Dunkin' Donuts Tries to Go Upscale, But Not Too Far

By JANET ADAMY
The Wall Street Journal
April 8, 2006; Page A1

Dunkin' Donuts last year paid dozens of faithful customers in Phoenix, Chicago and Charlotte, N.C., $100 a week to buy coffee at Starbucks instead. At the same time, the no-frills coffee chain paid Starbucks customers to make the opposite switch.

When it later debriefed the two groups, Dunkin' says it found them so polarized that company researchers dubbed them "tribes" -- each of whom loathed the very things that made the other tribe loyal to their coffee shop. Dunkin' fans viewed Starbucks as pretentious and trendy, while Starbucks loyalists saw Dunkin' as austere and unoriginal.

"I don't get it," one Dunkin' regular told researchers after visiting Starbucks. "If I want to sit on a couch, I stay at home."

SIZZLING SECTOR

Bridging some of that divide -- but not too much -- is key to Dunkin' Donuts' ambitious plan to expand its largely Eastern coffee chain into a national powerhouse that's as synonymous with coffee as Starbucks Corp., the nation's largest coffee chain. Armed with fresh capital from December's $2.43 billion private-equity buyout of Dunkin' Brands Inc., Dunkin' plans to remake its nearly 5,000 U.S. stores over the next three years, and have triple that number in less than 15 years.

Dunkin' plans to unveil the first part of the new strategy Monday with an advertising campaign aimed at rebranding the chain as a quick but appealing alternative to specialty coffee shops and fast-food chains. Chief Executive Jon Luther says Dunkin' is likely to consider an initial public offering in the next two to three years under new owners Thomas H. Lee Partners, Bain Capital Partners and the Carlyle Group.

While executives of Canton, Mass.-based Dunkin' insist they aren't trying to emulate their Seattle rival, Dunkin's store makeovers include some similarities to Starbucks. A prototype Dunkin' store in Euclid, Ohio, outside Cleveland, features rounded granite-style coffee bars where workers make espresso drinks face-to-face with customers. Open-air pastry cases brim with yogurt parfaits and fresh fruit while a carefully orchestrated pop-music soundtrack is piped throughout.

Dunkin's challenge underscores how Starbucks, which has blanketed the U.S. with almost 7,800 tony locations, has forced quick-service restaurants to rethink store designs and menus. With Americans eating more snacks and fewer meals, Starbucks is taking food sales from restaurants as it encourages customers to visit its coffee shops around the clock.

Yet Dunkin' built itself on serving simple fare to working-class customers. Inching upscale without alienating that base is proving tricky. There will be no couches in the new stores. And Dunkin' renamed a new hot sandwich a "stuffed melt" after customers complained that calling it a "panini" was too fancy.

Some customers "have remarked along the lines of 'You're trying to be somebody else,' " says Ryan Humphrey, who oversees Dunkin' franchisees in the Cleveland area. Regina Lewis, the chain's vice president, consumer and brand insights, says, "We're walking that line. The thing about the Dunkin' tribe is, they see through the hype."

Dunkin' Donuts hopes to counter Starbucks by expanding its menu beyond breakfast with snacks that can substitute for meals, like smoothies and dough-wrapped pork bites. The new Euclid store is doing three times the sales of other stores in its area, partly because more customers are coming after 11 a.m. for new gourmet cookies and Dunkin' Dawgs, hot dogs wrapped in dough, says Matt Zaroslinski, the store's director of operations.

Anne Saunders, Starbucks senior vice president, global brand, says Starbucks doesn't focus on Dunkin' Donuts as a competitor. While competitors may use elements of its strategy, they can't recreate Starbucks' "unique and differentiated concept," she says.

William Rosenberg opened the first Dunkin' Donuts in Quincy, Mass., in 1950 after running a business that delivered meals and coffee-break snacks on the outskirts of Boston. Residents flocked to his store for the coffee and fresh doughnuts. Mr. Rosenberg started franchising the Dunkin' Donuts name and, by 1963, the East Coast was home to 100 stores.

In 1982, the company began running ads starring Fred, the weary, mustachioed baker who woke before sunrise to make doughnuts. The popular spots helped transform the chain into a cultural icon. Expansion continued into the Midwest and Southeast, with franchisees owning all the stores. European drink maker Allied Domecq PLC bought the company in 1990.

