Panera sees sandwich delivery as growth driver

by Josh Sosland
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Panera has been testing delivery of its sandwiches for over a year.

ST. LOUIS — Calling sandwiches and salads products ideally suited to be delivered from bakery cafes, Ron Shaich, chairman and chief executive officer of Panera Bread Co., said delivery looms as a major source of future growth for the company.

Mr. Shaich spoke about the company’s delivery efforts in comments April 29 following the release of quarterly financial results.

Panera net income in the first quarter ended March 31 totaled $31,860,000, equal to $1.20 per share on the common stock, down 25% from $42,395,000, or $1.55 per share, in the first quarter of 2014. Revenues were $648,504,000, up 7% from $605,337,000. Contributing to the steep decline in earnings were charges during the first quarter of 2015 totaling $8.9 million related to the company’s refranchising initiative. The company is seeking to refranchise 50 to 150 bakery cafes. Excluding the charges associated with this effort, earnings during the quarter were down 9%.

While earnings were down, the company experienced a number of positives during the quarter, including a 1.5% increase in comparable bakery-cafe sales. Of the 1.5% increase, 0.1% was attributed to transaction growth and the balance of 1.4% was due to average check growth.

Pressuring profitability was a 180 basis point decline in operating margins, pressured by higher wages and costs related to the company’s strategic initiatives, specifically its digital Panera 2.0 program.

During the quarter, 25 new bakery cafes were opened, bringing the total operating as of March 31 to 1,901.

While the costs and promise of Panera 2.0 was a major topic during the conference call, Mr. Shaich spoke at some length about the company’s delivery program and its potential. He said the delivery initiative is being led by the former president of one of the “big three” pizza companies as well as this executive’s former executive vice-president of operations.

“Let me share some of what we’ve come to understand about delivery,” Mr. Shaich said. “We’ve come to believe that delivery offers us the potential to materially increase our sales volumes per cafe and to become a long-term driver of sales growth. In fact, I would call it a very powerful opportunity. Further, we have come to learn salads and sandwiches, because they’re generally not heated and because they travel particularly well in a vehicle, are a perfect product for delivery especially at lunch.

“We’ve also come to understand that delivery is hard, and the key to success with delivery is having the capabilities in place needed to execute delivery consistent with the high volumes it can generate and doing so all the while without damaging the retail business. Indeed, delivery is not something you want to throw into an already high volume cafe environment as doing so will appear smart in the short-term but ultimately prove a limited long-term positive impact if not executed properly with high customer satisfaction and with a driver network that efficiently leverages cost.”

Responding to a question, Mr. Shaich distinguished this delivery opportunity from Panera’s older catering initiative, handled mostly from delivery hubs.

“On our present model delivery will be done in our retail store,” he said. “Now our mission, as I defined for you earlier, the way we think of delivery, is it has to manifest itself or show up to our store managers as simply another to-go order. If they get more involved in it than that it is going to complicate their lives and be problematic. That is why it is so important that we have the digital ordering system. That is why it is so important the digital ordering system literally tie in to the production systems.”

To avoid this complication, Mr. Shaich said delivery would be “essentially either outsourced or managed through a modestly different management system much like we manage our baking.”

Panera has been testing delivery for over a year and is currently operating in two markets with its own drivers an in another two with outsourced drivers, Mr. Shaich said.

“We will expand our test to additional markets in 2015 and will make a judgment relative to a broader roll-out in 2016,” he said. “In any case, expect that when Panera does delivery it will do it right.” (For Mr. Shaich’s complete remarks about delivery, click here).

Expanding on the tighter margins, Mr. Shaich said increases in the minimum wage in several markets contributed to the pressure as did additional labor hours necessitated by work associated with Panera 2.0 conversions. He said the company was slow to pass these higher costs along.

“We took a 1.4% price increase partway through March, which we felt we needed to take to continue attracting to Panera the team members we desired,” he said. “We took the price to offset structural wage inflation, which in turn was driven by significant increases in the minimum wage in many markets in which we operate. In retrospect we likely waited too long to take the increase as the minimum wage increases on Jan. 1 drove our managers to quickly raise wages to maintain a differential versus minimum.”

Ingredient costs for bakery products represented an offset to the higher wages, said Mike Bufano, the company’s chief financial officer.

“The margins of our fresh dough facilities improved by 160 basis points in the quarter,” he said. “This margin improvement is primarily the result of a year-over-year decrease in wheat costs, which declined by roughly 10% compared to the first quarter of 2014. As a reminder, we ladder our wheat purchases (to) the impact of swings up and down in the market are moderated in our P&L.”

Mr. Shaich identified a number of product upgrades the company has implemented or planned, including the introduction of broth bowls, the reformulation of salad dressings with simpler ingredients and new turkey sandwiches.

“As well bread remains an important demonstration of our brand promise, so we will continue improving the health benefits of our breads,” he said. “Beginning in September all of our flatbreads will feature 15 grams of whole grain in each serving.”

Commenting on progress the company has made with Panera 2.0, Mr. Shaich said stores that now offer the digital ordering program average about 20% of their sales from business conducted using the capability.

“This is likely one of the highest digital percentages in the restaurant industry,” he said. “And let me say that is exclusive of the pizza players who are running close to 50% digital and who have been playing the e-commerce game for almost a decade.”

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