Chipotle mexican grill case study

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Chipotle Mexican Grill’s Strategy in 2018: Will the New CEO Be Able to Rebuild Customer Trust and Revive Sales Growth?

Arthur A. Thompson The University of Alabama

Headed into August 2015, Chipotle (pronounced chi-POAT-lay) Mexican Grill’s future looked rosy. Sales and profits in the first six months of 2015 were at record-setting levels, and expectations were that 2015 would be the company’s best year ever. But a series of events occurred over the next five months that alarmed customers, drove down sales at Chipotle restaurants, and proved frustrating for Chipotle top executives to fix.

• In August, a salmonella outbreak in Minnesota sickened 64 people who had eaten at a Chipotle Mexican Grill. The state’s Department of Health later linked the illness to contaminated tomatoes served at the restaurant.

• In August, 80 customers and 18 employees at a Chipotle Mexican Grill in Southern California reported gastrointestinal symptoms of nausea, vomiting, and diarrhea that medical authorities and county health officials attributed to “norovi- rus.” Norovirus is a highly contagious bug spread by contaminated food, improper hygiene, and con- tact with contaminated surfaces; the virus causes inflammation of the stomach or intestines, leading to stomach pain, nausea, diarrhea, and vomiting. After the reported food poisoning, the restaurant voluntarily closed, threw out all remaining food products, and sent home the affected employ- ees. Employees who tested positive for norovirus

remained off duty until they were cleared to return to work. County health officials also inspected the facility on two occasions and rendered passing grades, despite finding several minor violations. The restaurant reopened the following day, and no further food poisoning incidents occurred.

• In October, 55 people became ill from food poisoning after eating at 11 Chipotle locations in the Portland, Oregon, and Seattle, Washington areas. Medical authorities attributed the illnesses to a strain of E. coli bacteria typically associated with contaminated food. Most ill people had eaten many of the same food items, but subsequent testing of the ingredients at the 11 Chipotle restaurants did not reveal any E. coli contamination. (When a restaurant serves foods with several ingredients that are mixed or cooked together and then used in multiple menu items, it is difficult for medical studies to pinpoint the specific ingredient or ingredients that might be contami- nated.) State and federal regulatory officials reviewed Chipotle’s distribution records but were unable to identify a single food item or ingredient that could explain the outbreak. Nonetheless, out of an abun- dance of caution, Chipotle management voluntarily closed all 43 Chipotle locations in the Portland and Seattle markets, pending a comprehensive review of

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Copyright ©2019 by Arthur A. Thompson. All rights reserved.

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the causes underlying the food contamination and a check of whether any of Chipotle’s food suppliers were at fault. Chipotle management worked in close consultation and collaboration with state and federal health and food safety officials (including personnel from the Centers for Disease Control and Prevention, the U.S. Department of Agriculture’s Food Safety and Inspection Service, and the U.S. Food and Drug Administration) throughout their investigation of the incident and also launched a massive internal effort review of the company’s food preparation and food safety procedures. These internal actions included:

1. Confirming that more than 2,500 tests of Chipotle’s food, restaurant surfaces, and equipment all showed no E. coli.

2. Confirming that no employees in the affected res- taurants were sickened from the incident.

3. Expanding the testing of fresh produce, raw meat, and dairy items prior to restocking restaurants.

4. Implementing additional safety procedures and audits, in all of its 2,000 restaurants to ensure that robust food safety standards were in place.

5. Working closely with federal, state, and local gov- ernment agencies to further ensure that robust food safety standards were in place.

6. Replacing all ingredients in the closed restaurants. 7. Conducting additional deep cleaning and sanitization

in all of its closed restaurants (followed by deep clean- ing and sanitization in all restaurants nationwide).

Meanwhile, the Federal Drug Administration sought to identify a cause for the outbreak. The FDA’s investigation revealed no ingredient-related cause and no evidence that particular suppliers were the source of the outbreak. Ultimately, no food item was identified as causing the outbreak and no food item was ruled out as a cause, although fresh produce was suspected as the likely cause.

After health officials concluded it was safe to do so, all 43 restaurants in the Portland and Seattle mar- kets reopened in late November 2015, roughly 6 weeks after the incident occurred.

• Later, it was confirmed that at least 13 people in nine other states became infected with the same strain of E. coli linked to the Chipotle restaurants in Oregon and Washington states.

• In early December 2015, five people in three states— Kansas (1), North Dakota (1), and Oklahoma

(3)—became ill after eating at Chipotle Mexican Grill restaurants. Studies conducted by the Centers for Disease Control and Prevention (CDC) determined that all five people were infected with a rare strain of E.coli different from the infections in Oregon, Washington, and nine other states. However, investigators used sophis- ticated laboratory testing to determine that the DNA footprints of the illnesses in the Midwest were related to those in the Portland and Seattle areas.