Losing Sales to McMuffin

At that time, Dunkin' was losing breakfast sales to Egg McMuffins and other morning sandwiches at McDonald's Corp. and Burger King Corp. Starbucks and other high-end cafes began sprouting in the 1990s, bringing more competition. By then, Dunkin' concedes, some of its stores had become smoke-filled and dingy. Sales slid as the company clung to its strategy of selling sugary doughnuts by the dozen.

In the mid-1990s, Dunkin' shifted its focus to coffee in the hope that promoting a more frequently consumed item would drive store traffic, says William Kussell, Dunkin' Donuts' chief operating officer. Later, Krispy Kreme Doughnuts Inc. started gaining doughnut market share as it expanded beyond the South. From 1997 to 2002, some Dunkin' stores were moved under the same roof as two other brands owned by its parent company Allied Domecq, ice-cream-chain Baskin-Robbins and sandwich shop Togo's.

The idea was that each brand would draw customers at different times of the day: Dunkin' for breakfast, Togo's for lunch, Baskin-Robbins for late-day snacks. It didn't work. Customers were confused and franchisees complained it was too difficult to manage everything from slicing tomatoes to baking doughnuts to making milk shakes, Mr. Kussell says. Last fall, Dunkin' Donuts began extracting the other brands from stores.

The coffee push, however, was a success. By 2005, when Pernod Ricard SA acquired Dunkin' Brands Inc. as part of its purchase of Allied Domecq, sales at Dunkin' totaled $3.85 billion, up 14% from the previous year.

Coffee makes up 62% of sales. Dunkin' says it is continuing to improve its coffee. Last year, it created a special advisory council to travel across Central America in search of higher-quality beans.

Dunkin', which has about 6,800 stores world-wide, says operating profit grew 35% in the two years that ended in 2005.

Dunkin' says it sells 2.7 million cups of coffee a day in the U.S. A Starbucks spokeswoman says it sells about four million.

Starbucks, with roughly 11,000 stores world-wide, had revenue exceeding $6 billion last year. The Seattle-based chain created what it calls a "third place" -- outside the home and office -- featuring couches, eclectic music and art-splashed walls. It's part of the reason customers are willing to pay more for Starbucks coffee. A 10-ounce cup at Dunkin' Donuts costs $1.19 on average, while a 12-ounce cup at Starbucks costs $1.40 to $1.65, depending on the location.

Other chains mimicked Starbucks while Dunkin' stores remained essentially the same. Four years ago, McDonald's began a major redesign in areas where there was a high concentration of office workers, adding earth-tone colors and replacing fluorescent lights with single lamps that dangle over tables at restaurants. The fast-food chain is testing espresso beverages and last month rolled out a stronger coffee blend. In some stores it sells a blend made by Seattle's Best Coffee, a Starbucks brand.

Dunkin's Chief Executive Mr. Luther, a former president of Popeyes Chicken & Biscuits who joined Dunkin' in 2003, says he tried to convince other executives there was "life across the Hudson River." He thought the company should fill out markets in the East, then expand West. In 2004, Dunkin' finally began drawing its own plan to remake stores.

Company researchers set out to determine whether Dunkin' could draw consumers in new cities, and how to lure customers from fast-food chains, coffee houses and convenience stores. "Consumers love environments," Mr. Luther says. "We have to move our environment where the customer is."

Early research showed consumers wanted nicer stores, but revealed a potential problem: the loyal Dunkin' tribe was bewildered and turned off by the atmosphere at Starbucks. They groused that crowds of laptop users made it difficult to find a seat, Dunkin' says. They didn't like Starbucks' "tall," "grande" and "venti" lingo for small, medium and large coffees. And, Dunkin' says, they couldn't understand why anyone would pay as much as $4 for a cup of coffee.

"It was almost as though they were a group of Martians talking about a group of Earthlings," says Justin Holloway, an executive vice president at Hill, Holliday, Connors, Cosmopulos Inc., the advertising agency that helped Dunkin' with its research. One customer told researchers that lingering in a Starbucks felt like "celebrating Christmas with people you don't know."

