KRISPY KREME DOUGHNUTS

-Study case-

PERFORMANCE OF KRISPY KREME DOUGHNUTS Krispy Kreme Doughnuts, Inc. (Krispy Kreme) is a retailer and wholesaler of doughnuts complementary beverages and treats and packaged sweets. The Company's principal business is owning and franchising Krispy Kreme stores, at which a variety of doughnuts, including the Company's Original Glazed doughnut, are sold and distributed together with complementary products, and where a broad array of coffees and other beverages are offered. As of January 29, 2012, there were 234 Krispy Kreme stores operated domestically in 38 states and in the District of Columbia, and there were 460 shops in 20 other countries around the world. Of the 694 total stores, 292 were factory stores and 402 were satellites. The Company operates in four segments: Company Stores, domestic franchise stores, international franchise stores, and the KK Supply Chain. The revenue of KKD is generated from 3 sources: 1. From company stores owned by Krispy Kreme (Company stores). Krispy Kreme branded doughnuts are sold through a variety of outlets such as convenience and supermarkets; 2. Franchise fees and royalties from franchisees (Franchise); 3. Vertically integrated supply chain (KK Supply Chain). Compared with its largest competitors, Dunkin Donuts and Starbucks, Krispy Kremes revenues are drastically lower. Competition from these companies, as well as changes in consumer taste and poor expansion strategy, has put Krispy Kreme in a difficult position. Starbucks is even more impressive when it comes to variety on its menu as they offer pastries, muffins, fruit plates, salads, oatmeal, yogurt, and breakfast sandwiches to complement their main product, coffee. Even with a forecasted profit for 2010, how Krispy Kreme addresses and answers the health craze in the upcoming years will define the companys future. A shift in consumer demand to want healthier fast-food options has hit the industry hard. Dunkin Donuts and Starbucks have combated this shift by offering healthier menu items, something Krispy Kreme has failed to do. Dunkin Donuts offers healthy breakfast sandwiches and a variety of flatbread sandwiches that are based on both morning and lunch styles. Recently many Americans are beginning to prefer healthier food products. As a result many quick service restaurants have added salads to their menu or added menu items that are perceived as healthier choices by their customers. Even Dunkin Donuts offers a flat bread sandwich for their customers. However, at this point Krispy Kreme has made no attempt to add healthier choices to their menu. In fact, Krispy Kremes menu consists of donuts, coffee, and ice cream products. None of the previously mentioned products are perceived as healthy by the average consumer so if more consumers begin to demand healthier menu choices this could mean a significant reduction in sales for Krispy Kreme. Krispy Kreme is running into problems because they are unable to effectively control costs. One of the biggest reasons that they are having trouble controlling costs is that historically they have focused too heavily on expansion and not enough on increasing same store sales. In addition, their expansion was based on large,
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expensive factory stores which have not only been expensive to open and operate, but they fail to provide enough locations to reach a wide consumer base. These large factory stores require a large amount of fixed costs causing the break-even points to be quite high. In order to prevent the closure of more stores and ensure future survival Krispy Kreme must focus on more effectively managing costs and reaching a wider customer base. Another cause for the declining revenue is the retirement of the East Coast which is a convenience store from the business with KKD and which decided to open its own kitchen. International outlets shrunk with stores in Canada and Hong Kong shut down. These trends have impacted the profitability of the firm. The year 2008 has been more bad news with all quarterly earnings negative. Also the continuous change of management of