Doughnut Invasion: Krispy Kreme Takes on the Asian Market

The sugary delight of Krispy Kreme doughnuts once inspired a stock-market fever and a pop-culture buzz in the United States that turned the brand into an icon in the same league as Yahoo! and eBay.

But that was then. These days, Krispy Kreme is suffering indigestion at home. Not only are shops closing across the United States as Americans belatedly awaken to their bulging waistlines, but allegations of accounting irregularities, numerous lawsuits and securities investigations are hanging over Krispy Kreme, driving its shares down more than 80 percent from their peak three years ago.

cimg0551So, in search of new friends, North Carolina-based Krispy Kreme has come to Asia. The chain opened its first shop in Hong Kong last week and will debut in Jakarta by the end of the month. Tokyo, Manila and Macau outlets are in the works for coming months, building on an initial foothold established in Seoul a year and a half ago. At the other end of the continent, Krispy Kreme is setting up this fall in Kuwait with additional shops planned for the United Arab Emirates, Saudi Arabia and Egypt.

The calorie-laden, oil-saturated, sugar-packed treats appear to be making an impact.
“I love the Original Glazed donuts,” says a Hong Kong Internet advertising executive who almost immediately started keeping a box in his office for his staff and visitors after the shop opened across the street.  “Lots of people are lining up every day.  This is new to Hong Kong people..”

More than 2,000 people in Hong Kong, most of them ethnic Chinese, registered as "Friends of Krispy Kreme" on the chain's local web site ahead of the opening. Many know the brand from time spent in the United States.  The one Hong Kong store is being crowded by customers the way Japanese tourists used to throng the Louis Vuitton outlets in the Peninsula Hotel a few years ago, says the Hong Kong-based strategist for a Japanese investment bank.  Another fan, Ephraim Lam said he picked up a hot Original Glazed habit after a shop opened near his brother's apartment in Silicon Valley when both were working in California. He even looked into the chain's franchise requirements. "Krispy Kreme is different from other doughnuts," he says.

"There's lots more people outside the US than inside the US," says Jeffrey Welch, senior vice president of development and international franchising, while presiding over the Hong Kong opening. The company's most recent annual report to the US Securities and Exchange Commission put it another way: "Our growth strategy depends on opening new Krispy Kreme stores internationally."

That's because, according to the report, the chain cannot legally sell new franchises domestically until it straightens out its accounting; its latest audited results are a year and half old.

"Given that they are cash-constrained at home, franchising abroad is pretty much their only option," says Michael Lord, who directs the international studies center at the Babcock Graduate School of Management in Winston-Salem, NC, the leading business school in Krispy Kreme's headquarters city.

Krispy Kreme's new franchisees will pay the company a US$25,000 fee for each shop they open, buy thousands of dollars worth of baking equipment and doughnut mix and pay a development fee for the franchise itself. The new Hong Kong franchise, for example, is importing all doughnut ingredients, save sugar, from the company.

What's more, international franchisees pay 6 percent of their sales to the company as royalties, a rate one-third above that of recent domestic franchisees and twice that of older ones.

These numbers can add up as Krispy Kreme stores overseas generally charge significantly more than domestic ones. A box of a dozen of the chain's signature Original Glazed variety that goes for less than US$6 in its home market sells for the equivalent of nearly US$10 in Australia, more than US$11 in Hong Kong and Seoul, and US$13.25 in London.

In its last annual report, Krispy Kreme recorded a 67.6 percent gross profit margin from franchising, four times the company's overall margin, but franchising represented just 3.5 percent of total revenue. "In absolute terms, it's not very big," Lord says.

Asia is the chain's target, Welch and other Krispy Kreme officials in Hong Kong for the opening said, because of the region's combination of crowded cities and diets skewed toward freshly prepared foods such as sushi.

A key element of Krispy Kreme strategy and its ability to command more for doughnuts than the average bakery is the experience customers get in its shops. A red neon sign reading "Hot Doughnuts Now" turns on periodically to indicate when Original Glazed doughnuts are coming off the production line, Customers can watch the process through plate glass windows in the shop and when lines build up, staff often come through offering complimentary hot ones right off the line.

The showy production equipment requires a large shop space. "To make money at this requires a lot of [foot] traffic," says Lord, who leads annual class trips to Hong Kong and China. "The US is so suburban and spread out that it’s more difficult to have high traffic locations. The Krispy Kreme concept may have more promise overseas than in the US."
Timing is another reason to think so. A perennial issue for Krispy Kreme at home has been the cultural categorization of doughnuts as a breakfast item. The chain experimented unsuccessfully with offering sandwiches and salads to sustain all-day sales.

Welch, who previously worked abroad for the parent company of KFC and Pizza Hut, says most overseas markets treat doughnuts as a snack, enabling Krispy Kreme international stores to stay busy afternoons, evenings and late at night.

Hong Kong and other Asian cities likely present easier targets now than a decade ago.
Hong Kong-based restaurant group Dan Ryan's Chicago Grill began selling ribs, barbecued chicken and American-sized steaks in 1989. In the beginning, local customers rejected the restaurants' home-style French fries, considering the bits of skin left on to be dirty, according to Michael Nardozza, chief executive of parent company Windy City International. But these days, potato skins with cheese are a top menu item. "People's palates evolve," says Nardozza, whose group now also operates in Taipei and Singapore. ""I think Krispy Kreme will probably be very acceptable to the market."

