Business analysis report on krispy kreme

Krispy Kreme, an international doughnut chain operating in the fast food industry, was founded in 1937 by Vernon Rudolph in the USA.. Krispy Kreme’s signature item is a glazed doughnut, traditionally served warm.

Since the beginning of the 21st century Krispy Kreme has been actively expanding throughout the world. Krispy Kreme itself actively owns stores in the USA and Canada and has franchise-owned stores globally for example in Turkey, Kuwait, Thailand, and Puerto Rico.

This report will focus on Krispy Kreme in Hong Kong, where franchises liquidated, closing 7 out of 9 stores. The possible and evident reasons will be explored further thoughout the report.

General Information on Hong Kong

As being historically influenced by the Western culture – Hong Kong was a colony of Great Britain for nearly 150 years and combining this with the local culture, Hong Kong cuisine is characterized by the fusion of East and West. (Boland) As a result of this, doughnuts are seen by the customers in Hong Kong as a snack choice, one that is accompanied by tea or coffee. In support of this, one of the founders of Krispy Kreme franchise in Hong Kong – the Parfitt brothers has expressed, „We know it is not a product you should eat every day, it is a treat that you should reward yourself with. It is not a meal replacement.” (Standart)

If we take a look at the history of the Fast Food industry in the East, one could see that the two most preferred fast food chains have been McDonalds and KFC for a savoury meal, followed by Dunkin Donuts for snacks. These companies have been very successful in their business in Asia. The first McDonald’s shop in Hong Kong was opened in 1975 in Paterson Street in Causeway Bay, Hong Kong Islands – one of the most expensive areas in the country. (Walker, 2009) Four years earlier, in 1970 KFC opened their first store in Hong Kong. By the 1994, in China alone, they have 1243 outlets. (Chawla, 2005) Dunkin Donuts opened first in 1983 in Taiwan, have entered almost all Asian markets except Hong Kong – they never even entered the market. (Dunkin, 2008)

Other current competitors of Krispy Kreme included Pizza Hut, who have done very successfuly in trying to match consumer preferences. They introduced new slightly different pizzas and succeeded. The local fast food chains such as Cafe de Coral, Fairwood and Maxim`s Express also competed with Krispy Kreme. Probably, the biggest competition though came from the local „street food” – small shops offering something on the go, serving various local Chinese dishes and selling on much lower prices. (Lan, 1995)

3.0 Company analysis: industry and investment

3.1 Krispy Kreme

Krispy Kreme Doughnut Inc opened in Hong Kong, marking its debut on Chinese soil and its second only foray in East Asia – with nine shops already in South Korea. There are signs of the chain’s aggressive expansion in this region, however, China’s potential 1.3 billion consumers seems most attractive. Krispy Kreme’s expansion into Hong Kong proved unsuccessful after only two years of its launch.

3.1.1 Entering New Markets

There are several reasons for Krispy Kreme’s launch in Hong Kong, however, generally the chain faced no other choice but entering new markets due to indigestion in America: as Americans belatedly became aware to the health impacts linked with doughnuts, doughnut sales went down; so-called trans-fats contained in doughnuts which we said to exceed health and safety regulations become a topic of controversy for Krispy Kreme. Moreover, new markets were sought as a means of rebuilding and re-establishing the brand after allegations of accounting indiscretion, diverse corporate troubles and various investigations into the company’s accounts. Thus, the company was incurring great losses (see below). What was formally expressed as a strategy that “depends on opening new Krispy Kreme stores internationally” can be translated into the chain being unable to sell franchises domestically pending the straightening out of its accounting (annual report 200?).

The graph below illustrates Krispy Kreme’s net income (loss) from 2006 until 2010. Overall, one can see that the company hasn’t performed very well during this time, with profits worsening particularly in 2008, as the United States was in the midst of the financial crisis. On the positive side, nevertheless, this graph also shows that the losses made are decreasing.

Krispy Kreme’s overall performance: Net income 2006-2010

3.1.2 Hong Kong as a destination

Hong Kong’s market is both growing and attractive with potential consumers willing to spend extra on treats. It is also a hub for international taste, especially due to its openness for Western food. For this reason Krispy Kreme – upon deciding to expand into Asia – chose to open its franchises in Hong Kong, ultimately hoping to penetrate the Chinese market from thereon.