the company during some years is another reason for the variations of their revenues. The franchise companies that enjoy long-term success are those that focus on royalty payments; this aligns headquarters' goals with its franchisees. Forcing franchisees to buy equipment at tremendous mark-ups only bodes well for headquarters, and it is a very greedy short-term profit generating solution. Indeed, some companies look to their own profit rather than the profit of all franchisees. This may be especially true for a company that has gone public and trades stock shares on the public market. The pressures to produce profit can be extreme, and it could cause corporate leaders to make poor decisions, even leading to improper financial reporting. One of the reasons behind Krispy Kreme's downfall was its incredibly rapid growth. During the start of the glazed donuts' popularity, people would wait in lines for a rare taste of the warm delicacies, which were beautifully created in front of customers' eyes. Capitalizing on the popularity, Krispy Kreme attempted to sell its brand everywhere and anywhere - ranging from gas stations to kiosks -which diluted the appeal of its core product. Another definitive franchise failure tactic is to allow franchise locations that are too close in proximity. A new store may offer additional revenue to the home office, but the overall result is less profit for each individual store owner. This was certainly the case for Krispy Kreme. Some franchises would rather see quick bottom line profits on their statements than formulate a strategy for steady growth. In the case of Krispy Kreme, franchisees accused the company of "channel stuffing," wherein the stores received twice the inventory at the end of the quarter so the corporation could bolster its reported profits. In addition, Krispy Kreme forced its franchisees to purchase equipment and supplies from headquarters. While this is a common practice for franchises, the tremendous markup Krispy Kreme placed on these purchases could not bode well for the long-term success of its franchisee stores. The franchise companies that enjoy long-term success are those that focus on royalty payments; this aligns headquarters' goals with its franchisees. Forcing franchisees to buy equipment at tremendous markups only bodes well for headquarters, and it is a very greedy short-term profit generating solution. Indeed, some companies look to their own profit rather than the profit of all franchisees. This may be especially true for a company that has gone public and trades stock shares on the public market. The pressures to produce profit can be extreme, and it could cause corporate leaders to make poor decisions, even leading to improper financial reporting. Look for these kinds of signs from franchises, particularly a company that is publicly traded. A private franchise corporation may be a better opportunity since owners are generally more interested in seeing the company
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succeed as a whole, rather than pleasing fickle investors. Watch for signs that suggest that they could be growing too quickly. Krispy Kreme turned a profit in the second quarter (ended July) of 2010 for the first time in over five years; however, determining how well a company is controlling their costs is much more complicated than simply looking at operating profits. One problem that has led to high costs for Krispy Kreme is that they have focused too heavily on developing fewer large and costly factory store locations. A problem with this model is that customers are not willing to drive very far to go get donuts so with fewer, larger locations Krispy Kreme is not able to reach as wide of a customer base. Additionally, Krispy Kreme has another problem that is driving costs far too high they expanded too rapidly in the United States in the 1990s and early 2000s under poor management which has led to the company loosing focus on improving same store sales and profitability. Currently management is taking steps to fix this problem, but the fact of the matter is that high revenues do not always lead to high profits.

