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”

Bloomberg Businessweek (North America) - - Contents -

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.

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