore Orioles and Miami Marlins, also suspended their respective promotions with Papa John’s.
On July 14, 2018, in an interview with a TV station, Schnatter accused Laundry Service of provoking him into saying the n-word on a media training call in May and trying to blackmail him for $6mn to not reveal the issue, Schnatter asserted, “They tried to extort us and we held firm and they took what I said and ran to Forbes. Forbes printed it and it went viral.”
Laundry Service was quick to strongly deny Schnatter’s claims. In an internal memo to its employees, the media agency urged its staffers to not respond to inquiries from journalists about Papa John’s and Laundry Service, and to refer those contacts to its public relations representative. The memo read, “As you all know, there’s been a lot of coverage about Laundry Service and Wasserman related to the Papa John’s situation in the past several days. The disparaging and outrageous comments about Wasserman and Laundry Service that have been covered are completely false and we have a centralized PR strategy to go on the record and refute them. Until that time we cannot expect the media to know the truth. All matters pertaining to Laundry Service, Cycle, Wasserman and their clients are strictly confidential and should not be disclosed to anyone outside the company.”
In the midst of the controversy, Fallon decided to stop working with the company. Fallon asserted, “The agency was unaware of the incident with its previous agency and learned about it with the rest of the world. During our short time with Papa John’s, Fallon produced limited product-focused advertising that has yet to air. The agency has decided not to pursue additional business with Papa John’s.”
On July 16, 2018, Papa John’s requested Schnatter to “cease all media appearances, and not make any further statements to the media regarding the company, its business or employees.” The company decided to remove Schnatter’s face from its marketing materials. Schnatter appeared on pizza boxes, TV ads, at the center of a logo that usually was all over the company’s website, and in the store’s interiors. After he left, Schnatter was not allowed to use the office space at corporate headquarters in Louisville, KY.
While the company was trying to distance itself from Schnatter, he came up with an allegation against the board of directors. On July 17, 2018, in a letter to Papa John’s board, Schnatter wrote that he had made “a mistake” by stepping down as chairman and accused the board of not investigating the racial scandal. He claimed the board’s decision was based on “rumor and innuendo”. Vowing to fight the company over his ouster, Schnatter hired Los Angeles high-profile trial lawyer Patricia Glaser (Glaser) as his attorney.
In her letter to the board of directors, Glaser argued that the board could not remove him as a director without a shareholder vote. She said, “John is not going to go quietly into the night and watch the company he worked so hard to build fall off a cliff. He is going to protect shareholders and the company as much as he can.”
Toxic Culture Allegations
There seemed to be no end to the controversies dogging Papa John’s even after Schnatter left the company. On July 19, 2018, an investigative article in Forbes reported that Papa John’s suffered from a ‘toxic’ culture. The article stated that the problems at the company extended well beyond the founder’s PR crisis. Based on interviews with 37 current and former employees of Papa John’s, Forbes accused Schnatter of numerous allegations ranging from spying on his workers to sexually inappropriate conduct. It alleged that Schnatter had recruited employees to spy on their colleagues. He read workers’ emails, according to two sources with knowledge of the episodes, and sometimes conducted business from disposable phones.
Schnatter allegedly also engaged in sexual misconduct that resulted in at least two confidential settlements.
Furthermore, the employees alleged that Schnatter cultivated and sustained a ‘bro’ culture at the company by installing his loyalists in top positions. Two leading executives, Tim O’Hern, (a former schoolmate of Schnatter) president of international operations, and Ritchie (worked directly for Schnatter for three years), were involved in fostering the toxic environment in the company, they claimed. A former senior executive said, “John got Steve to where he is. Steve is not going to do anything to turn on John” Multiple sources mentioned that the meetings were filled with ‘profanity and inappropriate comments’ and that Ritchie allegedly never intervened and but just laughed at them.
Employees also said that despite being a public company, the pizza chain operated like a privately-owned one, and nothing happened there unless John wanted it to happen.
In response to the allegations, the chain said, “A special committee of the board of directors, comprised solely of independent directors, has retained an outside firm to oversee an audit and investigation of the culture at the company and to make recommendations for whatever changes may be necessary. We take this matter seriously. If anything is found to be wrong, we are determined to take appropriate action.”
On July 19, 2018, Ritchie sent a note to employees pledging to address failings in the company’s culture. He said that he was “personally offended by the actions (of Schnatter) as depicted in the (Forbes) story”.
Following the reports published by Forbes, Initiative, an IPG Media brands-owned media agency which had been associated with the pizza chain for a long time, decided to end its relationship with Papa John’s. The company was thus left with no media, PR, or creative agencies.