The Starbucks customers Dunkin' paid to switch were equally uneasy in Dunkin' shops. They bristled when workers dumped standard amounts of cream and sugar in their coffee, instead of letting them do it for themselves, choosing their own amounts. "The Starbucks people couldn't bear that they weren't special anymore," Mr. Holloway says.

About 45% of Dunkin' Donuts customers have an annual household income between $45,000 and $100,000 a year, the company says -- with 30% earning less than that and 25% earning more. Dunkin' says its customers include blue- and white-collar workers across all age, race and income demographics. Starbucks' Ms. Saunders says that while its early customers tended to be urban professionals, the base has expanded so broadly it can't be categorized. She wouldn't release information on customers' average income.

Dunkin' researchers concluded that it wasn't income that set the two tribes apart, as much as an ideal: Dunkin' tribe members wanted to be part of a crowd, while members of the Starbucks tribe had a desire to stand out as individuals. "The Starbucks tribe, they seek out things to make them feel more important," Ms. Lewis says. Members of the Dunkin' Donuts tribe "don't need to be any more important than they are."

Starbucks's Ms. Saunders says her company's customers don't fit into a mold but "tend to be people who do like to be introduced to new things." She says that the company hasn't done similar studies comparing its customers with those at Dunkin' Donuts.

Dunkin' executives made dozens of decisions, big and small, ranging from where to put the espresso machines to how much of its signature pink and orange color scheme to retain to where to display its fresh-baked goods.

They decided early on that Dunkin' would keep its goal of moving customers through its cash register line in two minutes; Starbucks, by comparison, has a goal of three minutes. Dunkin' customers said they didn't want any changes in store design to result in longer waiting times.

Out went the square laminate tables, to be replaced by round imitation-granite tabletops and sleek chairs. Dunkin' covered store walls in espresso brown and dialed down the pink and orange tones. Executives considered but held off on installing wireless Internet access because customers "just don't feel it's Dunkin' Donuts," says Joe Scafido, chief creative and innovation officer. Executives continue to discuss dropping the word "donut" from its signs to convey that its menu is now broader.

Dunkin' sought to add hearty snacks to appeal to meal-skipping customers. Focus groups liked hot flatbreads and smoothies, but balked at tiny pinwheels of dough stuffed with various fillings. Customers said "they felt like something at a fancy cocktail hour," Ms. Lewis says, and weren't substantial enough. Dunkin' increased the size and will market them as "bites" filled with pork and other ingredients.

Dunkin' stores have never had piped-in music. The company hired Muzak LLC to "architecture" a sound that was upbeat but "won't annoy people," Mr. Scafido says. The result is a soundtrack including pop-star Jessica Simpson, classic-rock group Queen and hip-hop singer Beyoncé Knowles -- as well as artists that are familiar at Starbucks, such as Stevie Wonder. "It's not the Starbucks sound," Mr. Scafido says.

New ads feature the slogan "America Runs on Dunkin' " and show office and construction workers relying on the chain to get them through their day. Marketers are exploring ways to allow customers to place orders online and via text messages.

At the Euclid store, Mr. Zaroslinski says most customers say they like the increased natural light from larger windows, the expanded menu and the new coffee bar that includes stainless steel pitchers of cream and skim milk that customers use on their own -- a first for Dunkin' Donuts. Franchisees are footing the $150,000 bill for remodeling each store.

Different Vibe

Stacey Stevens, a 34-year-old Euclid resident who recently visited the new Dunkin' store there, said she noticed it felt different than other Dunkin' locations. "I don't remember there being lots of music," she said, while picking up a dozen doughnuts. "I like it in here." She said it felt "more upbeat" than Starbucks.

One Euclid store manager persuaded Richard Wandersleben to upgrade from a regular coffee to a $2.39 latte during a recent visit. The 73-year-old retired tool-and-die maker, who drinks about three cups of coffee a day, says he liked espresso when he got his first taste from a coffee vending machine in Arkansas. But when he tried it later at specialty coffee shops, "it didn't taste anything like that." The Dunkin' Donuts latte, however, suited him fine. "It's a little creamier," than regular coffee, he said.

Dunkin' Donuts plans to expand in the East, adding stores in Charlotte, Pittsburgh, Indianapolis, Jacksonville, Fla., Nashville and Cincinnati. It doesn't plan to start building out on the West Coast for about five years. Mr. Luther says there's one city it has no plans to enter: Seattle.