Dunkin' Donuts Growth Strategy Questioned

But while many Wall Street experts are enamored with the company's West Coast expansion prospects, one former Dunkin' Donuts franchise owner knows firsthand the flaws with that strategy.

"The franchisor wants to create more sales, and the best place to create more sales is to create new sales where you already have high sales," said Irwin Barkan, author of "Dunk'd, A True Story of How Big Money is Corrupting the Franchising Industry." "When you have two stores (of close proximity) you invariably will have a higher volume of sales between the store, but you'll be cannibalizing your store base.

"But when the pendulum swings to the franchisor, his goal is to sell as many cups of coffee as possible and gets 5 cents for every dollar."

Barkan's book, "Dunk'd" is an e-Book published through Smashwords. It is available online for $9.99 at Amazon, Barnes & Noble and other online retailers. Barkan's Web site is dunk-d.com.

The Canton, Massachusetts based company, which also owns Baskin-Robbins, unveiled its IPO on Tuesday night at $19 and immediately saw its stock price trend upwards. Currently the stock price sits at a little over $29 ahead of its earnings report on Wednesday.

One reason Wall Street liked Dunkin' is how the company has competed against Starbucks and others in the Northeast, where Dunkin' has a high concentration of stores, while the West is prime with growth opportunity. There is one Dunkin' Donuts for every 5,000 people in New England, while only about one for every 1.2 million people out west of the Mississippi.

Dunkin' executives refer to it as "white space opportunities," and are hoping to successfully leverage its well-known name out West, but Barkan doesn't buy into the hype.

"They've been trying to fill up that white space for 30 years," the former Rhode Island area Dunkin' Donuts franchise owner said. "It's not like they haven't heard of the rest of the United States, they are in 20 other countries."

The company has plans for major expansion over the next few years, hoping to add 250 stores over the next year and to double its 6,800 locations in the next 20 years. The costs of expansion will largely fall on potential franchisee owners as the company looks to boost volume and revenue.

While Dunkin' sees that expansion as a key to its long-term success, Barkan sees opening 250 new stores as the ultimate lose-lose for Dunkin'.

"If they do I think they will be in more trouble than if they don't," he said. "Either they will over expand and (thus) report poor sales growth, or they under expand and have unmet expectations."

"Then you start making excuses and the excuses will be just like Krispy Kreme's."

Krispy Kreme proved to be a cautionary tale for the risks of over expansion. Krispy Kreme saw incredible growth in its amount of stores only to see it all collapse in 2004. The company attempted to move its Southern based hot donut company northward only to face major resistance from companies like Dunkin' Donuts.

The "Dunk'd" author foresees Dunkin' Donuts facing similar resistance when it enters markets out of its main base.

"You can't hopscotch over these white areas and decide that you are going to land in Louisville and they are going to love Dunkin' Donuts," he said. "Krispy Kreme went public on franchising in new markets-it turned out as much as everyone loved those hot donuts in the South, there were already plenty of donuts in the Northeast."

"The real story there is (Krispy Kreme) got franchisees to open stores in markets that were untested and the stores failed miserably."

Barkan expects Wednesday's earnings numbers to be positive-the company wouldn't announce its IPO a week before a bad report-but that over the next two years the company will face a multitude of problems.

"My prediction is next two quarters they will be talking about unmet expectations in growth in new markets," Barkan said.

"I don't see much value in the stock at all-but that's not untrue of a lot of IPOs. This is an IPO that is based on projections that are completely unrealistic. And you should be able to make realistic projections when you've been around as long as Dunkin' has."