3.1.3 Why they went, how they went, when they went

In early 2006 Krispy Kreme announced that it would operate a franchise in Hong Kong together with the successful Parfitt brothers, Brian and Wayne. Being Australian, they got attracted to Krispy Kreme through American investors who wanted to set up a restaurant franchise in Asia. (The Standard)

In order to get a better insight to Krispy Kreme`s expansion strategy, it must be said that they exclusively operate under franchises, especially outside their home market, the US.

3.1.4 But the question remains, why do firms franchise in the first place?

Firms sell the rights to the brand in return for a fee to franchisees who also have to pay a monthly percentage of the sales to the headquarters, so money keeps coming in. No major investment has to be made by the firm as franchisees have to pay for equipment, rent and everything else out of their own pocket. Furthermore, it is a much preferred strategy in the hospitality sector.

Krispy Kreme actually has a holding company named KKD lotte holding company with which they work together in terms of franchising and they have been awarded the rights for mainland China for the upcoming years.

In this particular case, Krispy Kreme actually sold all its rights to monitoring the store as well meaning they had no say in future operations, having restricted access. Some would argue this is a reason they failed in Hong Kong because as mentioned above it would be no more than a test market for Krispy Kreme I argue that the owners would still have an interest in being profitable as they are liable for both success and the failure of the stores. (The Standard)

This expansion is regarded as a market seeking FDI investment which is further emphasised due to the close proximity to China, a market with a number close to 1.3 billion people where big potential lies.

In terms of Krispy Kreme, this can be regarded as a “test market” to then evaluate a possible expansion towards Chinese mainland.

Even with aggresive regulations in terms of franchise agreements which requires an opening of at least 10 stores in a limited number of time paired with troubles Krispy Kreme was facing at home such as administration disorder, accounting indiscretions, court charges and falling national trade, the brothers still believed that the product was the key to success.

Surprisingly the number of franchise stores has nearly doubled in the years of 2006 between 2009 reaching from 269 stores to 430 stores respectively. The main reason being the focus of international expansion which as stated previously operate solely under franchises. (annual report 2006/09)

Knowing that Chinese people prefer the savoury rather than the sweet and having been given advices by third parties that this move may well be a risky one to take, they still felt confident that people would treat themselves with such a delicates every now and again. (The Standard)

So on August 8th in 2006, the first Krispy Kreme store was inaugurated in Causeway Bay, the finest area in Hong Kong and only second to 5th Avenue in New York in terms of rent prices (The Standard) ,which is not something to be proud of as will be seen later.

3.2 Nature of Investment

3.2.1 Amounts invested

Krispy Kreme opened in Hong Kong in form of franchises. Its headquarters presented interested franchisees, such as the Parfitt brothers, with certain criteria that had to be fulfilled in order to open up a franchise; these are as follows:

• US$25,000 fee for each shop they open

• Thousands of dollars worth of baking equipment and doughnut mix

• Development fee for the franchise itself

• 6% of sales paid to company as royalties (1/3 above what domestic franchises pay)

• A minimum net worth of $1,000,000 for each store

In addition to this, franchisees had to pledge to give their best efforts to guarantee the success of the company as a whole and uphold Krispy Kreme’s reputation.

3.2.2 Risk involved

Of the main risks involved in the investment, two stand out: on the one hand, failing in Hong Kong would further damage Krispy Kreme’s reputation; on the other hand, the lack of appetite for doughnuts in Hong Kong. In spite of the first proving true, new shops continue to open in the Asian region. The latter concerned the Chinese preference of savoury rather than sweet food and the notion that doughnuts are greasy and heavy. However, the Parfitts saw no problem in this, advocating that this is merely an exaggeration. Above all else the Parfitts seemed convinced that Krispy Kreme would be successful because it suited the Asian way of sharing food as well as the preparation of food in front of customers through its “Hot Doughnuts Now” philosophy.

The graph below contrasts Krispy Kreme’s overall revenues to the total revenues of all franchises. On the one hand this shows how little the revenue of franchises contributes to Krispy Kreme’s overall revenue. On the other hand, and perhaps more importantly, the graph accentuates the performance of franchises by showing the worsened performance of the company overall.

Comparison between Krispy Kreme and Franchises regarding revenue; 2005-2009.

The graph demonstrates the total amount of revenue generated by franchises in the years of 2006 – 2009. The fourth column shows the average revenue per store, calculated by taking the total yearly revenues of franchises and dividing them by the total number of stores. Whilst the calculated average cannot be multiplied to show the net revenue of the franchises in Hong Kong, it can be used as an attempt to indicate store revenues.