• In mid-December 2015, about 120 Boston College students became ill after eating at a Chipotle Mexican Grill near the campus, an outbreak that local health officials attributed to a norovirus. Health officials also tested students for E. coli infections but the tests were negative.

Extensive reports of the last three incidents in the national media took a toll on customer traffic at most all Chipotle locations. The average decline in sales at Chipotle locations open at least 12 months was a stunning 14.6 percent in the fourth quarter of 2015, causing Chipotle’s revenues in Q4 2015 to be 6.8 percent lower than in the fourth quarter of 2014. The company’s stock price crashed from an all-time high of $758 in early August 2015 to $400 heading into 2016.

2016 aND 2017—GROWING FRUsTRaTION IN ReVIVING saLes aND ResTORING CUsTOMeR TRUsT IN THe CHIPOTLe BRaND In January 2016, the CDC announced that the prior food contamination and food safety issues at Chipotle were “over.” Chipotle management followed up by finalizing plans to install comprehensive food safety procedures at all Chipotle restaurants and establish Chipotle as an industry leader in food safety. In February 2016, Chipotle shut all of its restaurants for a period of four hours to conduct food safety training for all store employees. That same day, in an effort to get customers back into its stores, Chipotle offered a free burrito to anyone who signed up on its website. Recognizing that the task of rejuvenating customer traffic at its restaurants would not be easy, Chipotle

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any Chipotle in the United States or Canada just for playing.

• On Halloween, from 3 p.m. to closing at all Chipotle locations, customers dressed in costume could buy $3 burritos, bowls, salads, or tacos.

• All active duty military, reserves, national guard, military spouses, retired military with a valid U.S. military ID, and veterans with ID were offered a special buy-one-get-one-free with the purchase of an entrée from 3:00 p.m. to close on Veterans Day.

In addition, in October 2016, Chipotle began an “Ingredients Reign” advertising campaign highlight- ing its carefully selected ingredients and reinforcing Chipotle’s commitment to sourcing, preparing, and serving only the very best ingredients. The campaign featured a series of animated stop-motion short films shown in movie theaters across the country and also distributed through various online, digital, and social media outlets. In addition, the company used indoor and outdoor advertising with content showcasing the company’s obsession with fresh ingredients.

But the results of all these efforts to revive cus- tomer traffic were disappointing. Average sales at Chipotle restaurants in 2016 dropped to $1.87 million, 22.9 percent below the 2015 average of $2.42 million. Chipotle’s revenues dropped from $4.5 billion in 2015 to $3.9 billion in 2016, despite the opening of 240 new restaurants. Net income plunged 95 percent, from $475.6 million in 2015 to $22.9 million in 2016.

Chipotle’s performance in 2017 was better, but far from comforting to top management or shareholders. Revenue rose 14.7 percent to almost $4.5 billion, fractionally below the amount for 2015, but with 400 more restaurants in operation than in 2015; net income rose to $176.3 million. Average res- taurant sales climbed 3.9 percent to $1.94 million, but were still almost 20 percent below the 2015 aver- age. Exhibit 1 presents recent financial and operating data for Chipotle Mexican Grill.

At the end of November 2017, Chipotle Mexican Grill announced that Steve Ells, chair- man and CEO—and the founder of the company in 1993—would relinquish the title of CEO and become executive chairman following the comple- tion of a search to identify a new CEO. Ells rec- ommended the change in his role to the company’s Board of Directors, indicating it would “allow me to focus on my strengths, which include bringing inno- vation to the way we source and prepare our food.

management launched a series of marketing efforts and incentives to entice former and new customers to dine at Chipotle restaurants. For example:

• In March, Chipotle introduced a new online game called Guac Hunter—a digital photo hunt where players saw a series of two images that looked similar and had to spot the differences before time runs out. During a specified 11-day period, play- ers were rewarded for their keen eyesight with a mobile offer good for a free order of chips and guacamole at any Chipotle in the United States and Canada.

• In May, teachers, faculty, and school staff with a valid school ID received a free burrito, burrito bowl, salad, or order of tacos with the purchase of another menu item at all U.S. Chipotle loca- tions from 3:00 p.m. to close in honor of Teacher Appreciation Day.

• All nurses who showed a valid ID were rewarded with a special buy-one-get-one-free promotion on June 8.

• In June, chorizo sausage was introduced as a meat selection.

• A national advertising campaign featured Chipotle’s carefully selected ingredients and its longstanding commitment to sourcing, preparing, and serving only the very best ingredients.

• In July, Chipotle initiated a three-month pro- motion called Chiptopia where customers were rewarded with a free entrée on their fourth, eighth, and eleventh visit and purchase of paid entrée within a given month; customers who registered for the program in July earned a free chips and guacamole with their first entrée purchase.

