Published January 27, 2010

Learning from the Franchising Mistakes of Failed Krispy Kreme

Buying and operating a franchise can be a great way for an entrepreneur to get into business with a proven brand, business model, and marketing strategy. However, while most franchises can offer sound home office support and allow an enthusiastic entrepreneur a way to make a great income, there are still franchise risks that are out of the hands of the individual entrepreneur.

Case Study: Krispy Kreme's Rise and Fall

Krispy Kreme is one example of a franchise-gone-wrong. The Krispy Kreme craze in the early 2000s drove millions of customers to stores, waiting in line for the cherished fresh glazed delicacies. As a result of the demand, the number of Krispy Kreme franchises exploded, with new entrepreneurs trying to enter in the market. New stores emerged in 400 locations all over the country and the world, and the Krispy donut that enjoyed a large fan base in the South soon had hungry customers in New York, LA, Seattle, Las Vegas, and almost everywhere else.

However, the rapid growth became a problem for Krispy Kreme, and a few years later, the financial fallout became apparent. What can you learn as an entrepreneur who wishes to run a franchise and avoid the franchise risks?

The Problems with Aggressive Growth

One of the reasons behind Krispy Kreme's downfall was its incredibly rapid growth. During the start of the glazed donuts' popularity, people would wait in lines for a rare taste of the warm delicacies, which were beautifully created in front of customers' eyes. Capitalizing on the popularity, Krispy Kreme attempted to sell its brand everywhere and anywhere - ranging from gas stations to kiosks - which diluted the appeal of its core product.

Another definitive franchise failure tactic is to allow franchise locations that are too close in proximity. A new store may offer additional revenue to the home office, but the overall result is less profit for each individual store owner. This was certainly the case for Krispy Kreme. For example, between 2003 and 2004, second quarter revenues increased by 15%, but same store revenues had only increased by .1%. These numbers pointed to oversaturation in the market, which did not bode well for the franchisees themselves.

Profit Over Growth Mistakes

Some franchises would rather see quick bottom line profits on their statements than formulate a strategy for steady growth. In the case of Krispy Kreme, franchisees accused the company of "channel stuffing," wherein the stores received twice the inventory at the end of the quarter so the corporation could bolster its reported profits.

In addition, Krispy Kreme forced its franchisees to purchase equipment and supplies from headquarters. While this is a common practice for franchises, the tremendous markup Krispy Kreme placed on these purchases could not bode well for the long-term success of its franchisee stores.

The franchise companies that enjoy long-term success are those that focus on royalty payments; this aligns headquarters' goals with its franchisees. Forcing franchisees to buy equipment at tremendous mark-ups only bodes well for headquarters, and it is a very greedy short-term profit generating solution.

Indeed, some companies look to their own profit rather than the profit of all franchisees. This may be especially true for a company that has gone public and trades stock shares on the public market. The pressures to produce profit can be extreme, and it could cause corporate leaders to make poor decisions, even leading to improper financial reporting.

Look for these kinds of signs from franchises, particularly a company that is publicly traded. A private franchise corporation may be a better opportunity since owners are generally more interested in seeing the company succeed as a whole, rather than pleasing fickle investors. Watch for signs that suggest that they could be growing too quickly.

You don't want your franchise opportunity to turn in to a failed franchise. If you want to join the success ranks of franchise owners, do your homework and assure that your business will have the support needed to prosper.