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Runner-Up: Coffee & Donuts

Student explores the rise and fall of Krispy Kreme

The Gamble
Within most Krispy Kreme stores sits both an impressive feat of engineering and a spectacular economic gamble: the Donut Theatre. ‘Theatre’ is probably far too unassuming a term for a roomsized conveyor belt system which carries donuts from their birth as small balls of dough through cooking, turning and glazing, until they finally roll off the assembly line as fully formed glazed donuts. The larger models could belch out a staggering 100,000 plus donuts each day. As Krispy Kreme (KKD) expanded across the US in the late 90’s, it built hundreds of these machines in its stores nationwide. It was a startling wager on not just America’s appetite for donuts, but an even greater bet against another American favourite: coffee, on which Starbucks was placing a bet of its own.

Krispy Kreme’s bet would go spectacularly wrong over the next decade, while Starbucks would prove, against all odds, that Americans could view coffee as a luxury product. The story of donuts and coffee in America is one of stunning failures and triumphs of corporate strategy.

Frosted Unicorn
The year 2000. Britney Spears was still at the top of the charts and Harry Potter and the Philosopher’s Stone was the only Harry Potter book in existence. Krispy Kreme had also just become a national phenomenon and IPOed to a storm of media attention (it listed on the NASDAQ, naturally, despite donut-making having dubious links to tech). Scott Livengood, the firm’s CEO, rang the NASDAQ opening bell on April 5th and embarked on a barnstorming day of 25 television interviews — bringing boxes of glazed donuts for the staffers of each of the news networks he visited. By the end of the day, the stock price had surged 76% from its IPO price — and Livengood was riding a sugar high.

The company’s superb unit economics made it easy to understand investors’ excitement. It solved an age-old problem which had plagued the $40 billion Coffee & Snacks segment of the restaurant industry: low revenue per sale. If a barista takes 60 seconds to serve a $1 cup of coffee to a customer, high margins on the coffee won’t save your store from high fixed costs on labour and rent. Starbucks was trying to get around this by persuading middle- class Americans that they should opt for more expensive espresso-based drinks over filter coffee. Krispy Kreme rejected this coffee-driven sales approach entirely: it was trying to prove that Americans could be lured into its stores just to buy donuts (it didn’t carry its own brand of coffee, although still had external brands). The strategy was paying off spectacularly. By 2001, while Starbucks brought in $600,000 in sales per store, Krispy Kreme was pulling in an eye-watering $3.5m per company-run store. KKD’s earnings per share began a steady march upwards.

The Golden Goose
Because of the extra floor space required to house the Donut Theatre within its stores, KKD had usually opted for locations that were more out of the way to save on rent, which meant it had a harder time capturing regular commuter traffic than its competitors. The company still had one secret weapon: the Donut Theatre itself. Because customers could watch the baking process unfold on the company’s donut- laden conveyor belts, visiting a Krispy Kreme was a novelty. Since the average customer visited a Krispy Kreme only once or twice a month, the novelty factor was a critical selling point for the firm.

But Scott Livengood wasn’t content to wait for consumers to wander into his stores. His strategy was to use the gargantuan donut-making capacity of his retail outlets to flood fresh product to third-party sellers like gas stations, convenience stores and supermarkets. The wholesaling strategy allowed the company to continue growing same-store sales, which hit $4m per company-run store in 2003. In August 2003, Krispy Kreme’s stock hit $50 — which was, and would forever remain, its all-time high.

Cooking More Than Just Donuts
In early 2004, Wall Street’s analysts were blindsided by a surprise profit warning from Krispy Kreme. Scott Livengood initially cast blame on the concurrent health crisis sweeping America (the Atkins diet was in vogue). But the analysts were suspicious: why wasn’t Krispy Kreme’s plunging profitability to be found amongst its competitors?

The accounting scandal that would be uncovered in the following few months would go down as one of the most precipitous falls from grace in American corporate history.

Krispy Kreme’s steadily rising earnings had indeed been too good to be true. The firm had been stuffing its affiliates with extra shipments of donuts before purchasing the unsold donuts back itself, which inflated apparent sales. As real sales slowed, reported earnings were further inflated by more and more ‘accounting errors’ — the euphemism used throughout the report into the scandal, which Krispy Kreme submitted to the SEC. The report heavily implicated Livengood, but stopped short of accusing him of cooking the books.

Krispy Kreme’s all-in bet on donuts had placed it on the wrong side of a trend towards espresso-based coffee, and over-saturation from aggressive wholesaling killed off the novelty factor that drew customers in the first place — long before ‘errors’ tarnished its corporate brand.

Starbucks’s success has made it ubiquitous in cities across the planet, including ours. There is only a single Krispy Kreme Donut Theatre in Edinburgh, near the airport, but it works away without the attention it used to receive. The novelty is gone.

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