Krispy Kreme's Essential Ingredient

The opening of the first Krispy Kreme doughnut shop in a new market has become something of a pop-culture event. In October, it was New England's turn, as people slept outside and lined up in the dark at a Krispy Kreme in Newington, Conn. Earlier this year, the Minneapolis Star-Tribune assigned four reporters to cover the chain's local debut.

The one place Krispy Kreme's rapid expansion doesn't draw a crowd is at corporate headquarters in a nondescript office park in Winston-Salem, N.C. The company has grown from 100 stores in 1999 to 249 stores in 2002, but has only added 14 information technology workers in that time (total tech head count is now 26). And while companies in the restaurant industry tend not to spend much on information technology—the industry average is just 0.78% of revenues— Krispy Kreme is especially frugal, spending 0.5% of revenues.

"The battle is to grow but not add too much expense," says Chief Financial Officer Randy Casstevens. "If we are considering an infrastructure that can support 2,000 stores, we can't add a person in IT every time we add 20 stores."

Krispy Kreme's 2000 stock offering catapulted the longtime regional favorite into the national limelight, requiring the company to add important technology tools including a warehouse management system and an online ordering application that allows store managers to order supplies electronically from those automated warehouses. "Our goal is to be highly scalable, to add technology if it makes sense," says Chief Information Officer Frank Hood.

There is no secret formula for Krispy Kreme's parsimonious style of expansion, no single metric to track its cost- effectiveness. "Pragmatism is the banner we operate under," says Hood. "We joke about statistics like dollars per IT worker." Michael Litvak, a senior research analyst at Gartner Measurement, agrees high-level numbers alone are inadequate for measuring the productivity of a company's technology staff. "They give you some direction, but you have to look at how the technology actually works at an individual company," he says.

Krispy Kreme managers focus on specific business needs and then approve technology projects to support them. Budgets start from zero each year, expensive consultants are eschewed—"We don't need someone from a big-name company to tell us what's broken," says Hood—and development is phased to allow users to provide input into the design process. Up to 30% of prototyped features may end up getting scrapped on a typical project, as users identify things they can live without.

Developers working on the online ordering system, for example, rethought a rule that would have forced managers to order only full pallets of doughnut mix from a Krispy Kreme warehouse. "We architected for that functionality [to require full pallets], but with the prototype we could see it was something that could alienate people," says Jim Saunders, a principal with consultants JS Walker & Co., which worked on the project. (The Matthews, N.C., firm generally charges $105-$150 per hour for coding and design work, about half, say, what Accenture would charge.) "If a pallet holds 50 bags and someone orders 51, you want to ask him if he really needs that extra bag. But if you have corporate telling him he can't have it under any circumstance, you might offend him."

Updating During Development

Saunders says the phased development approach may have saved Krispy Kreme as much as 50% on the work his company did for the online ordering project. Allowing for less-than-pallet orders after getting feedback on a prototype, for instance, meant the development team didn't have to go back into the system and recode for the capability after release. "The old model of keeping all the requirements frozen is unrealistic," he says. "It can't be taboo to say in the middle of a build that requirements have changed."

The ordering system, rolled out to the entire company by late 2001, is part of an intranet known as mykrispykreme.com, which was built using software from vendor CoreChange. It replaced a system in which store orders were faxed to keypunch operators, thus freeing those operators to provide customer service to three or four times the number of stores they could handle before. The new method also lets store managers order at their convenience instead of restricting them to business hours when they have customers of their own to service. "We wanted return on investment in one year, and it paid for itself," says Hood of the efficiencies the system has brought.

The warehouse management system, built with radio- frequency tag technology from Integrated Visual Systems, was rolled out in 2000 and quickly paid for itself by increasing the accuracy of picking and packing orders. "There are virtually no errors now as far as correct orders coming to us," says Mar- tin Hendrix, general manager of a Krispy Kreme in Fayetteville, N.C. "Before there were probably three or four mistakes a week—it could be off by as much as ten or fifteen bags of mix, usually not enough of it instead of too much."

Krispy Kreme needs an efficient supply chain not only to meet consumer demand for its trademark hot doughnuts, but also because selling supplies to its franchisees is an important part of its business. "They want to be like Coca-Cola, selling the syrup to its bottlers," says financial analyst Andrew Wolf of BB&T Capital Markets in Richmond, Va. "Franchises have to buy their mix, and they charge a lot for it." Wolf estimates that margins on mix, prior to interest and tax expenses, are in the 30%-40% range.

Krispy Kreme also sells franchisees its proprietary doughnut-making machinery, manufactured at a new plant in High Point, N.C. The company has upgraded its physical facilities as well as its technology, adding a distribution facility in Mira Loma, Calif., and a distribution and manufacturing site in Effingham, Ill., to its Winston-Salem operation. (Last year, Krispy Kreme used an accounting gimmick to reduce its balance sheet exposure to the Illinois plant, but reversed itself after a spate of post-Enron criticism.)