History (02/28/2013)

2008

2009

2010

2011

2012

YTD

KKD

-46.84

75.60

136.61

-6.30

43.43

40.72

Restaurants S&P 500 TR +/- Restaurants +/- S&P 500 TR Dividend Yield % Market Cap USD Mil REVENUE

-12.41 -37.00 -34.43 -9.84 113

19.45 26.46 56.15 49.13 199

35.38 15.06 101.23 121.55 471

28.64 2.11 -34.95 -8.42 445

2.68 16.00 40.74 27.42 612

6.26 6.61 34.47 34.12 861

Gross margin 16.01% Net profit margin 38.02% Operating margin 8.24%

NET INCOME
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Return on assets 61.29% Return on equity 92.97% Return on investment 73.34%

MISSION AND VISION The mission of KKD is to make the products of the company the centerpiece of the business and to grow that business internationally. It is strongly believed that KKD has a unique product, a heated fresh doughnut with a distinctive taste. The mission and values statements are as follows: Vision: to be the global leader in doughnuts and complementary products while creating magic moments worldwide; Values: we believe: Consumers are our lifeblood, the center of the doughnut There is no substitute for quality in our service to consumers Impeccable presentation is critical wherever Krispy Kreme is sold We must produce a collaborative team effort that is unexcelled We must cast the best possible image in all that we do We must never settle for second best, we deliver on our commitments We must coach our team to ever-better results. A Krispy Kreme Original Glazed doughnut is made from at least 50 ingredients mostly artificial food additives that increase your risk of cancer, diabetes, heart disease, allergies, and digestive disorders. In addition to increased cancer risk and cardiovascular disease, food additives are associated with other health conditions that can include; irritability, restlessness, poor sleep mood swings, anxiety, depression, panic attacks difficulty concentrating or debilitating fatigue speech delay, learning difficulties eczema, skin rashes, and swelling reflux, colic, stomach aches, bloating, and other irritable bowel symptoms including constipation and/or diarrhea, bedwetting headaches and migraines frequent colds, flu, bronchitis, tonsillitis, sinusitis; stuffy or runny nose, constant throat clearing, cough or asthma joint pain, arthritis, heart palpitations, racing heartbeat
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These additives demonstrate that the company looked more after the profit instead of the well-being of their customers. Also, even if the products tasted good the quality of them had to suffer greatly. This is against the value There is no substitute for quality in our service to consumers. So this made the company a liar and people disagree with this thing and dont like to buy products from a firm like that. Since the formation of the company, Krispy Kreme has been renowned for its positive employee satisfaction. This fact does not just refer to the employees in the stores dotted around North America, but in all the stores located across the world. The company has won a wide range of awards for its treatment of its employees in the US and achieves a 4.2/5 employee satisfaction score on Indeed.com In LEDC countries such as Indonesia where poverty is often strife, Krispy Kreme outlet stores have given these people a secure work placement and direct access to a wage, in turn boosting their economic prospects. "Krispy Kreme UK Ltd was charged under Regulations 41 of the 2005 and the 2007 Regulations for failing to register with the Environment Agency and failing to recover and recycle packaging waste. These are either way offences for which the court has power, on summary conviction, to impose a fine up to 5,000 and on conviction on indictment to impose an unlimited fine." - The UK Environmental Agency 2011. This identifies that Krispy Kreme have had some negative impacts on the places where they are located as they have been accused of packaging waste, showing total disregard for the natural environment. These charges are against the value We must cast the best possible image in all that we do and what they have done in the countries and to the environment have affected the lives of the people living there. But for the company, the employees are very important and KKD wants to offer good working conditions and is looking for their best interest. KKD INTERNATIONALIZATION The Krispy Kreme story began Winston-Salem, N.C. in 1937 when Vernon Rudolph began selling doughnuts to grocery stores using a secret recipe from a French chef. Strong demand from customers who wanted to buy their doughnuts freshly made and still warm caused him to open almost 100 retail outlets throughout the South. After Rudolphs death in 1973, his heirs sold the chain to Beatrice Foods, which immediately began to tinker with the successful recipe. By 1982 franchisees were so upset with Beatrice that they joined together to repurchase the chain. This created a franchisor owned and dominated by its own franchisees, which would create serious difficulties later on. By the mid-1990s Krispy Kreme had escaped its Southern heritage and opened shops in the Midwest and Northeast, even invading Manhattan, home to many influential writers. But instead of deriding hot doughnuts as a provincial culinary fare like hominy or grits, the critics raved. A New York Times columnist even wrote: W hen Krispy Kreme are hot, they are to other doughnuts what angels are to people. The product began to appear on TV in sitcoms and late-night talk shows; people bragged
