Less than three months after hiring a new advertising agency, Steak n Shake has jettisoned and is now suing the Georgia-based firm.

The hasty firing of The Varnson Group and subsequent lawsuit has industry analysts wondering if the tumult will become a distraction in the effort to turn the restaurant chain around.

"It's really difficult for an outsider to know what's going on," said Bryan Elliott, an analyst covering the restaurant industry for Raymond James & Associates in Georgia. "But they need to keep their focus on moving forward."

Industry analysts called the developments between the locally based chain of 490 restaurants and its new—now former—ad agency highly unusual, noting that such relationships usually last years, not months.

The Varnson Group signed a $4.36 million, 26-month contract in mid-November, with just over half of that to be paid in Steak n Shake stock. Steak n Shake terminated the deal in early February.

The lawsuit filed by Steak n Shake March 3 in Indianapolis doesn't go into why the company and Varnson split. Rather, it deals with the aftermath of the breakup. Steak n Shake claims the agency is refusing to turn over myriad proprietary material, including data, Steak n Shake's marks, promotional materials, photographs, coupon templates and other print advertisement templates.

Additionally, Steak n Shake claims The Varnson Group refuses to release a Web site domain name where customers can access and print online coupons. Steak n Shake is seeking unspecified damages and return of the proprietary information.

Steak n Shake officials and their attorneys declined to comment on the lawsuit.

In a response filed in court April 9, The Varnson Group denies it has retained any proprietary Steak n Shake material.

Further, Varnson in the counterclaim accuses Steak n Shake of dealing in bad faith by engaging in discussions with some of the nation's largest ad agencies, including J. Walter Thompson, Empower Media, Zimmerman and ID Media, in an attempt to replace Varnson. Varnson officials claim Steak n Shake never intended to retain them for the full 26 months of their original contract.

Varnson also claims Steak n Shake axed the firm before the 90 days mandated in the original contract's termination agreement. Upon receipt of the termination notice, Varnson submitted invoices for $1.62 million to wrap up the account. It says it is still owed almost $450,000.

Officials for The Varnson Group and their attorneys declined further comment, but stated in their counterclaim they are seeking a jury trial.

Y&L: No complaint

After Texas investment guru Sardar Biglari became Steak n Shake chairman and CEO last year, the restaurant chain parted ways with Indianapolis-based Young & Laramore, its ad agency of 18 years. Y&L was instructed to forward much of the advertising material it developed for Steak n Shake directly to The Varnson Group. Y&L officials said the transition went smoothly.

"Steak n Shake completely honored their obligation in winding down their relationship with us," said Y&L CEO Paul Knapp. "We had a 90-day termination clause in our contract, and they paid all the way through. That's an honorable thing to do."

Knapp said Y&L hasn't heard from Steak n Shake since.

The rift between Steak n Shake and the agency it left Y&L for couldn't come at a worse time for the restaurant chain. The company has reported 13 consecutive quarters with same-store sales declines, including a 7.4-percent drop in November.

And on March 19, Miami-based Burger King Corp. filed a lawsuit against Steak n Shake in Florida alleging the Indianapolis restaurant chain is infringing upon its trademarks.

The lawsuit claims Steak n Shake's name for mini hamburgers, Steakburger Shots, is "confusingly similar" to trademarked Burger King names. They include BK Burger Shots, BK Breakfast Shots and BK Chicken Shots.

Steak n Shake declined to comment on that lawsuit.

The product the chains are battling over is part of Steak n Shake's new strategy of emphasizing value meals.

Last month, Steak n Shake introduced a low-cost lineup, including meals under $4, daily milkshake happy hours, and a $2.89 Steakburger "snack pack." Its advertising campaign has shifted from the clever, catchy Y&L creations to a more straightforward approach emphasizing low prices.

The strategy seems to be paying dividends, with customer traffic in the first part of the first quarter up 6.2 percent and same-store sales improving 1.8 percent.

"The new ad campaign's emphasis—which is a vast departure for Steak n Shake—is on value, value, value," said Bruce Bryant, president of locally based Promotus Advertising and Indianapolis AdClub past president. "That's OK to a point.

"I thought Young & Laramore did a great job of taking them away from the fast-food approach. With this new campaign, they jumped right back into the fast-food fray. From a competition standpoint, that can be a difficult way to go."

Trouble from the start

Bryant said he started hearing late last year from locally based Varnson employees.

"They were looking for other work," he said. "They said things weren't going well."

The structure of the contract—which was attached to the lawsuit filing, indicates Steak n Shake wanted the project "fast-tracked," Bryant said.

Sources within the local ad industry said Steak n Shake officials insisted Varnson Group employees work out of Steak n Shake's local headquarters to keep a close eye on them.

"When Steak n Shake agrees to pay an agency that kind of money in such a short time, that shows they had a very aggressive timetable," Bryant said. "With a timetable like that, you can bet a client will demand a lot of your time. That can hinder things from running smoothly. The ramp-up and learning curve on a campaign like this can be pretty substantial."

The pressure the company was putting on its new agency is probably being felt internally as well. Steak n Shake employees are likely feeling the pressure from Biglari, who is insisting on higher profitability, industry analysts said. Already, there has been fallout between Biglari and board members and some defections within the restaurant chain's marketing staff, industry sources said.

The strategy of discounting core menu items—and not just lower-priced items like most restaurants do—is probably putting intense pressure on Steak n Shake and its marketing division, Raymond James' Elliott said.

"If they're going to lower their margins with steep discounts, there's pressure to increase the number of customers significantly," Elliott said. "There's a substantial amount of improvement that needs to take place."