Administering Poison Pill
On July 22, 2018, The Wall Street Journal reported that the board members of Papa John’s had voted to adopt a ‘poison pill’ to block Schnatter from taking a controlling interest in the company. Schnatter owned about 30% of the company’s shares. The company announced, “The maneuver would block any investor from acquiring more than 15% of Papa John’s stock without board approval. The company’s founder, John Schnatter, remains on the board and already owns a 29% stake. The new plan would constrain Schnatter’s stake to less than 50%.”
Industry experts said the move was hardly been ever used against a company founder. Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, asserted, “If it’s happened before, it is circumstantially quite rare. What he did isn’t illegal. It’s just very, very disturbing. He insulted a good deal of their customers, and that’s the problem. But he’s still a large shareholder. And a shareholder, whether you agree with them or not, is still a shareholder.”
On July 23, 2018, soon after the announcement, the company’s shares fell by nearly 8%. Commenting on the situation, O’Cull, Stifel analyst, cut his rating on the stock. O’Cull predicted same-store sales would fall by 12 and 10% in the third and fourth quarters respectively. He further estimated that the average franchisee’s annual store cash flow would fall from $95,000 in 2016 to $60,000 in 2018J O’Cull added, “The implications of the current situation are far-reaching. For example, employee morale is likely extremely low at the corporate office and in the field following media reports about senior executive behavior and with the likelihood compensation and continue employment could be at risk from the declining sales.”
The Blame Game
On July 27, 2018, Schnatter sued the company accusing it of failing to produce internal files related to his ouster. Reportedly, he had demanded to be given documents including internal communications by directors, officers, and attorneys relating to him from October 31,2017, through July 15, 2018, when a special committee was formed to address the allegations mentioned in the Forbes article. Schnatter had also asked for documents relating to any allegations of sexual harassment or sexual misconduct by any board member or officer. The board of directors, however, refused to handover those records.
In a complaint filed in Delaware’s Court of Chancery, Schnatter claimed that after Forbes published the article falsely accusing him, the board had treated him in an “unexplained and heavy-handed way”. He claimed that instead of standing behind him and trying to explain what actually happened, the company had followed “its usual, and flawed, manner of dealing with false and mistaken reporting.”Schnatter, in his complaint, blamed the company directors of either having acted in a hasty and uninformed manner, thus breaching their duty of care to the corporation, or secretly having planned a “coup” in advance to oust him.
The company, however, denied Schnatter’s allegations and accused him of filing “a needless and wasteful lawsuit in an attempt to distract from his own words and actions”. It said it would not be distracted from the “numerous misstatements” Schnatter made.
The blame game put Papa John’s at a crossroads. The ever-worsening fiasco highlighted an apparent lack of internal controls, illustrated the dangers of tying a company’s brand to its CEO, and opened the doors to potentially nasty litigation. Analysts viewed this entire episode as a PR nightmare for the company. Neil Saunders, managing director of Global Data, commented, “What was a serious situation now seems to be descending into an ongoing farce with allegations and claims flying around all over the place. This is not good for the brand, and it is not good for the business which is distracted by fighting fires rather than on more important activities.”
The unsavory situation started hurting sales and footfall at Papa John’s franchisees. Locked in long-term contracts with Papa John’s which required them to pay the company for all marketing materials and food as well as a percentage of the their sales, the franchisees found themselves in a vulnerable position. As of July 2018, same-store sales for domestic franchisees turned negative and were likely to drop further.
Judy Nichols, a franchisee who owned three locations in Nederland, said, “Our phones aren’t ringing like they generally ring, It’s hitting us suddenly, which means we have to respond dramatically for our financial survival.” Papa John’s was reportedly trying to address the situation through conversation with the franchisee community and by providing some financial relief so as to limit the need for franchisees to close their units.
What Next?
Experts opined that the need of the hour was to restore the reputation of the company. Analysts issued sell recommendations on the stock and dropped earnings projections, citing damage to the brand and a projected decline in pizza sales. As of August 2018, the company’s net income had fallen to $11.7mn, down from the $24.1mn in 2017. Revenue too had declined 6.1% to $408mn from $434.8mn compared to 2017. Analysts opined that the turmoil had left Papa John’s vulnerable to a takeover. They also predicted that if the debacle did not stop, the company would fall behind Pizza Hut and Domino’s in terms of market share.
It was felt that it would be difficult for the company to convince internal and external stakeholders and establish credibility. As per industry experts, the biggest challenge would be for Ritchie and his leadership. The company, however, remained hopeful about getting through the tough times. Reportedly, Ritchie had outlined a five-part plan to revitalize the company and was planning to roll out new marketing campaigns. In addition, an independent cultural audit and investigation of the company’s diversity and inclusion practices was also taken up.
While the company was preparing to address all the issues and move into the future, Schnatter was gearing up for a fight. It would be interesting to see who would win the war.