The great donut rebellion Featured

9:57am EDT July 22, 2002

Paul Sattler knows almost everyone who comes into his Donut Connection shop in Carnegie. He greets people and addresses many of them by name. He pauses briefly to kibitz with the letter carriers and the senior citizens who sit at the counter or in one of the orange booths sipping a cup of fresh-brewed coffee and munch on a doughnut.

He likes his business, accepts the long days that a retailer has to endure and likes calling the shots. He and his wife, Joanne, who helps him run the store, have done pretty well in the last eight years, and he says they are seriously considering a second location.

Jim Edwards operates five Donut Connection stores in the Pittsburgh and Washington, Pa., areas. He’s been at it for more than two decades and, like Sattler, still enjoys a business that is often tough and rarely boring. He’s on the job virtually 24 hours a day, and although he has to handle myriad problems, from equipment failures to personnel issues, he revels in the independence.

But things haven’t always been so sunny for Edwards, Sattler and other former Mister Donut franchisees. The sale in the early 1990s of their former franchiser threatened their ability to keep their businesses afloat and sparked a rebellion by these hardy, independent-minded entrepreneurs.

The backlash ultimately led Sattler, Edwards and others into a successful effort to leave the franchise fold and form a new cooperative organization under a new name and a significantly different — and friendlier — business structure.

A crisis looms

In 1991, Sattler had been a Mister Donut franchisee for about a year. A former Mister Donut district manager squeezed out of his job by downsizing, Sattler opened his own shop. Now, he was facing another change, this one at the franchiser level. American Multifoods, parent company of the Mister Donut franchising operations, had decided to sell the doughnut shop franchise to its giant competitor, Dunkin’ Donuts.

On the face of it, it would seem that converting from Mister Donut to the better-known, slickly marketed Dunkin’ Donut marquee would be a boost for the franchisees. Dunkin’ Donut thought it would be a boon, too, predicting a 40 percent jump in business when the changeovers took place.

But for Sattler, who was still bearing the burden of start-up costs, the expense of renovating his store would have been a crushing burden. Sattler figures it would have cost him $40,000 at minimum to implement the changes Dunkin’ Donuts demanded.

Sattler and other franchisees were uncertain the changes would bring the level of sales that would justify the expenditures. On top of that, fees to the franchiser would have amounted to about 12 percent of sales, considerably higher than what franchisees had paid to Mister Donut.

“I just couldn’t see how I could have been profitable,” says Sattler.

For Edwards, the modifications could have put him out of business.

He estimates it would have cost him $500,000 to make the changes necessary for conversion of his five units to Dunkin’ Donuts. Taking on that kind of financial burden, he says, could easily have forced him into selling his shops.

“The financial end of it was so onerous, with the tremendous advertising fees and franchising fees that they required,” says Edwards.

To make the change even less attractive, Mister Donut, with 36 stores in the Pittsburgh area versus a dozen Dunkin’ Donuts at the time, had accumulated considerable goodwill in the Pittsburgh market.

“It was terribly hard to give up the Mister Donut name,” Edwards says.

What a franchise does

Franchising can be a fast-track way for an entrepreneur to step into business and avoid some of the obstacles faced by start-up owners, according to Ken Franklin, president of Franchise Developments Inc., a Pittsburgh-based consulting firm. He says a franchise can offer a business instant credibility if it has a recognizable image to its target customer.

Franchisers typically offer an off-the-shelf business plan and tried-and-true methods to help an entrepreneur succeed. They can help with site location, marketing and advertising, financing, training and support services. Many entrepreneurs, Franklin says, find a level of comfort in owning a franchise because it makes them feel like they are part of a larger organization, especially in the early stages. That support “is normally what people buy a franchise for. That’s a frightening period of time. That person needs all kinds of help and assistance.”

But that tidy packaging comes at a price. Franchise fees, in addition to the normal start-up costs entrepreneurs encounter, mean in most cases that a franchisee has to hit the ground running. Many franchisers charge a fee for national advertising, and depending on the individual agreement, may stipulate that franchisees undertake periodic remodeling of the businesses to conform to corporate standards.

Beyond the money

There were other things that bothered the Mister Donut owners. Sattler says the Dunkin’ Donuts mentality was fixed on higher coffee sales and more modest doughnut sales than what the Pittsburgh franchisees were used to.

“Pittsburgh’s a doughnut town,” says Sattler.

Still, coffee is a high margin item, and while baked goods offer a wide profit margin, the cost of labor to produce them eats away at the spread. The Dunkin’ Donuts management insisted that profits were tougher to come by because the Mister Donut stores didn’t sell enough coffee. Sattler and the other franchisees agreed, but they didn’t know how to make that change in their customers’ buying habits.

Other programs were forced on them as well, such as a bagel line — efforts costly to maintain yet not widely promising in the eyes of some of the Mister Donut owners.

“You had to do business their way,” says Sattler. “You were more like an executive vice president (than a store owner).”