Revenues to Franchises to Krispy Kreme

Number of franchises worldwide

Average revenue per franchise

Franchises in Hong Kong

2006

$ 18,394,000

269

$ 68,379

9

2007

$ 21,075,000

282

$ 74,734

9

2008

$ 22,958,000

344

$ 66,738

2

2009

$ 25,537,000

430

$ 59,388

2

Calculated average revenue per store; 2006-2009.

Krispy Kreme`s Initial Public Offering (IPO) came in 2000 after seven years of rapid expansion throughout the USA and Canada mainly. The initial share price started off at a moderate $8.50 and the hype created over the glazed donuts soon reflected in the share price when it reached its peak in 2003 by trading just under $50. In fact people were so crazy about donuts, stores ran out and queus of up to two hours formed outside several stores. (fool.com)

But every success story has an end and Krispy Kreme`s came with the Stock Exchange Comission looking into their financial well-being and being accused of shady accounting.

Investors started pulling out and loosing confindence thus creating a negative spiral on the stock market for Krispy Kreme.

Furthermore, the enlargement plans were too forceful and chaotic and the single objective of the board was “short-term profit” and what was an inimitable trademark soon become mind-numbing and turned into an over-saturated market. (morebusiness.com)

To make matters worse, people became aware of their diets and what they were eating and donuts was unquestionably a product which should not show on a healthy regime.

Scandals have also contributed to the crumbling image of Krispy Kreme in recent years. The most outrageous and shocking scandal were the so-called “trans fats”, which are essentially hydrogenated fats helping to reduce the process of making them as well as making them last longer. This is a scandal in the sense that Krispy Kreme explicitly raise awareness to the freshness of their donuts, making several batches a day. (Top News)

Even though in 2008 they announced a “zero trans fat policy”, it was only upheld in the US, with international stores still making use of it. Not only does this show a double standard for US and other stores but the most worrying part is that these fats can cause coronary heart diseases and other side effects.

The Hong Kong Consumer Council investigated this further and found that the donuts in the Hong Kong franchises still contained 2.2 grams of trans fats, which is double the average standard recommended by the World Health Organisation. (Top news)

3.2.3 New store openings in China

Krispy Kreme, even though having failed in Hong Kong, have together with KKD lotte holding company agreed on new store openings in China. Street food is very popular and Krispy Kreme are planning to offer hot donuts directly from the oven to their Chinese customers, having learned that market adaptation is key to survive, let alone prosper. 35 stores are planned within the next five years, the first being opened in Shanghai. (Krispy Kreme)

The question remains if Chinese people are ready for the one-of-a kind Krispy Kreme experience.

3.3 Government Intervention in Hong Kong

Hong Kong is the world’s 11th largest (HKTDC, 2011) trading economy and is well-known for its laissez-faire approach. Meaning that businesses are able to operate in an environment in which the government is solely responsible for the provision of basic functions such as maintaining law and order, providing infrastructure and guaranteeing property rights. As far as consumer goods are concerned there are no restrictions on the imports and exports however, there are some indirect taxes on certain products such as tobacco and alcohol for example.

Did they welcome it?

In Terms of the Government:

As aforementioned Hong Kong is an example of a laissez-faire economy and hence it does not mind foreign firms operating there. However, they do not support foreign firms nor giving them any incentives to come there either.

In Terms of Customers:

It appears that Krispy Kreme was in fact the first doughnut store in Hong Kong which aforementioned did bear a lot of risks. Being the first meant that there was no specific strategy, previously successful in Hong Kong, they could have followed. There are however, doughnut chains in the Asian region, that at the time of Krispy KReme’s entering into Hong Kong, were running successfully or had failed. Hence, Krispy Kreme could have looked at these competitors and learnt from their successes or failures (see…..).

Furthermore, it needs to be recognised the “doughnut culture never penetrated the Hong Kong eating culture” (The East west hospitality scribe). Firstly, all of Krispy Kreme’s products are far too sweet for the Hong Kong consumer who prefers savoury foods and when he does consume sweet products they are less sweet than American or Korean products. Secondly, within Kong Hong there is a strong culture of local bakeries that sell what is known as “Gaimeibao” or Cocktail Bun which is a soft bun which is either filled or has a topping; flavours including “sausage, dried pork, read bean, custard and coconut in animal fat” (The east west hospitality scribe).These cocktail buns are sold everywhere in Hong Kong including stations and street corners. People consume these cocktail buns in the mornings or afternoon as their breakfast or lunch respectively whereas doughnuts are primarily only seen as a snack. Moreover, the cocktail bun is far cheaper with 4-6 HKD (32 – 48 pence) than Krispy Kreme who sold their doughnuts for 15HKD (119 pence).

