Krispy Kreme Will Dough Continue to Flow to Shareholders Course Hero

Founded 1937 in Winston-Salem, NC, Krispy Kreme began as a doughnut wholesaler serving primarily local grocery stores. Passers-by smelled the sweet scent of fresh doughnuts being made and asked to buy hot doughnuts directly from the factory. Company management took notice of the market demand for fresh, hot doughnuts and continued to grow the business through the factory-store model. Today, Krispy Kreme has over 1,000 stores systemwide and can be found in 24 countries.¹

Business Model

Krispy Kreme primarily sells doughnuts, complimentary products such as coffee, and packaged sweets. The company earns revenue from retail, wholesale and franchising Krispy Kreme stores.²

Retail: Customers purchase products directly at a factory or satellite store. The major appeal at factory-stores is being able to purchase freshly made doughnuts. Satellite stores heat unglazed doughnuts and finish them using a warm glaze waterfall on premise.

Wholesale: Fresh doughnuts and other packaged sweets are distributed to various retail partners, such as grocery and convenience stores. The wholesale distribution business is largely limited to the domestic US and make up approximately 49% of company-owned store sales.²

Franchise: Krispy Kreme has also licensed out its products and brand to franchise partners. As of August 2015, there were 173 domestic franchise stores and 758 international franchise stores.³

Operating Model

While Krispy Kreme continually draws customers en masse to its store openings worldwide^4,5,6 , flaws in its operating model have led to store closures⁷ and disappointing profits⁸ in recent history.

Large Store Formats: Traditionally, Krispy Kreme factory-stores have been large 2,800 to 5,500 square foot facilities, operating as both quick service restaurants and packaged goods distributors. The large size of the stores limit the density of stores in many markets where real estate is competitive. These stores require high initial investment and operate with high fixed costs driven by the company's desire to manufacture their own equipment. Some stores are able to produce up to 600 dozen doughnuts per hour, but often operate with excess capacity.²

Krispy Kreme's operational choices forced the company to be reliant on wholesale to earn a profit from their factory-stores. As a result, their retail business suffered from the lack of store density in strategic markets. Consumers began to think of Krispy Kreme as a "destination" location, rather than as part of their normal routine.² Since their retail business signals demand on wholesale, both businesses became hindered by the company's operational model. Meanwhile, competitors such as Dunkin Donuts and Starbucks sprinted ahead to ensure their foothold in quick service retail.

Distribution: Wholesale customers are served through a fleet of company-owned delivery trucks. Doughnuts are delivered daily and packaged goods every other day. In contrast, Krispy Kreme delivers fresh doughnuts to its satellite stores twice-daily to maintain product quality at its own retail locations.² The lower frequency of delivery to wholesale customers has created a hierarchy among retail locations where factory-stores sit at the top, satellite stores in the middle, and wholesale partners at the bottom. Subsequently, astute consumers purchase fewer Krispy Kreme doughnuts at grocery and convenience stores. Since the yeast-based doughnuts spoil in two days, Krispy Kreme is forced to absorb the cost of spoiled, unsold products.⁹

Turnaround Plan

Weak profits and low market penetration forced Krispy Kreme to rethink its strategy. It was clear the larger store formats did not work and they needed to disentangle the retail and wholesale business into separate operations. To do so, Krispy Kreme is pursing smaller retail-only locations, measuring about 2,300 square feet. The new store will continue to produce fresh, hot doughnuts, but at a lower capacity of 65 to 100 dozen doughnuts per hour.¹⁰ Stores will be cheaper to operate and require lower initial investment for both Krispy Kreme and its franchisees. Lower overhead enables more locations to be opened, which will hopefully shift the brand from being a "destination" concept to higher accessibility.¹¹

Did it work?

Unfortunately, the focus on retail has come at a cost to the wholesale business. Shares of Krispy Kreme plummeted 16 percent following weak quarterly results in packaged goods and lowered guidance.¹² It's not clear the company has developed a strong enough product line of packaged goods or a sustainable operating model for its wholesale business.

Even in retail, the pace of smaller factory-store openings domestically has also been moving at a snail's pace. Only 24 new stores in this format have opened since the company's shift in strategy three years ago.² International expansion appears to be more attractive to Krispy Kreme where there is a very low percentage of wholesale.¹³

Can Krispy Kreme figure out how to do both retail and wholesale? Do you think the factory-store model makes sense against the success of Dunkin Donuts and Starbucks?

Sources:

¹ Krispy Kreme company website

² Latest Company 10-K, filed April 2, 2015.

³ Latest Company 10-Q, filed September 11, 2015.

⁴ Delaware Business Now. Krispy Kreme Opening Draws Army of Doughnut Lovers, July 3, 2014.

⁵ China Post. Krispy Kreme flagship opening attracts long lines, December 13, 2013.

⁶ Seattle Times. Crowds go doughnuts for Krispy Kreme, October 31, 2001.

⁷ Franchise Times. Downward spiral, November, 2007.

⁸ USA Today. Krispy Kreme sinks 15% on disappointing profit, August 30, 2013.

⁹ Business Insider. Krispy Kreme Donuts Don't Last Long Enough, September 13, 2013.

¹⁰ Bloomberg Business. How Krispy Kreme Plans to Sell Even More Glazed Doughnuts, September 12, 2013.

¹¹ Fortune. Behind the Krispy Kreme Turnaround, June 27, 2013.

¹² The Wall Street Journal. Krispy Kreme Shares Plunge as Guidance Is Cut and Results Miss Views, September 9, 2013.

¹³ The Wall Street Journal. Krispy Kreme Takes Chance on International Flavor, September 8, 2013.

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Source: https://d3.harvard.edu/platform-rctom/submission/krispy-kreme-a-fresh-hot-mess/

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