Making Dough
Panera Bread Co. wants to be boss when it comes to bread.

By David Farkas

Ronald M. Shaich once oversaw a 25,000-square-foot factory that produced 80 million frozen-dough products a year. He also OK’d the construction of a state-of-the-art frozen-dough plant in Mexico, Mo., later sold to Bunge Foods for $13 million. But don’t you dare get the idea he’s an authority on frozen dough. “I don’t think that is in any way, shape or form who I am, or where Panera Bread Co. is going,” he coolly informs an interviewer in early December.

Panera Bread Co. Chairman and CEO Ronald M. Shaich is stressing fresh baked goods in an effort to position the concept as the bread leader.

Shaich, chairman and chief executive of the Richmond Heights, Mo.-based, 484-unit bakery-cafe chain, is now a cheerleader for fresh dough. “We drove 450,000 miles [in 2002] bringing it to the stores,” he merrily boasts. Yet that product was used chiefly to whip up batches of Panera’s signature sourdough bread and bagels. This month, however, the company’s 14 commissaries begin supplying fresh dough products for all 14 breads, including nine new “artisan” breads being sold in about 130 restaurants so far. The program requires a $40,000 stone deck oven and, in some units, more cooler space.

“It would be very easy to do frozen bread,” Shaich declares. “But we believe fresh dough is different in taste and in shelf life. As much as anything, the consumer is at the core of this decision—and they know the difference.”

Americans are indeed consuming crusty, European-style breads that remain fresh for only a day or so and cost $2 to $5 per loaf. Although per capita consumption figures are dated, Milling & Baking News reported in 1998 that Midwesterners may eat as much as 3.7 pounds of sourdough, an artisan favorite, annually. Northern Californians eat the most—over 4 pounds a year. Modern Baking recently put the size of the U.S. market for crusty bread and rolls at about $1.8 billion and growing. Both magazines regularly publish articles about the artisan bread movement.

Yet Shaich’s contention that consumers can tell the difference between fresh and frozen artisan breads is a matter of debate. In 1997 a sourdough baguette from Los Angeles-based La Brea Bakery, which ships par-baked breads frozen, easily beat out fresh-baked breads in a San Francisco Chronicle Taster’s Choice panel. “The results are pretty much in on frozen products—people like them,” says Peter Reinhart, a renowned artisan baker, author and instructor at Johnson & Wales University.

Schlotzsky’s recently started selling breads from La Brea Bakery in two Austin, Texas, units. “Until I saw the bread, I would have argued all day long that frozen was worse,” says CEO John Wooley.

Not by Bread Alone
Panera officials concede there may not be much difference in taste between the two. “Is there a dramatic difference? No,” allows Chief Brand Officer Jon Jameson. “But what we do know is that from a consumer perspective we get high marks for making bread fresh every day. We think that’s important.” The bulk of unit sales, by the way, are sandwiches, salads, pastries and soft drinks. Sales of takeaway bread account for a tiny portion of the $1.8 million average volumes, analysts say. The company won’t publicly disclose the figure.

Still, the idea of freshness (“fresh baked,” in Panera lingo) is crucial. Panera has employed a fresh-bread format to create a concept with one of the industry’s highest store-level return—nearly 50 percent (cash-on-cash, noncapitalized lease). That in turn has propelled earnings to an estimated 71 cents in ’02, a 54 percent jump over last year’s 46 cents. Add that to the $1.8 million AUVs and 20 percent store margins, and it becomes very clear why 11 of the 13 analysts who follow the stock and report their findings to First Call rate PNRA a buy.

No surprise, then, that ROI-admiring franchisees have lined up, giving the 48-year-old CEO the luxury of selecting only well-capitalized operators capable of getting restaurants up in a hurry. In October Panera announced two 15-store agreements in Southern California with veteran operators of McDonald’s and Pizza Hut. “[Franchisees] are taking money and cash flow from other businesses and diverting them to Panera,” Shaich boasted in a November conference call to analysts.

Among them is Sam Covelli, who operates 74 units in Ohio, Pennsylvania, West Virginia and Florida, making Warren, Ohio-based Covelli Enterprises the largest Panera franchise. He and his father operated McDonald’s stores before selling them and opening a Panera five years ago. “This is a great concept that’s doing things right,” he says, adding volumes at his stores exceed the system average and continue to grow. “I’ve got a store that’s five years old that has been up double digits every year.”

Expansion—the company and franchisees opened 115 units in ’02—is Panera Bread’s path to glory. But the pace is not exactly clear. Raymond James analyst Brian Elliot, who recently raised PNRA’s price target from $40 to $45, thinks that “at maturity” Panera will be a $5 billion to $10 billion brand. Possible? Even if you define maturity as 10 years hence and assume $1.8 million volumes, the chain would have to open 229 units a year from now until 2013 to reach even the low end of the estimate.

Panera won’t come close this year; franchisees are expected to open 92 units, the company 28. For his part, Shaich doesn’t sound like he wants to speed things up that fast. “We are only in 60 percent of the country. We haven’t sold the country out, and we aren’t going to,” he says.