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about their attempts to score a dozen of the treats, and a new cultural phenomenon was born. At the of February 2009, KKD was operating 523 stores in US, Australia, Bahrain, Canada, Hong Kong, Indonesia, Japan, Kuwait, Lebanon, Mexico, the Philippines, Puerto Rico, Qatar, Saudi Arabia, South Korea, the United Arab Emirates and UK. There are two types of KKD stores: factory and satellite stores. In 2009 there were 281 factory stores which contained a doughnut-making production line in addition to a retail establishment. They support other sales channels. The second type of KKD store is the satellite store, which sells doughnuts and beverages which are much smaller than a factory store. Another form of satellite store is the kiosk format. Krispy Kreme engaged in a costly expansion strategy, at least within the United States. They became a publicly traded company in April 2000 which generated a lot of positive publicity and exposure causing investors became anxious for Krispy Kreme to expand their business; the company followed suit by rapidly expanding until late 2003 when they realized that their high store sales were not sustainable and many stores began losing money. This, coupled with the fraudulent accounting practices used to hide these losses in earnings, forced CEO Scott Livengood into early retirement in 2005 and replaced by Daryl Brewster. Brewster settled the lawsuits facing Krispy Kreme and he began closing underperforming stores in the U.S. while pursuing an aggressive overseas expansion program; despite all of his efforts Krispy Kremes stock price continued to fall until 2008 when he resigned and was replaced with current CEO James H. Morgan. This shows why the company still owns underperforming stores in less than desirable locations today. If Krispy Kreme is unable to improve same store sales they will continue to underperform because their costs will be too high keeping their profits low. In the companys 10K report they claim that international sales have been a very important component of Krispy Kremes growth as they currently operate more stores internationally than domestically; in fact, management thinks that international expansion is probably the most profitable expansion Krispy Kreme has engaged in. Though generally profitable, even this international expansion has met with some failures. For example, in August 2008 Krispy Kreme expanded into Hong Kong and opened a total of seven locations, but by October that same year all seven locations were closed down. In more recent news, as previously mentioned the companys Australian stores are suffering and nearly half are being closed. Overall, Krispy Kremes international operations, despite a few setbacks, are performing well, but there is always risk involved when entering foreign markets. The magnitude of growth in the late 1990s and locations chosen for expansion have not worked as well as Krispy Kreme had hoped. These seemed like solid investments when the management was participating in unethical accounting methods. Why are these franchises now failing and have they been falling since they opened? Almost all new locations have competition in the form of multiple options for consumers to choose from, putting Krispy Kreme at a disadvantage. For example, many of the new Krispy Kreme outlets were located within the food courts of major shopping centers, where rents are high and consumers can immediately compare
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retail offerings. Other quick-service restaurants can offer more selection than Krispy Kreme can and this makes them more appealing. As primarily a doughnut shop, Krispy Kreme is viewed as a snack and not a full meal which is leading to the aforementioned store closures. STRATEGIES Krispy Kreme Doughnuts (KKD) projects an image as the Stradivarius of doughnuts, creating a unique enriching experience that increasingly gains customer enthusiasm and loyalty. Krispy Kremes melt-in-your-mouth, hot, sugar-glazed doughnuts, the doughnut theater, and the HOT DOUGHNUTS NOW feature are clearly a few of the differentiating factors it attempts to make itself identified with. Fortunately, this appeals to a broad base of buyers; demographically, buyers come from all walks of life: all genders and ages, from skilled to blue-collar, high-income to low-income workers. KKDs strategy provides the company three sources of revenue: (1) Sales at company owned stores; (2) Royalties from franchised stores and franchise fees from new stores; and (3) Sales of doughnut mixes, customized doughnut-making equipment, and coffees to franchised stores. KKD shifted in focus from a wholesale bakery to a specialty retail bakery to promote and increase sales at the companys own retail outlets. The company emphasized the HOT DOUGHNUTS NOW feature as a response to customer feedback as well as a form of local advertising. The company was able to boost its store sales-volume by combining on-premise sales at its stores to capture customer base and then to secure off-premise sales at supermarket and convenience stores for packaged sales. Furthermore, KKD gave reliance on franchising associate stores and opened a few new company-owned stores as a means of expanding nationally and internationally. However, franchise licenses were granted only to candidates who have experience in multi-unit food establishments and who possess adequate capital to finance the opening of new stores in their assigned territory. KKD should promote more aggressively their products in the stores worldwide, because people dont know much about what the company offers and persons look after the known brands and the trustworthy ones. Also, KKD should consider not going on with the disputes with the franchise store because this hurt the companys image. There are various factors that contribute to the losses that the company incurs. These include the decrease in percentage of the store operating hours due to closure of various company-owned and franchise stores. This is attributed to an increase in the number of store closures prompted by poor performing stores. The lack of an updated Uniform Franchise Offering Circular hinders the company from offering franchises to new franchisees who may opt to open stores in new potential markets. The high operating costs from poor performing stores also contribute to the losses the KKD experiences.

