Krispy Kreme Finally Goes on a Diet
- Jan 21, 2005
- admin
- Investing
IT WASN’T SUPPOSED TO END LIKE THIS.
No way.
Scott Livengood – the recently ousted CEO of Krispy Kreme
(SYM: KKD) – had other dreams.
In one of them, he’s holding hands with Howard Schultz – the
brassy Chairman of Starbucks (SYM: SBUX) – as they skip wildly into
the retail hall of fame.
After a lunch packed with caffeine and carbs, Schultz whispers into
Livengood’s ear that he – Scott Livengood – was the true king
of $2 food retailing.
Livengood chuckles wildly as he licks the glazing off his donut.
In another recurring dream, the CEO of Dunkin Donuts
(Allied Domeniq SYM: AED) is on his knees begging Livengood to stop
making his donuts so darn fresh.
Laying sideways in his toga, Livengood pops a couple of grapes
and decides the fate of the lowly Dunkin Donuts CEO:
5 minutes later the Dunkin Donuts guy is tossed out of his chair
“Dr. Evil” style.
Why?
Because Livengood can.
But none of that will ever happen.
Not now.
So that begs the following question:
Were shareholders of Krispy Kreme just dreaming about rolling in
all that dough?
Not at all.
As a matter of fact they had a decent shot.
But their best shot is past.
And the sad part is that what happened to Krispy Kreme has
happened to many a growth company before it.
And No – it wasn’t that silly low-carb craze that will disappear
as soon Richard Simmons starts dealin meals again.
Nor was it the SEC/accounting issues at the company.
Sure, that’s going to be A PROBLEM.
But that wasn’t THE PROBLEM.
No, the right kind of CEO could have survived that stuff easily.
The kind of CEO that understands what skill set is needed to take a
company from the hyper-growth phase of its business plan to
the more mature-growth phase of its business plan.
The kind that knows how to manage one of the most precious gifts
a CEO could ever manage – a strong brand name.
No, Scott Livengood – and by extension the shareholders of Krispy
Kreme – were taken down by that all to familiar condition
that has plagued many a growth manager:
Inexperience (with a hubris frosting).
Not inexperience in the sense that Scott didn’t know how to open
new stores with plenty of fanfare.
He proved he could do that.
Inexperience in the sense that once the stores were open, Scott
didn’t know how to protect the brand.
Let me explain:
Every company has a natural life cycle.
The kind that takes a business through the 4 phases of
it’s corporate existence:
Phase 1: Start-up
Phase 2: Growth
Phase 3: Maturity
Phase 4: Decline
When Scott Livengood started working at Krispy Kreme in the
1970’s, the company was at a relatively early point in its life
cycle.
Let’s call it the early growth phase.
And then they watched in awe as Starbucks began to conquer the
western world.
That was the turning point.
Knowing that he could sell frosting as easily as Schultz
sold whipped milk, Livengood began plotting.
Plotting to go “Dr. Evil” on Dunkin Donuts.
Plotting to bring Krispy Kreme into the retail hall of
fame with Starbucks.
But a funny thing happened on the way through the donut hole.
The strategy changed.
It went from “super-exclusive” to “all-inclusive.”
From lines around the block to blocks around the lines.
And that, in a nut-shell, was Livengood’s strategic mistake:
Instead of keeping people waiting, he flooded the market
with donuts.
He diluted the brand.
Wiped off the frosting.
Donuts at Starbucks.
Donuts at the local drugstore.
Heck, even donuts while you shopped at the supermarket.
This hurt for three reasons.
First, by distributing his donuts to every outlet available,
his product became less exclusive.
In other words, people didn’t need to wait on lines
when the new store opened – all they had to do is walk
into a local Walgreens.
That killed the buzz.
Which led to his second problem:
When you sell mass quantity through the mass merchants not only do
you sell it for less, but you have to take a smaller cut.
And that hurts.
But you know what’s even worse?
In a rush to expand he took out a lot of debt.
So much so that the company went from $0 to $130 million
in debt in 4 years.
That’s 20 percent of their entire capital structure since 2000.
All of these factors created a situation – not altogether
uncommon in situations like this – where a company
begins to dilute the value of its brand.
It’s happened before folks.
First, you expand too much – making the product
almost ubiquitious (and taking on too much debt).
Then people lose interest in the product.
Then prices go lower.
And finally, returns on capital decline.
Just look at the facts:
In 2000, Krispy Kreme had a return on capital of
11.7%.
This year they’ll be lucky to break 5%.
Thats because brand power = pricing power.
And pricing power = high returns on capital.
And high returns on capital = high stock price.
But Livengood was just focused on sales, sales, sales.
And that’s an admirable thing – for Phase I of a business
plan.
But not for Phase II.
Phase II needs a different kind of skill set.
The kind of skill set that knows a thing or two
about expanding a brand at the right time and at the
right price.
The kind of skill set that could save this company
from its over ambitious plans.
Do I think Krispy Kreme can reach its old glory once
again?
Sure I do.
But that depends a lot on if they bring on a
Phase II manager, not a grower or a liquidator.
And for now we’ll just have to wait and see.
Remember, you are what you read…
–By Dylan Jovine