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Dunkin' Donuts' expansion plans may create coffee clash: Chain could put damper on Starbucks' local growth

October 22, 2007

The return of Dunkin' Donuts to the metropolitan area last month gave java lovers here their first whiff of a brewing coffee war.

The Boston-area-based chain's Carmel location is one of 80 franchised stores slated to open within the next eight years. Its re-entry into the market is part of a national campaign to more than double the number of its 6,000 locations by reinventing itself to challenge Seattle's Starbucks.

Dunkin' Donuts is rolling out concept stores with hipper furniture and music and more emphasis on hot and cold beverages than on its high-carb yeast and cake doughnuts.

Indeed, the Northeast institution boasts of selling more coffee by the cup than anyone in the country. Within the company, coffee sales account for 63 percent of revenue.

Speed and price are central to the expansion of its blue-collar appeal that hinges on a faster and cheaper "cup of joe" for, well, the Average Joe. Its regular blend is about $1 cheaper than Starbucks'.

"You could open a Dunkin' Donuts right next to Starbucks and get two completely different types of consumers," said Richard Feinberg, a Purdue University retail professor. "If they fail, it will not be because of Starbucks."

A business model harnessing the experience of food and beverage veterans who can develop multiple locations, rather than relying on individual entrepreneurs like in the past, should give the stores an advantage, executives said.

Franchisees lined up

In Indianapolis, for instance, Dunkin' Donuts has agreements with three franchisees:

Harlan Bakeries Inc. of Avon, a multimillion-dollar operation that produces bagels and other baked products, hopes to open 40 stores.

Miracle Restaurant Group of Mandeville, La., an operator of 46 Arby's restaurants in Indiana, Illinois and Chicago, wants to open 25.

Local developers Ken Wright and Mike McCracken plan to open 15 franchise locations.

Besides the Carmel location, stores will launch by year's end at 38th Street and Shadeland Avenue, and at 86th Street and Ditch Road. More will follow in the spring, said Lynette McKee, vice president of franchising for Dunkin' Donuts.

"We just know that this is going to be a great market," she said. "When we announced we were going into Indianapolis, the response was overwhelming."

Starbucks vulnerable?

Even so, Dunkin' Donuts might have to work hard to recapture customers after it abandoned the market. Indianapolis once had nine stores, with the last one, at 86th Street and Ditch Road, closing in 2003.

Dumpy franchises and tired product lines led the company to slowly fizzle out in central Indiana, retail experts say.

The chain since has beefed up its food offerings with breakfast and lunch sandwiches, spiffed ups its décor, and may be catching Starbucks at a vulnerable time. Lower-than-expected sales growth during Starbucks' fiscal third quarter may be one indication its momentum is slowing.

During that period, the company reported same-store sales growth of 4 percent and a 20-percent increase in revenue, to $2.4 billion. While solid, the growth missed analysts' 6-percent expectations, reflecting flat traffic for the second consecutive quarter.

In an Aug. 1 research note, Deutsche Bank retail analyst Marc Greenburg speculated that waning traffic and increased pressure from competitors will hurt Starbucks' aggressive expansion plans.

"Starbucks is growing up, and coping with maturity is rarely an easy process," he wrote.

Starbucks' sales in 2006 grew 21.5 percent, to $7 billion, ranking it No. 5 in the top 100 restaurant chains tracked by Chicago-based food consulting firm Technomic Inc. Dunkin' Donuts' sale grew at nearly an identical pace, 20.7 percent, to $4.6 billion, ranking it No. 9.

The ubiquitous Starbucks announced last October its long-term plan to add 40,000 stores worldwide, half of which will be in the United States. How many will be in Indianapolis is unclear, as the company doesn't break out growth by city, said spokeswoman Bridget Baker via email. Executives declined to be interviewed about plans for Indianapolis or competition with Dunkin' Donuts.

For now, Starbucks is still opening stores at a rapid pace. During the third quarter, it opened 668 stores, as part of its overall target of 2,400-1,700 in the United States-by the end of fiscal 2007. It forecasts another 1,700 locations nationwide next year.

Starbucks operates about 80 stores within 20 miles of downtown Indianapolis, according to the company's Web site.

"Specific to competition, we believe there is room in the coffee world for many different approaches and providers," Baker said. "We're focused on continuing to provide the coffee expertise and welcoming experience that customers can get nowhere else."

McKee at Dunkin' Donuts dismissed the competitive nature of the industry as well, saying the company views its expansion as an opportunity to bring its products to an expanding customer base.

At any rate, the coffee industry remains lucrative. The number of shops is growing at an annual clip of 7 percent, making them the fastest-growing sector of the restaurant business, according to industry statistics. Further, it is projected there will be more than 50,000 shops nationwide by 2010.

In a country where 400 million cups of coffee are consumed each day, it's logical to assume there's room for two competitors. After all, McDonald's and Burger King, as well as Coca-Cola and Pepsi, are among the scores that have fought it out for years.

The small players may feel the tightest squeeze, however, said Steve Delaney, a principal with locally based Sitehawk Retail Real Estate.

"The unfortunate victim of all these coffee wars will be the independent guys," Delaney said, "as opposed to Starbucks and Dunkin' Donuts hurting each other ... sadly."

Local independent Hubbard & Cravens Coffee Co. has just five stores, but is somewhat shielded from exposure by its large wholesale business. Still, Marcia Hubbard, director of store operations, thinks there remains room for more operators.

Yet expansions of national coffee and doughnut chains have not been without problems.

Krispy Kreme Doughnut Corp. rolled into town in the 1990s, intriguing consumers with its hot doughnuts they could

watch being made behind a glass partition. In 2000, the Winston-Salem, N.C., company went public and its stock soared.

It later tanked, the victim of too much hype, over-expansion, heavy debt and franchisee issues. The company closed a number of stores, and today only one operates locally.

Poor timing contributed as well, expanding at the "height of the carbohydrateswill-kill-you-in-a-week phase," Feinberg at Purdue said.

It's doubtful Dunkin' Donuts could suffer a similar fate. None of its stores are corporate-owned, and they're better positioned to succeed this time around, executives argue. Delaney at Sitehawk concurred.

"Dunkin' originally looked for the mom-and-pop franchisees," he said. "Now they're looking for large, aggressive ones. They've really changed their profile."
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