• Families were offered a free kid’s meal with the purchase of an entrée on Sundays during the month of September.

• Also in September, high school and college stu- dents with a valid ID received a free fountain soft drink or iced tea with any in-store entrée purchase.

• In October, Chipotle introduced a new online game that allowed players to test their memory skills by matching up real Chipotle ingredients while being careful not to select the imposters (added flavor or added color cards). Anyone who played the game received a limited time mobile buy-one-get-one-free entrée offer redeemable at

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EXHIBIT 1 Financial and Operating Highlights for Chipotle Mexican Grill, 2011–2017

In millions of dollars, except for per share items

Income Statement Data 2017 2016 2015 2014 2011

Total revenue $4,476.4 $3,904.4 $4,501.2 $4,108.3 $2,269.6 Food, beverage, and packaging costs 1,535.4 1,365.6 1,503.8 1,421.0 738.7 As a % of total revenue 34.3% 5.0% 33.4% 34.6% 32.5% Labor costs 1,206.0 1,105.0 1,045.7 904.4 543.1 As a % of total revenue 26.9% 28.3% 23.2% 22.2% 23.9% Occupancy costs 327.1 293.6 262.4 230.9 147.3 As a % of total revenue 7.3% 7.3% 5.8% 5.6% 6.5% Other operating costs 651.6 642.0 515.0 434.2 251.2 As a % of total revenue 14.6% 16.4% 11.4% 10.6% 11.1% General and administrative expenses 296.4 276.2 250.2 273.9 149.4 As a % of total revenue 6.6% 7.1% 5.6% 6.7% 6.6% Depreciation and amortization 163.3 146.4 130.4 110.5 74.9 Pre-opening costs 12.3 17.2 16.9 15.6 8.5 Loss on disposal of assets 13.3 23.9 13,194 6,976 5,806 Total operating expenses 4,206.6 3,869.8 3,737.6 3,397.5 1,919.0 Operating income 270.8 34.6 763.6 710.8 350.6 As a % of total revenue 6.0% 0.9% 17.0% 17.3% 15.5% Interest and other income (expense) net 4.9 4.2 6.3 3.5 (0.9) Income before income taxes 275.7 38.7 769.9 714.3 349.7 Provision for income taxes (99.5) (15.8) (294.3) (268.9) (134.9) Net income $ 176.3 $ 22.9 $ 475.6 $ 445.4 $ 214.9 As a % of total revenue 3.9% 0.6% 10.6% 10.8% 9.5% Earnings per share Basic $ 6.19 $ 0.78 $ 15.30 $ 14.35 $ 6.89 Diluted 6.17 0.77 15.10 14.13 6.76 Weighted average common shares outstanding Basic 28.5 29.3 31.1 31.0 31.2 Diluted 28.6 29.8 31.5 31.5 31.8

Selected Balance Sheet Data

Total current assets $ 629.5 $ 522.4 $ 814.6 $ 859.5 $ 501.2 Total assets 2,045.7 2,026.1 2,725.1 2,527.3 1,425.3 Total current liabilities 323.9 281.8 279.9 245.7 157.5 Total liabilities 681.2 623.6 597.1 514.9 374.8 Total shareholders’ equity 1,364.4 1,402.5 2,128.0 2,012.4 1,044.2

Other Financial Data

Net cash provided by operating activities $ 467.1 $ 349.2 $ 683.3 $ 682.1 $ 411.1 Capital expenditures 216.8 258.8 257.4 252.6 151.1

Restaurant Operations Data In thousands of dollars

Restaurants open at year-end 2,408 2,250 2,010 1,783 1,230 Average restaurant sales $1,940.0 $1,868.0 $2,424.0 $2,472.0 $2,013.0 Average annual sales increases at restaurants open at least 13 full calendar months 6.4% (20.4)% 0.2% 16.8% 11.2% Development and construction costs per newly opened restaurant

$ 835 $ 880 $ 805 $ 843 $ 800

Source: Company 10-K reports, 2015, 2016, and 2017.

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In July 2018, Chipotle once again had a food safety lapse; this foodborne illness outbreak sick- ened over 600 customers at a restaurant just out- side of Columbus, Ohio. Health officials attributed the problem to bacteria that formed when certain food items were left out at unsafe temperatures. Upon learning the cause, Chipotle top management immediately announced it would launch retraining of all its restaurant workers nationwide the follow- ing week. While the company’s stock price dropped about 7 percent on news of the incident, it recov- ered quickly since customer traffic at Chipotle res- taurants nationwide was largely unaffected and the company’s future performance seemed to be on the upswing remained amid reports that the company was testing a number of new menu enhancements, perhaps to include the addition of a new breakfast menu and earlier opening hours.