Krispy Kreme Case Study

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Krispy Kreme Doughnuts Case|
Seminar in Finance|
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Gregory Steigerwalt|
4/17/2012|

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Krispy Kreme Case – Discussant

Krispy Kreme’s rapid expansion may have been the reason for its rapid fall. Recently becoming a publicly traded company in April 2000, Krispy Kreme shares had seen amazing growth as they were selling for 62 times earnings. Naturally, this created a buzz around Wall Street, and an “obsession” with Krispy Kreme began as it became one of the hottest stocks on the market. Yet, analysis of the fundamentals of Krispy Kreme needed to by analyzed to see the true threats the company had brought upon itself. Analysis of Krispy Kreme’s business model and strategy gives a good insight as to how the company had become so successful. Within their revenue generation, Krispy Kreme had four main sources: on-premise sales (27%), off-premise sales (40%), manufacturing and distribution of product mix and machinery (29%), and franchise royalties and fees (4%). Taking a quick snapshot of these percentages, we find that roughly 67% of their revenue comes from selling their finished product with the remainder coming from producers/owners. The nature of these revenues may be part of the reason for the fall of Krispy Kreme. An analysis of their revenues shows:

At first glance, it may appear that Krispy Kreme’s different income sources may give it a diversified revenue stream. However, with only two thirds of their revenue coming from sales to the end customer, the remainder 33% needs to be analyzed to how it affects the margins of Krispy Kreme. Krispy Kreme requires all of its franchise stores to purchase the proprietary doughnut mixes and doughnut making equipment directly from their Manufacturing and Distribution division which also provided quarterly service to all system units. Yet, these were mostly one time purchases by startup franchises, and in turn, the sales level of the machinery was directly related to growth in the number of stores. As the Wall Street Journal article stated, “Krispy Kreme has relied for a significant chunk of its profits on high-margin equipment that it requires franchisees to buy for each new store” (Krispy Kreme Doughnuts Case – Page 105). This statement further shows that an aggressive expansion policy (in number of stores) would be vital for Krispy Kreme to grow its annual revenue, especially with the high margin it receives on these items. Moreover, royalties and fees were a source of income for Krispy Kreme as up to $50,000 were paid in franchise fees with an additional 6% in royalties along with 1% of a franchise’s total annual sales were given to the corporate advertising fund. When looking at these two sources of income, one-third of Krispy Kreme’s revenue, there is ample reason for Krispy Kreme to pursue aggressive expansion of its business. Being a “darling of Wall Street” (KKD Case – Page 101) had created pressure on the executives of Krispy Kreme to continue outperforming expectations, and expansion was the only way to continue receiving the high margin income from selling machinery. However, the aggressive expansion that Krispy Kreme pursued also played a part in its own financial downfall. By expanding so quickly, Krispy Kreme had “diluted its cult status” (KKD Case – Page 105) which had originally made it so popular. A number of analysts following Krispy Kreme had come out with recent statements, commenting on the growing uncertainty of Krispy Kreme’s business strategy and accounting practices. Some items the analysts commented on regarding revenues were (KKD Case – Page 105):

* Krispy Kreme had lost focus on its operations, resulting in too many new stores being opened in poor locations * Improperly trained franchisees, resulting in inefficient running of off-premise business which lowered Krispy Kreme’s operational efficiency/income potential * Restructuring of store contracts that charged reduced fees for equipment and...
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