Chipotle’s intricately local supply chain could be the problem

▶ ▶ Chipotle’s strengths are suddenly its weaknesses, too ▶ ▶ “It strikes deeper because so much of their story is based on the quality of their ingredients”

After years of winning customers and investors with its promise of healthy fast food and premium burritos, Chipotle Mexican Grill and its business model have been upended by a far-reaching E. coli outbreak. Sales have plummeted. So has the company’s stock as investors bet that its woes are far from over. All of a sudden, highly processed industrial food doesn’t look so bad.

The outbreak linked to Chipotle has sickened at least 52 people in nine states. And pinpointing the source of the contamination hasn’t been easy, in part for the very reasons consumers have been drawn to the burrito specialist. Unlike the big burgerand-fries brands, which deal with a handful of large beef and potato suppliers and distributors, Chipotle’s 1,900 restaurants depend on a more complex supply chain that includes scores of small, independent farmers. That’s a great way to attract wouldbe locavores and the farm-to-table crowd, which usually looks askance at Mcdonald’s and its kin. But it can also lead to ingredient shortages and questions about food safety.

When Chipotle can’t deliver on its healthy and fresh promise, its greatest strength can turn into its biggest weakness. “It strikes deeper at their brand, because so much of their story is based on the quality of their ingredients,” says Allen Adamson, former North America chairman of branding firm Landor Associates. “This can clearly do long-term damage if they don’t get it under control.”

Chipotle says it’s begun a “farm-tofork assessment” of each ingredient it uses, and that it’s tightened supplier standards, reexamined its food safety protocols, and changed how it handles tomatoes and cilantro. Nonetheless, sales tumbled 16 percent in November, prompting the company to rescind its 2016 sales forecast and announce a $300 million stock buyback to shore up its sliding shares. Chipotle’s stock is down 22 percent over the last four months, the worst performance among restaurant companies in the Standard & Poor’s 500- stock index.

Managing a supply chain that consists of more than 50 independent farmers can be like herding cats. An increased risk of contaminated produce is just one difficulty. Another challenge is securing a reliable flow of responsibly grown products with fewer chemicals and no antibiotics in the volumes that a $4.1 billion restaurant chain demands. In recent years, Chipotle has occasionally struggled to fully stock its stores with

hormone-free chicken, grass-fed beef, and pork raised at noncorporate farms (the company says 95 percent of U.s.-raised pork doesn’t meet its standards). And it has warned it may have to stop selling Gmo-free salsa and guacamole because of rising costs.

Earlier this year, the company suspended a pork supplier after an audit determined it wasn’t meeting Chipotle’s standards for housing pigs, which call for “deeply bedded barns” and access to the outdoors. Chipotle was forced to pull carnitas from about a third of its restaurants, and it took the chain months to find additional pork suppliers. The absence of carnitas dragged on sales and led investors to question whether the chain’s much-ballyhooed food standards might restrain its growth.

In the wake of the E. coli cases, Chipotle says it’s reevaluating its local produce program, which began in 2008. The program mainly runs from June through October, the growing season in most of the U.S. Any pullback would hit at the heart of Chipotle’s culture and marketing, which has touted its support of small farmers and sustainable agriculture.

“You can never eliminate all risk, regardless of the size of suppliers, but the program we have put in place since the incident began is designed to eliminate or mitigate risk to a level near zero,” Chris Arnold, a spokesman for Chipotle, said in an e-mail.

Even before the outbreak, Chipotle was struggling with slowing growth, with sales at established stores rising only 2.6 percent in the third quarter ( before the latest health scare began), compared with 19.8 percent a year earlier. The company has faced higher food costs associated with sourcing GMO- and hormone-free ingredients. It also had to step up its advertising spending this summer “to keep Chipotle top of mind,” Chief Financial Officer Jack Hartung said in October.

This isn’t the first time Chipotle has hit a bump. It posted a meager 2.2 percent gain at established restaurants in 2009, leading to questions that the chain may have plateaued after growth of more than 10 percent in two of the previous three years. But that turned out to be a rare off year. Chipotle’s sales at established stores rose 17 percent in 2014.

The company may be facing a more serious challenge this time. What initially appeared to be an E. coli outbreak limited to the Pacific Northwest, where Chipotle closed 43 restaurants in Oregon and Washington, took on larger proportions when the Centers for Disease Control and Prevention said there were cases in additional states.

The string of incidents has raised concerns about the company’s business model. “I worry about the small, local supplier who doesn’t have the resources to track the latest things to do on food safety,” says David Acheson, a former Food and Drug Administration official who now runs a food safety consulting business. “They’re small operators, and you simply don’t have the infrastructure and the capacity to keep up with this stuff.”

In July a smaller Chipotlelinked E. coli outbreak occurred in Washington, sickening five people. Another Chipotle, in California, saw about 180 customers sickened by an outbreak of norovirus during the summer. In September salmonella infected dozens of the chain’s customers in Minnesota. In that case, tainted tomatoes were to blame. And in early December, as news of the latest E. coli scare made headlines, Chipotle closed a restaurant in Boston following complaints of “gastrointestinal symptoms” from Boston College students, including members of the men’s basketball team.

“It’s not very common to see outbreaks linked to the same place, the same brand, in a couple of months with different issues,” says Benjamin Chapman, an associate professor and a food safety specialist at North Carolina State University. “It does make you wonder how they’re managing food safety as a whole.” �Craig Giammona and Leslie Patton

The bottom line After E. coli-tainted food sickened 47 customers, Chipotle is rethinking using local farms—one of its key marketing points.