Thus, overall the Hong Kong customers were not very welcoming towards Krispy Kreme.

Competitors

In the domestic market the main competition to krispy kreme were the so called cocktail buns which were sold by local stores. These were far cheaper and hence, posed a big threat to KK which they failed to address; especially since donuts were not very popluar in HK and were sold as an add-on to traditional products in bakeries.

Nonetheless, Krispy Kreme could have looked at the doughnut competitors in the Asian region to see how they succeeded or failed.

Dunkin’ Dounts in Japan

Dunkin’ Dounts had been operating for 30 years in Japan until they failed in 1998. The reason for this can be explained as follows. The Japanese consumer is always looking for something “new” and is always willing to try new things hence, if a company wants to maintain successful they need to be able to come up with new products. Furthermore, it is very important for competition to be relatively low so that consumers cannot switch their supplier easily.

In the 1990s the “European European-style bakery and café boom that hit Japan” (Japan Marketing News) which were able to offer a broader variety of products and not all just doughnuts and coffee hence, it was a place where consumers could have breakfast for example. Furthermore, the European-style bakery and cafés were able to offer a more sophisticated dining area which of course was very appealing to the consumer. Thus, by the late 1990s the Japanese consumers were faced with a large option of different cake type desserts and hence, only one doughnut chain was able to survive; this turned out to be Mister Donut.

Mister Donut

Mister Donut, who actually merged with Dunkin’ Donuts in the US in 1990, managed to survive and flourish in Japan. Their ability to do so can be lead back to its original Japanese franchisee who had bought regional rights in 1983 i.e. claiming certain areas for themselves. Furthermore, they also adapted to the consumers tast by introducing flavours like green tea, seaweed or mochi, for example. Ever since, they have been able to expand to Thailand, the Philippines, Shanghai and Taiwan.

ES GÄBE NOCH GO NUTS DONUTS: REIN BRINGEN ODER NICHT?

WICHTIG VLLT WEIL COPIED KK UND SUCCESSFUL: AUCH NUR KOPIERT WEIL ER KEIN FRANCHISE FÜR KK BEKOMMEN HAT

Reasons for failure

Krispy Kreme’s failure can be traced back to low sales. Whilst the company held the global financial crisis responsible for it’s unsuccessfulness in Hong Kong, this idea can be denounced – because matter-of-factly Hong Kong was not as badly affected by the crisis as others. Thus, one has to look at other, more plausible, reasons for Krispy Kreme’s demise. Due to lack of market research, Krispy Kreme failed to fully localise its flavour offering to compete successfully with local bakeries, which as mentioned above, sold sweet buns for less than half the price of a doughnut. Moreover, doughnuts were to sweet for the main Hong Kong bakery consumer as concerns about trans-fats were raised. In addition, franchises were opened in too close a proximity with very little advertising around the product so that there was hardly a “hype” as there is around other Krispy Kreme stores. Finally, at the core of its failure lay the fact that the doughnut culture never really penetrated the Hong Kong eating culture.

4.0 Conclusion

Analysing the case of Krispy Kreme operating in Hong Kong, we came up with the following results:

Failure of KK in HG was directly connected with a lack of market research, especially in terms of specific tastes preferred by Asian customers, eg savoury against sweet;

High rental costs in HK and high prices on the equipment provided by Krispy Kreme HQ based in the USA;

Health and safety issues raised in the USA and then transferred to other countries where KK franchises were operating, eg trans-fats scandal;

American investors have largely shunned the company the past two years because of management turmoil, accounting irregularities, securities investigations, numerous lawsuits and slumping domestic sales;

KK was too profit-oriented focusing on the short-term profitability and aggressive growth plans such as opening 10 stores within HK where the population is only about 8 million people;

Besides the fact that all franchises were closed in HK except those in the airport, many have been opened in other Asian countries;

HOWEVER, one of the most salivating prospects for any multinational business is China’s 1.3 billion potential customers, and East-meets-West Hong Kong, already a hub for both Chinese and Western gourmet cuisine, may be an ideal testing ground. Thus hopefully in the future KK will not repeat its mistakes and they will succeed in the Asian market!