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  • CFO Magazine

Kremed!

The rise and fall of Krispy Kreme is a cautionary tale of ambition, greed, and inexperience.

Giant Krispy Kreme competitor Dunkin’ Donuts, for example, doesn’t “generally sell equipment or product to [its] franchisees,” says Kate Lavelle, CFO of the 6,400-store chain. “We have a strong royalty stream that is based solely on store sales.” This model, says Lavelle, “keeps company and franchisee interests aligned.”

Krispy Kreme, on the other hand, raked in $152.7 million — 31 percent of sales in 2003 — through its Krispy Kreme Manufacturing and Distribution (KKM&D) division, which sells the required mix and doughnut-making equipment. With initial equipment packages selling for $400,000, KKM&D can have operating margins of 20 percent or greater. But what’s good for the franchisor’s bottom line isn’t necessarily good for the franchisee’s. “[Raw ingredients and equipment] are sold to franchisees at what [is] an exceptionally high margin…. It is difficult to say how much this margin needs to drop to support franchise operations, but it must,” wrote Ivankoe in an August 2004 report.

The Thrill Is Gone

In its quest for growth, Krispy Kreme also squandered some of its mystique. “They became ubiquitous,” says Jonathan Waite, an analyst for KeyBanc Capital Markets in Los Angeles. “Not just in sheer numbers of restaurant units, but also roughly half of their sales started going to grocery stores, gas stations, kiosks. Anywhere that consumers could be found, you could find a Krispy Kreme.”

In what amounted to an act of heresy to Krispy Kreme devotees, the company also added smaller “satellite” stores that didn’t actually make doughnuts. Unlike its factory-style franchises where customers could watch as the pastries were showered in glaze — “doughnut-making theater,” the company called it — some new stores offered doughnuts that had been made elsewhere. Other products were added to the menu, too, including a line of high-carb, high-calorie frozen drinks, or “drinkable doughnuts,” as people dubbed them.

Straying further from the appeal of its key product, in May 2004 the company announced that it was developing, of all things, a sugar-free doughnut, in response to the popularity of low-carb diets. (The sugarless doughnut has yet to be rolled out, however, and the new management team is reviewing the concept.)

Fudging the Numbers

As Krispy Kreme pursued its ambitious growth strategy, it was making missteps in the finance department as well.

Except for the company’s plan to finance a $35 million mixing plant in Illinois with an off-balance-sheet synthetic lease — a plan the company scuttled in February 2002, in the face of post-Enron suspicions — Krispy Kreme’s accounting seemed unremarkable until October 2003. That’s when the company reacquired a seven-store franchise in Michigan, called Dough-Re-Mi Co., for $32.1 million. The company booked most of the purchase price as an intangible asset called “reacquired franchise rights,” which it did not amortize, contrary to common industry practice. Krispy Kreme had also agreed to boost its price for Dough-Re-Mi so that the struggling franchise could pay interest owed to the doughnut maker for past-due loans. The company then recorded the subsequent interest payment as income.

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