Dunkin’ Donuts management could be surly and cold, both owners claim. While Mister Donut had been lax in some ways, allowing some franchisees to go for months without paying franchise fees before bringing up the issue, a late payment to Dunkin’ Donuts triggered a nasty letter from the franchiser’s lawyer, plus a $75 bill for the legal fee to prepare the action, Sattler says.

In the wake of the sale of the franchiser, the Mister Donut owners had the options of joining as Dunkin’ Donuts or “de-identifying” their stores, removing all traces of the Mister Donut identity. But a group of franchise owners decided they wanted to continue to operate as Mister Donut.

They put together a legal fund of several tens of thousands of dollars, went to court and sued to be allowed to keep the name.

They lost the suit.

Donut co-op

That’s when they decided to make a go of it outside of Dunkin’ Donuts. But they weren’t interested in starting another franchise. Instead, they formed a buying cooperative.

The group started out with about 100 store owners out of the 500 Mister Donut stores, but lease commitments and other considerations pared the number to about 80. The owners then met in Harrisburg and selected an executive committee to oversee the establishment of the cooperative.

The new company, Donut Connection Cooperative Corp., is essentially a franchise, but without the large franchise and advertising fees. It’s owned by the franchise operators, each of whom pays a small royalty fee on purchases through the cooperative and is required to purchase stock in the company (see sidebar).

The big advantage for the former franchisees is that they save a considerable sum in franchise fees. Rich Beazley, Donut Connection’s general manager, say s franchisees can expect to put $30,000 to $50,000 in their pockets in fees that would otherwise have gone to a franchiser.

Favorable factors

While the transformation was by no means simple, Sattler and Edwards agree that the owners had several factors in their favor.

  • Individual Mister Donut franchisees had three years, ending in 1995, to decide how they were going to continue in business. They could convert to a Dunkin’ Donut franchise, dismantle the Mister Donut identity or close their doors. That bought time for Mister Donut operators to put together a plan for conversion, says Edwards, and present the idea to owners considering their options. “That gave us a chance to get stores willing to switch over,” Edwards explains.

  • The owners already had an arrangement with a supplier and local distributors, so setting up a buying cooperative, the most valuable piece of the program, was relatively easy. The group worked closely with suppliers during the transition, keeping them apprised of conversions so that the suppliers could anticipate changes in their purchasing. They were able to reduce inventories of supplies displaying the Mister Donuts identity and switch over to Donut Connection items.

  • The Mister Donut franchisees were united in their purpose and focus. While they struggled with individual issues, according to Edwards and Sattler, members were willing to compromise and come to a consensus.

    “Not anyone in the whole group got their whole choice all of the time,” says Edwards. “Nobody got too bent out of shape along the way and decided to go their own way.”

    Not insignificant was the owners’ will to succeed without Dunkin’ Donuts.

    “I guess we were just determined to not let Dunkin’ beat us,” says Sattler.

  • Individual operators had strong ties to their customers, so they weren’t dependent simply on the name. Sattler and Edwards admit they harbored fears that sales would tail off once the name was changed, given the strength of the Mister Donut name. Edwards says the owners experienced some anxiety when it came to crafting a new name.

    Beazley, who was working for Dunkin’ Donuts at the time, says the assertion by the owners that they hadn’t lost sales once they made the switch was scoffed at by the competition. But when he came on board to manage the business, he found that sales had, in fact, held fast. He attributes that largely to the customers’ apparent loyalty to the operators and not simply to the name.

    “They’re going to Paul and Joanne’s doughnuts,” Beazley says.

    The name change had little impact on sales due to customer loyalty to location and owners and a new name that clearly defined the business.

    “I would think that with Mister Donut, the location is probably what drove them there,” says Gayle Marco, associate professor of marketing at Robert Morris College. She likens the Donut Connection situation to that of the perceived brand loyalty to particular typesof gasoline that was prominent up until the early 1970s. The brand loyalty was more likely location loyalty, in which customers connected with a particular brand because of the convenient location of a particular service station.

Going forward

With shifting consumer buying habits that indicate a shrinking appetite for doughnuts and other pastries, stores like Dunkin’ Donuts and Donut Connection will likely need to shift their product offerings to include other items, such as bagels, to retain sales. Dunkin’ Donuts has made the shift with bagels and soup to bolster sales. Presumably, other operators will need to adjust to market preferences as well.

For Beazley, the challenge for Donut Connection is in gaining a foothold in markets where Donut Connection isn’t a recognized name. Without a full-scale marketing program, most new franchisee prospects come through word-of-mouth referrals.

True to the independent spirit that led the franchisees to strike out in a new direction, Sattler says it’s not easy to find an operator willing to take the risks, put in the time and effort and be essentially self-reliant.

“Finding the right franchisee” is the biggest challenge for Donut Connection, Sattler says.

Donut Connection offers owners autonomy, but little in the way of packaged solutions for their businesses.

“It’s not a nine-to-five job,” Sattler warns. “If that’s all you think you’re buying yourself, forget it.”

That may be the most important connection of all.

How to reach: Donut Connection, Richard Beazley, (412) 278-1880; Ken Franklin, Franchise Developments Inc., (412) 687-8464