The companys competitors include Dunkin doughnuts and Starbucks. The companys international presence is low and it is not well known in its local market despite its long presence in the industry. In order for the company to improve its revenue, there has to be a new developed strategy that will help eliminate the failures and improve on the companys performance. The company has two options: to expand its activities locally or internationally in order to achieve its goal. In my analytical view I will suggest and draft a three year plan for the companys local expansion. The preference of local expansion over international expansion The focus on local expansion is preferable because international expansion may tend to be slow because of difficulties in penetrating new markets. According to the American management association the taste, preference and cultural differences in foreign markets may also not favor the development of the brand in foreign markets (AMA, 1956). Additionally, most major prospective foreign markets are already occupied by other competitors such as Dunkin doughnuts. Therefore, going into an already occupied market niche where the company has not made its presence felt may not work well for the company. Another reason for local expansion is based on the fact that much of the present revenue amounts are generated locally. The international market generates a smaller percentage of the revenue compared to the local generation. This may be contributed by the fact that the international market does not acquire its supplies from the Krispy Kreme Doughnuts network of supply.

The plan for the first year The first strategy for the company should be the acquisition of an updated Uniform Franchise Offering Circular. This will enable the company to offer franchises to new franchisees that will be willing to open up business units in new potential markets. The current state of having no Uniform Franchise Offering Circular hampers the local expansion of the company. This is because it is left with only one option: which is to open company-owned stores. However, we note that the company owned stores are disadvantageous for Krispy Kreme Doughnuts. This is because they increase the companys operating costs and increase the chances of incurring losses if the stores perform poorly. Additionally, the company owned stores pay no royalties and franchise fees to Krispy Kreme Doughnuts. Therefore, the acquisition of the Uniform Franchise Offering Circular and new franchisees should be coupled with closure of poorly performing stores. This will cut the companys operating costs that result from under-performing stores.

New established stores should also be given a characteristic design that will be associated with the brand of Krispy Kreme Doughnuts. This characteristic identity will serve to market the brand locally. Secondly, along a similar line of action; the company should reduce its current percentage of payment for royalties under the area developer program and the associate program. This action will serve to stimulate the local expansion by attracting franchisees that will enjoy higher proceeds due to the reduced payment of royalties and franchise fees. The plan for the second year The second year plan should involve an introduction of complementary products such as coffee and soft drinks. This will offer more variety to the customers and increase the volumes of sales. This program should also include a full roll-out of the complementary products throughout all the stores in the companys network. The new products are will increase sales and revenue that will further prompt expansion. In addition to the complimentary products, the company should introduce more varieties of doughnuts. This will give the customers a wide array of choice that will keep them loyal to the company because it offers them a change. The company should also introduce healthier varieties of products because the population is getting conscious each day on issues that pertain to fast food effects on health. This should include the development of low calorie doughnuts. Smaller satellite stores should be designed for under-performing stores in order to cut operational costs incurred from larger, poor performing Krispy Kreme stores. A similar design should be used for new ventures in areas with a limited market capacity. The smaller satellite stores will have less expenditure on capital and will run on a low operational cost. This can favor further inexpensive expansion. The plan for the third year The plan for the third year should include an increase in the local marketing campaign. This will serve to increase awareness about the company to the general public. The campaign plan should be more active than the normal marketing of the brand. In order for the company to achieve this goal it will have to increase the rates of contributions from its network of stores. Thus, developers and associates should contribute more than the usual 1 % and 0.25 % contribution that they make to the advertising agency in charge of marketing. The company should also increase its non-traditional package sales to grocery stores, convenience stores and mass merchants. This can be realized via a strong marketing campaign that will target this section of the supply chain. This will be especially useful for places that the company may find store establishment highly expensive or poor performing. This should also incorporate private labeling and unlabeled sales to grocery and convenience stores.

Krispy Kreme Doughnuts should also consider introducing supply chains for overseas networks of branches in order to maximize revenue gains that accrue from its supplies delivered to the international branches of stores. Krispy Kreme Doughnuts should also try to limit the number of franchise stores so that they should not be more than the companys own stores. This is because they may hamper its expansion due to uncontrolled closures. Therefore, the company should consolidate much of its production to the company stores. This is clearly depicted by the closure ratio of domestic stores (among the 71 local store closures 60 of them were from the franchises whereas; closed company stores were only 11). The company could also source more capital in the third year to further its expansion. Considering the fact that Krispy Kreme is a corporate company this should be done by a rights issue to be offered to the public. In order to finance the corporations expansion the company should cut down the number of its employees in the top management. This can be made possible combining duties carried out by the many presidents and vice presidents that the company has in its organizational structure.

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