Assitant Manager

3/24/08

Krispy Kreme Top-Management

From: Jason Hasan

A MASTER PLAN

Executive Summary

The main objective of this case memo consists of analyzing financial data and developing a new strategy for Krispy Kreme to promote financial growth and stability. Provided will be a brief introduction of Krispy Kreme’s current crisis situation, which includes falling stock prices and unethical behavior, as well as greed and rapid expansion as possible culprits of the downfall. After financial data was analyzed, logical future options for Krispy Kreme include selling the company, product innovation, and trimming store levels. Recommendations for future growth and methods to get Krispy Kreme back on track are provided.

INTRODUCTION

When Krispy Kreme went public in April of 2000, the future outlook of the company was very promising and profitable. Investors rushed to buy into a business that had a solid foundation, and was increasing sales and profits at a measured pace. In the summer of 2003, Krispy Kreme was trading at over $50 per share, which was a huge percentage increase in such a short period of time. The company was extremely attractive and many investors bought up several shares as long-term investments. In May of 2004, as quickly as Krispy Kreme rose to prominence, it tumbled downwards and lost much of its popularity. The company may near bankruptcy, and it reported its first losses and missed quarterly target. To worsen the damage, the SEC questioned Krispy Kreme’s purchases of several franchises, and investors filed suite for the rapid plunge in share price. In early May of 2005, Krispy Kreme’s share price was trading at only $6 per share. The question at hand is “What went wrong?” with a business in service for over 70 years, with a popular and well-known product, loyal consumers, and healthy financials? This case memo will analyze Krispy Kreme’s current crisis situation, and will explain how greed, rapid expansion, and suspected unethical practices may have contributed to the quick downturn of one of the industry’s most profitable firms. An in-depth analysis of the current industry and Krispy Kreme’s internal problems will also be examined. Based on the evaluated financial data and current company situation, possible future options for the firm will be outlined and examined, as well as recommendations for the possible future growth of the company. But all in all, the story of Krispy Kreme’s downfall can be looked at as one important idea; how not to expand a franchise.

THE CULPRITS

Greed

An all too familiar foe may have attributed to Krispy Kreme’s downfall; greed. The company viewed sharing markets with other firms as a barrier to increased wealth and profits. They played with several ideas, whether popular or unpopular, to increase profits. As a franchise, Krispy Kreme received fee and royalty payments. In addition to these sources of income, the company required franchisees to purchase supplies and ingredients from the headquarters at high mark-up prices. Krispy Kreme viewed itself as a profit center; prices were aggressively priced and highly marked up. Although the aggressive mark-up in prices may help inflate the next few quarterly reports, it will hurt the company’s long-term profitability. A successful franchise usually builds their business around the royalty payment, and Krispy Kreme built their business around sales. To further this assessment, we can look at Krispy Kreme’s manufacturing and distribution center, KKM&D. KKM&D “averaged about 30% of total Krispy Kreme revenues and 38 to 45% of annual operating income” (Case Book, 139). The doughnut-making equipment packages sold are aggressively marked up, and allows for a greater operating margin. The healthier operating margin looks better for the company’s financial statements and from an investor’s point of view. This approach is beneficial for the franchisor, but may not be the case for the franchisee. These aggressive strategies engaged in by Krispy Kreme may have weakened their ties with the franchisees, and reduced profits and loyalty.

Rapid Expansion

As with all companies going public, there is extreme pressure to grow quickly and maintain healthy quarterly growths in the future. Unfortunately for Krispy Kreme, the industry it participated in, unlike the technology or oil industry, wasn’t accustomed to that consistent future growth. Since Wall Street and the media had high expectations for Krispy Kreme, the company went to extreme lengths to meet these expectations. Krispy Kreme needed additional ways to sustain profitability, especially since they were having accounting problems. They viewed expansion into new markets as a way to increase their profitability. They may have expanded too rapidly. Krispy Kreme got surrounded by the media’s hype and their own hype. According to several accounts, the average number of Krispy Kreme stores has increased almost 5% faster than sales growth during the past three fiscal years. These two graphs show the relationship between the number of stores and sales growth (taken from company documents):

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There is a consistent decrease in sales growth as total stores increase. The inverse relationship suggests expansion was too rapid and wasn’t carefully planned out.

Unethical Practices

As with many other companies and firms, practicing business ethically can be time-consuming and costly. Krispy Kreme was willing to push the ethical and legal boundaries to keep their investors happy. As an informed opinion, the fraudulent activity and unethical accounting practices were the main cause of Krispy Kreme’s downfall. Although no illegal actions have been tied to Krispy Kreme currently, the SEC investigated its accounting practices and several shareholders filed suit against the company claiming fraudulent activity on the part of company officials. Certain details of their accounting practices aren’t completely available, but the SEC claimed Krispy Kreme misused allowance and revenue accounts to increase the sales numbers for their quarterly release. These types of unethical practices may have

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