Can Dunkin' KO Krispy?

In the war of the doughnuts, the reigning champ has been getting bopped by the upstart. Now, Dunkin' Donuts is plotting a new offensive

By Faith Arner

For half a century, Krispy Kreme and Dunkin' Donuts have warily eyed each other from different sides of the Mason-Dixon line. Krispy Kreme Doughnuts (KKD ) ruled the Southeast with its hot, gooey glazed doughnuts, and Dunkin' blanketed New England with boxy outlets that served more cups of coffee than they did crullers.

Each chain built a cult following: Krispy Kreme combined a wholesome, 1950s image with an airy, sweet-beyond-imagination doughnut. Dunkin' was the dependable delight at the strip mall, a blue-collar joint that supplied cops and construction workers but also drew regular folks who shunned $3 lattes from Starbucks (SBUX ).


  Yet the doughnut détente is about to end as both chains race to expand nationwide. Krispy Kreme took a major step in June when it opened its first store in Massachusetts -- Dunkin' Donuts' home turf. But the impact of KK's lone Bay State outlet on DD will be more symbolic than financial in the near term. Dunkin', a division of Allied Domecq (AED ) based in Randolph, Mass., boasts 600 stores in the Boston area and 3,800 stores nationwide, vs. Krispy Kreme's 292. Its $2.8 billion in annual revenue dwarfs Krispy Kreme's sales of $492 million in the year ending Feb. 2.

So why does Dunkin' Donuts seem like the underdog in this battle? Partly because Krispy Kreme has come on so strong since it went public in April, 2000. Since then, it has opened about 150 stores -- more than it estimated in half the time it allotted. Krispy's stock price has quadrupled to more than $40, and same-store sales grew 11% last year, vs. 6% for Dunkin' Donuts. Krispy Kreme spends nothing on advertising (except for handing out free doughnuts to local media outlets when it opens a new store), yet it boasts nearly as much brand buzz as megamarketing wonders like Nike or Coke.

For investors, the question is whether Krispy Kreme's run in the sun on Wall Street is threatened. Dunkin' Donuts is gearing up big-time to fight back even as it has had to combat negative images about its brand. Outlets that weren't doing enough housekeeping to meet the chain's standards became the butt of late-night jokes. Some franchisees were convicted of underreporting income and evading income taxes. Dunkin' sued hundreds of franchisees to help clean up the chain's reputation.


  Unlike Krispy Kreme, investors can't bet on just Dunkin' Donuts. It's just one part of the Quick Service Restaurant (QSR) division of the British-based Allied Domecq. Baskin Robbins and Togo's are the other two. QSR makes up 9.5% of sales and 13% of the parent's profit.

Still, Dunkin' has its work cut out for it. After 53 years of making doughnuts, the chain has yet to match its well-known brand name with a nationwide presence. "Dunkin' Donuts is the 800-pound gorilla that is only living in 40% of the forest," says Christopher Muller, an associate professor at the University of Central Florida's Rosen School of Hospitality. Nearly two-thirds of its stores are located in the Northeast and mid-Atlantic states, with very few west of the Mississippi.

Meanwhile, Krispy Kreme's blistering expansion has helped it pick up market share. In 2002, it owned 13.1% of the U.S. doughnut market, up from 4.8% in 1999. In the same period, Dunkin' Donuts' share has dropped 20 points, to 57%. Some of that has gone to mom-and-pop operations, but a huge chunk has gone to its main rival, according to Technomic Information Services.


  Dunkin's numbers could erode further as Krispy Kreme borrows a move from its competitor's playbook. First, it's not stopping at doughnuts. It'll be building a bread business, and it's heating up its coffee offerings -- just like Dunkin' Doughnuts. And Krispy plans to open smaller, cheaper satellite stores. "They'll make Krispy Kreme much more convenient for customers," says Scott Livengood, the Southern chain's CEO.

Convenience is exactly what has made Dunkin' Donuts thrive. In the densest parts of its core New England market, it boasts one store per 6,750 people (Krispy Kreme until now has aimed for one store to serve 100,000). In some places, four or five Dunkin' outlets can be found within a half mile of each other, each with cars lined up through the parking lot and out onto the highway shoulder during morning rush hour. For Boston-area commuters, stopping at a Dunkin' Donuts outlet for coffee in the morning is about as routine as getting dressed.

"We're talking massive customer loyalty," says Nancy Koehn, professor of business administration at Harvard Business School. Even a Krispy Kreme manager at the Medford (Mass.) construction site had an orange-and-purple Dunkin' cup and bag on his desk.


  Yet spreading that customer loyalty beyond the Northeast and getting existing customers to spend more each time they come in is a tall order. Jon Luther, who heads the chain as CEO of Allied Domecq's QSR unit, is trying to serve up solutions. To get more franchisees in new areas to sign on, he has offered to build doughnut-production facilities for them and run them for up to five years. In the past, franchisees in an area formed a co-op and shared the burden.

"Dunkin' Donuts' weakness is that it isn't national, but it will be," says Luther, the first outsider to run the company since founder Bill Rosenberg sold his first Dunkin' doughnut in 1950. The chain plans to open 342 new stores this year in the U.S. and 630 more in 2004 -- the equivalent of more than three entire Krispy Kreme chains.

Next, Luther will try to convince customers used to a regular cuppa joe to switch to pricier espresso and latte. But doesn't the upscale coffee clash with the chain's Joe Doughnut image? Not necessarily, say some marketing experts. The popularity of Starbucks and other specialty coffee stores has started to move once-elite espresso and cappuccino into the mainstream -- where Dunkin' Donuts rules.


  "Small luxuries [like premium coffee] have become more mass market," says Koehn of Harvard. "Core customers are considering trying a latte or cappuccino. It may seem more palatable or trustworthy in a Dunkin' Donuts cup." The trick for Dunkin' will be to serve them fast. The chain promises to deliver a cappuccino in less than a minute.

Dunkin' has never claimed to be a trendsetter. Quite the opposite, in fact. After Starbucks introduced frappuccino, Dunkin' came out with its Coolatta and saw beverage sales soar. When bagels took off in the mid '90s, Dunkin' jumped on that trend, too. Now it's the largest bagel retailer in the country. "We watch trends and then Dunkinize them," says Ken Kimmel, a vice-president of Dunkin' Donuts Concepts, the chain's marketing arm.

And at the pace Dunkin is going now, the pressure on Krispy Kreme to execute its strategy perfectly increases. It's something for investors to think about the next time they bite into a nice sugary donut.

Arner writes for BusinessWeek in Boston

Edited by Beth Belton

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