Nardozza said that in economically advanced Asian cities, residents eat homogeneous meals at home balanced with occasional outside alternatives.  "Outside you have these extremely cosmopolitan cities selling a tremendous variety of ethnic foods," he said. "We're seen as variety."

Hong Kong residents are especially into eating international foods, says Joseph Salvacruz, who researches food marketing as a professor at the Hong Kong University of Science and Technology.

"The Hong Kong market is very receptive to new ideas," says Salvacruz. "I think doughnuts will sell well in Hong Kong."

Krispy Kreme hopes so, but doughnuts have previously been almost invisible in the city. They represent just 1 percent of sales at La Rose Noire, a leading pastry and baked goods wholesaler.

"Chinese people like savory more than sweet [flavors]," says general manager Yvonne Wong. "[Doughnuts] are a bit too greasy for them and a bit too heavy for them."

Brian Parfitt, one of two Australia brothers operating Krispy Kreme's Hong Kong/Macau franchise, concedes the preference for tangy flavors among Hong Kong residents. But he adds, "They still eat a lot of sweet things," noting that a Chinese dessert shop around the corner from his office is full of customers as late as 3 am on weekends.

A challenge for the Parfitts is Krispy Kreme's aversion to traditional advertising in favor of buzz. In the US, the chain usually got out word to the public about new stores by dropping off boxes of sample doughnuts at local television stations a week or two ahead of time. TV news crews usually then made an event of the openings themselves, in effect offering Krispy Kreme cash-free advertising. But the only television crew that covered the Hong Kong opening was from CNN International, a channel with a limited audience in the Chinese-speaking city. The chain's arrival also received little mention in Hong Kong's dozen-odd Chinese newspapers. The city's largest English-language daily reported the chain's coming but editorialized against it for tempting children with junk food.

The chain's best chance to make a sweet impression on the press came when Tsang Yok-sing, leader of the city's largest pro-Beijing political party, brought Krispy Kreme doughnuts to reporters covering a marathon legislative debate a few days before the Hong Kong opening. Most newspapers mentioned Tsang's gesture, but none of the Chinese papers mentioned the brand.

Competitors have already built doughnut markets in most of the other Asian cities Krispy Kreme is targeting. Dunkin' Donuts, its primary domestic rival, failed in its initial international foray in Japan, but has since spread into South Korea, Thailand, Indonesia, Malaysia and the Philippines as well as Saudi Arabia and the UAE.

Mister Donut, a chain established by the brother-in-law of Dunkin' Donuts' founder, is another key player in the region. Dunkin' Donuts and Mister Donut were merged in the US in 1990, but Mister Donut has survived to flourish in Asia thanks to its original Japanese franchisee, which bought regional rights in 1983, extended the brand to Shanghai, Taiwan, Thailand and the Philippines and overhauled the stores' offerings.

Mister Donut made a blockbuster debut in Taipei around the same time Krispy Kreme reached Seoul. For months, Taipei residents waited in line as long as four hours just for a taste of non-traditional doughnut flavors like seaweed, mochi and red bean.

Krispy Kreme will also face local chains, such as Go Nuts Donuts, a Philippine group started by a young businessman who was spurned in his bid for a franchise by Krispy Kreme.
Go Nuts has copied the visible on-site baking approach, but says its doughnuts are bigger and less sweet and last longer than the originals. This spring, Go Nuts started franchising domestically and it also opened a franchise shop in Kuwait City in June, beating Krispy Kreme to the punch. The Middle East franchise comes with rights to nine countries and Go Nuts is next aiming for Malaysia, China and Australia, according to its web site.

Another hassle, cited in Krispy Kreme's annual report, comes from people who registered the chain's name or a soundalike in countries including Indonesia, the Philippines and Thailand. Welch said the company recently reached agreement with the registrant in Indonesia and has decided Philippine food-cart operator Krispy Krepe poses little threat.

The Asian franchises are selling doughnuts only at their own stores and stalls to establish them as destinations. Krispy Kreme's US business originally focused on wholesale sales and some observers have traced the popping of the Krispy Kreme bubble in the US in part to a cheapening of the brand through distribution of lower-end items with the Krispy Kreme mark in supermarkets and convenience stores.

To bridge the freshness and production gap from the move to small in-store production lines, franchises like the Hong Kong one are setting up full-scale production lines in cheaper industrial buildings to make the other doughnuts that share the menu with Original Glazed and will equip stalls with ovens to finish off the baking process in front of customers.
The Asian franchisees are doing all this with their own money. When Krispy Kreme first started selling international franchises four and a half years ago, it took large equity stakes in franchises in four of the five territories granted.  The key exception, where Krispy Kreme took no equity, was South Korea.

According to Krispy Kreme's annual report, three of the part-owned international franchisees went deep in the red in 2004 and two others barely broke even, contributing to the company's US$157.1 million loss for the year. Recently the company sold off its stakes in its franchisees for Australia, New Zealand, Britain and Ireland, and those franchisees are opening new stores again.

"The franchisees will have a good idea of what it takes to succeed," says Lord from the Babcock School. "These entrepreneurs will work hard because it's their money that's invested."

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Protected by WP Anti Spam