Asked to explain his philosophy of growth, Shaich says: “What we are trying to drive is average unit volumes, and sales drive return on investment. If there is a high return on investment at the store-level, that allows for development, and development fuels expansion and EPS.”

No Boston Chicken
Don’t confuse that analysis with Boston Chicken’s strategy of the mid-’90s, Shaich warns. “Those guys were developers who said, ‘We’ll build 100 stores and then figure out the concept.’ We come from exactly the opposite place,” he insists. However, there are parallels between prebankruptcy Boston Chicken and Panera: Both peddle upwardly mobile products, get good press, changed names and split their stock 2-for-1. Yet crucial differences exist. A big one: Panera is debt free. At the end of third-quarter ’02, the company had $25 million cash in hand.

Moreover, Shaich, to his credit, hasn’t come up with anything as amorphous as “home-meal replacement” to describe his menu. “Artisan bread,” however, troubles some, who say the term as been co-opted. “What Panera and La Brea are doing right now is an extension of artisan,” Reinhart argues.

What can’t be disputed is the perception of freshness. Busy Paneras bake bread throughout the day. No surprise, then, that the chain is pushing the point in a series of 30-second television spots. In one, a baker prepares loaves of French bread for the oven as a voice-over intones that bread has gotten hip while you weren’t looking; in another, a baker sprinkles Asiago cheese into fresh dough; a third has a sandwich maker cutely stressing the importance of bread. Two of the spots, all of which were directed by the award-winning Tony Kaye, assume the customer’s point of view, one linking rye bread to familial responsibility. Jameson says it tested particularly well among males.

He won’t say how much the commercials cost or offer a figure for the company’s marketing spend (“it’s below 3 percent” of revenues). “I can tell you that 60 percent of marketing resources go against nontraditional brand-building: public relations, buzz marketing, giving back to the community through Operation Dough-Nation,” says Jameson. Panera’s Web site is also an important part of the marketing scheme, he says. Visitors can download a newsletter that explains bread-making, buy gift certificates and locate restaurants.

Jameson and Shaich seem to view themselves as much specialty retailers as restaurant operators. Shaich told Wall Street analysts in a November conference call, “Our whole view is not to promote. ...It’s to find a reason to celebrate.” Panera stores were hawking seasonal bread that featured cranberries, raisins, apples and cinnamon in November and December.

That strikes a chord with former marketing executive Barry Krantz, now a foodservice consultant. “A celebration is a much better reason to give a coupon away,” he says. “It’s much more optimistic than discounting.” Still, he adds, “Most concepts doing beautifully eschew promotions. [But] when they get to the point that something bad happens, they will start doing it.”

How close is Panera to that point? Asked for chinks in the armor, CFO William Moreton can’t think of any. “But we are paranoid,” he asserts. “We’ve all been around a long time. I’d say to anyone wondering, the key indicator will be our average unit volumes. They are the best predictor of how we are doing.” As of last year’s third quarter, units in the comparable sales base were averaging $35,533 a week, a year-over-year gain of 5 percent. That works out to $1.84 million annually.

Tapped Out?
Some observers wonder if there is much sales capacity left. Officials, however, like to remind doubters that volumes have nearly doubled since Shaich, then running Au Bon Pain, bought 19 bakery-cafes in St. Louis some 10 years ago. He sold ABP to a private investment group in ’99, retiring the company’s debt and devoting management’s full attention to St. Louis Bread Co., which outside St. Louis had been renamed Panera. “Four years ago, we thought $1.25 million was great,” Moreton says.

One way Panera can build volumes is by raising prices, something executives are wary of. “We do think we have some pricing power,” Moreton says. “But we’ll always be mindful.” Panera’s $6.30 check average places the concept squarely between traditional fast feeders and the lower end of casual dining, a spot typically described these days as “quick casual.”

Another way to swell volumes is to increase frequency. Officials decline to offer traffic counts but have talked about stimulating more business in a variety of ways. A three-month old prototype in Aurora, Ill., is Panera’s R&D site for several sales-building initiatives. One of them, Shaich says, is figuring out how to speed up service during lunch. “We think it’s difficult [getting through the line] given our volumes,” says Shaich, who clams up when asked for other in-store plans to hike sales.

Another test is in the works: an Outback-like joint venture that offers experienced local operators access to cash flow from as many as 10 units for a modest investment.

In the end, however, Panera Bread Co. fortunes most likely depend on how quickly they can establish the brand across the United States. Shaich has the luxury of picking and choosing battle-tested franchisees eager to share in the bounty. As he explains it: “Usually it’s nine-month mating process, and it has as much to do with how you think of the world and what matters to you. We are not selling you the right to do anything with the Panera brand. We are selling you a very high-return business.” All well and good, assuming Shaich keeps the pace measured and no one gets too greedy. Then, as bread expert Reinhart contends: “This could be a golden era for bread and for the consumer, as long as the integrity of the product is maintained when these companies are faced with profit issues.”