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The Hump-Day Dance

By

"I need a vacation from Todd-O's vacation"

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Jeff,

Having attended college at Virginia Tech, (you may know it as The Harvard of Montgomery Country, Virginia) I have been very familiar with the KrispyKreme (KKD) product for over 20 years. When KK's arrival at 23 St. in Manhattan coincided with my arrival at 22nd St, in 1995, I nearly had my mail delivered to the shop for convenience. What I don't know though, even after reading your article, is why the company, and subsequently the stock, failed in their plan to go national.

Unlike your Blockbuster (BBI) column, I didn't gain any more of an idea about why KKD failed from your piece, other than a vague comment on the need for tight controls during an explosive growth stage. There is a comment about it being just a matter of time until KKD imploded and that the growth projections were laughable (and then a comparison to IOM and TASR). The premise that I took out of the story is that KKD should have never gone public. Here are the questions that I have (and, btw, I have never traded professionally, or owned personally KKD or any stock in the retail space. My curiosity about the story of businesses is at the heart of these questions):

1) Basically, I don't know how a franchiser books revenue. Is it from fees (% of sales) from the franchisee? Or do KKD's revenues reflect total doughnut sales? Because as I look at quarterly sales figures of a company that has been public for over five years, I'm not sure I buy the premise that the growth projections were laughable. I don't have the original prospectus of course, but the sales growth was explosive and five years is certainly long enough to be a trend. (I haven't followed closely enough but were the sales numbers fraudulent?)

2) If a company has the best product in a particular industry but a miniscule market share, does it really matter that the industry itself is not a growth industry? Since the decision to expand, I don't believe the KKD product has suffered.

3) Was there something about KKD that put it at a competitive disadvantage against say, Dunkin Donuts in the Northeast? Is serving doughnuts hot not a viable strategy?

4) Reading your article, it's easy to conclude (and I am clearly inferring this -- you didn't imply it) that we should have viewed Starbucks (SBUX) as a cult stock too and that In-N-Out should never go public. Do you agree or is there something about KKD's business and retail exposure that made a national roll out an idea that was truly doomed from the start like say, Webvan?

These questions don't really deserve an in-depth answer to a single reader, but maybe they provide ideas for a follow up column.

Thanks for your time,

Minyan Joe

Hey, Joe!

"Thanks for (my) time"?!

Brother, thank you for an e-mail so thought provoking and well-worded I hardly even noticed the bitter sting of the "constructive" portion! Your note shall serve evermore as a feedback template for the capable young Collins (who often pronounces my work "not even suitable for Critter Litter").

Your questions are all more than worthy of column time. Part one, regarding the financing of franchise operations in general and KKD's accounting failings in particular, is worth its own full piece. I've forwarded your note to Herb "The New Guy" Greenberg. He's been on them for years; I am but the candy sprinkles on the deep-fried goodness of Herb's labors. We can compile a Krispy Kreme reading list and maybe add some more thoughts in a coming effort.

Let's hit the others...

#2:) If a company has the best product in a particular industry but a miniscule market share, does it really matter that the industry itself is not a growth industry?

"It depends" is a lousy answer but, alas, is the also the most correct.

What it depends on is, in no particular order: a) How much being the "best product in the industry" is worth (Family Golf Centers (trading only in money heaven) had the best driving ranges anywhere... turns out that doesn't really matter) b) What does the company do once they've rolled-up scattered weak players in a space? (Blockbuster (BBI) rolled up the mom and pop's, once upon a time.) c) How does the company in question plan to go about solving that "miniscule market share" issue?

We'll address C, which is the clearest failing of Krispy Kreme, in more detail later. The major point is that franchising (selling others the rights to your trademarks, product, design etc. in exchange for a chunk of general revenues) is the fastest way to gain share. Your franchisees are paying you for the right to do most of the "wet work" of growth. They usually build the site, hire the staff, serve the customers etc.

The problem is that there are limits to the control a parent organization has over franchise stores. Not even the king of kings franchise chain (McDonald's (MCD)) can dictate policy to all their units.

That's the best of the franchise-driven model problems. The more common, and why this deserves more space, is that the relationship between parent co and franchise operations is a labyrinth of shell companies and self-dealing, most of which is obscured in financial communications (for both nefarious purposes and because the parent co themselves doesn't really know).

3. Serving doughnuts may be a viable strategy, that just doesn't make Krispy Kreme either the company to take advantage of it or an operation interested in returning the dough to shareholders. (Again, not to be a column-tease, but we'll get to this).

4. Starbucks (SBX) is the next Starbucks.

I'm not being at all flip. I'm saying "be very, very skeptical of 'the next...' stock ideas". Krispy Kreme has a wildly different business model, a great track record as operators and they actually expanded the market for their product.

The funny thing about the stocks that are always used for the latter part of the "XXXX is the next $$$$!" stock pitches is that they were never, themselves, "the next" anything.

Starbucks was an original, right from the start.

When we walk through the franchise model in general, and Krispy Kreme's particular "Stylings" on same, we'll see how you can tell the difference.

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