Franchising is critical to Krispy Kreme's growth strategy, and the company needs systems that will help its franchises prosper. There are three types of Krispy Kreme stores—90 or so owned or co-owned by the company itself, the rest owned by an older generation of franchisees who operate a small number of outlets, and by the newer wave of so-called area developers, partners responsible for opening up new territories with multiple stores. Under its franchise agreements, Krispy Kreme gets a royalty of 4.5% of all revenues from its area developers. From its smaller franchisees the company gets 1% of wholesale revenues (doughnuts sold at grocery stores and other offsite outlets) and 3% of retail sales.

Maintaining the Brand

One of the company's priorities is to support a consistent look and feel for the brand at all locations. The low point in Krispy Kreme's long history—the company was founded in Winston-Salem in 1937—came when then-owner Beatrice Foods diluted the brand in the '70s and '80s by adding sandwiches to the menu. In terms of systems consistency, all stores use the order-entry system, although some area developers choose to run some internal accounting and e-mail systems of their own. The online ordering system supports a supply-chain alliance program that offers area developers the benefits of bulk buying power and freight concessions. Says Hood, "We give away solutions. We do charge if franchises want hardware on site, or they can come here via frame relay."

The just-opened New England market is served by area developer Jan Cos., a Cranston, R.I., company that plans to open 16 stores over the next five years in Massachusetts, Rhode Island and Connecticut. Jan Cos., which operates almost 80 Burger King restaurants and several other properties, relies on Krispy Kreme's corporate systems to run its local doughnut business. "We get everything, including help-desk support," says Jan Cos. Vice President Janice Mathews.

Controlling expenses is one important strategy as Krispy Kreme tries to justify the pricey multiples that its shares still attract (the price-to-earnings ratio in late October was 60). But Krispy Kreme remains very much a growth story, and analysts see plenty of room for more stores. "We believe it is in the infancy of growth," wrote analyst David Geraty of RBC Capital Markets in Minneapolis in a research report dated Oct. 11. The company also is aiming to increase the size of its average retail transaction by upgrading the quality of the coffee it serves. The goal, says Casstevens, is to double coffee sales from 5% of revenues to 10%. That would help maintain the impressive 10% annual growth in same-store sales Krispy Kreme has achieved since its IPO.

Another key to increasing same-store sales is adding wholesale business by upping the number of grocery stores and other outlets on delivery routes. Wholesale transactions are handled by a recently upgraded system that runs on AS 400 computers in the stores. Using the AS 400 system, checks that used to take two weeks to apply to Krispy Kreme's account are now handled in half a day. Store manager Hendrix recently used the system to restructure all his delivery routes in one week, a job that would have taken him months in the past.

Members of Hood's staff are expected to be capable of handling multiple tasks. His assistant, Glenna Gerard, also handles hardware leasing and routes calls to the help desk. Hood says a surprising number of his people have advanced degrees, and that turnover is so low that he hasn't lost anyone to another tech job in at least three years (a record that may be helped by the company's high-flying stock).

And some technology costs get amortized by pushing responsibility out into the field. Store managers can handle many routine support tasks, and the company will pay for some technical training of store employees. Hendrix, who started as a route driver for the Fayetteville store in 1970, was reimbursed for courses in Word and Excel at a local technical school, and has sent some of his own staff there, too.

The CIO's next project will likely be a new ERP system from a major vendor to replace a product from Macola (now owned by Exact Software) that has worked fine but won't scale to match the company's growth. He also plans to put all remaining support applications on the Web, including daily cash reconciliation and order entry. "We want to offer our franchisees services that they would otherwise have to pay for," says Hood.

The crowds that seem certain to attend the Nov. 19 opening of the next new Krispy Kreme store in Milford, Conn., will be focused on doughnuts, not Web services for advanced ordering. But for the franchisees and the company to which they pay royalties, those new services could end up being no less sweet.

You may think Krispy Kreme is simply fortunate to find itself in an industry with small outlays on information systems. But the company still spends less than its industry's average. How do you compare to your nearest competitors when it comes to information-technology spending? Is the trick to spend less...or simply target your spending better? E-mail us at baseline@ziffdavis.com to let us know your answers. Krispy Kreme Base Case Headquarters: P.O. Box 83, Winston-Salem, NC 27103 Phone: 1-800-4KRISPY Business: Doughnut shops, some owned and some franchised, selling to retail and wholesale markets Chief Information Officer: Frank Hood Financials: $394 million in revenues, net income $26.4 million (fiscal year 2002) Challenges: Support rapidly growing number of stores without linear increase in information technology costs

Baseline Goals: Limit error rate to 1.05%—or below—for online orders (Current rate: 0.51%) Maintain 10% year-over-year growth in same-store sales Double percentage of revenue derived from coffee sales from 5% to 10%

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in Baseline.