Krispy Kreme Fell Apart, Then Came Back Strong. Here's How. At one point, ice cream and soap was sold at the Krispy Kreme locations.

By Jon Marcus

entrepreneur daily

This story appears in the September 2017 issue of Entrepreneur. Subscribe »

Richard Lautens | Getty Images

Ah, that smell! The smell of featherlight, just-out-of-the-fryer doughnuts covered in a sugary glaze. The smell so good it drew lines of single-minded devotees, zombie-like, to the wholesale factory during the only time they were allowed to buy them -- between midnight and 4 a.m., through a window cut into the wall. Even the name was delicious: Krispy Kreme.

Related: 10 Crazy Things You Never Knew About Krispy Kreme

That's how the iconic company started, in Winston-Salem, N.C., in the 1930s. How it nearly ended, decades later, is a case study in how franchises can stumble. First there was the sale, in the 1970s, to an international conglomerate so big it peddled everything from luggage to bras to window treatments. For the new parent company, a doughnut chain was a handy way to unload products made by its other myriad divisions, including soup and ice cream -- which it actually sold at Krispy Kreme outlets. To cut costs, it even committed the sacrilege of changing the doughnut recipe.

Saviors emerged in 1982, when outraged franchisees banded together to buy back the company. But 18 years later, when the new owners took it public, the brand got sidelined again while scrambling to satisfy Wall Street's demand for higher earnings, fast. It responded to this pressure by abandoning its famous neon-clad promise of "Hot doughnuts now," making some of its signature product in central kitchens and trucking it to stores, and by selling cold doughnuts -- cold Krispy Kreme doughnuts! -- everywhere from 7-Elevens to gas stations to supermarkets, effectively competing against its own franchisees.

Meanwhile, the head office kept the balance sheet looking as hot as the doughnuts had once been. This was done in part by requiring franchisees to buy equipment and the doughnut mix from corporate's own manufacturing and distribution division -- which came to account for nearly a third of the company's revenues by 2003, all on the backs of franchisees -- and by adding hundreds of new locations (including many in New England, which were routed by a local religion known as Dunkin' Donuts). So while revenues were reported to be rising, same-store sales remained ominously flat.

Related: How to Figure Out Your Best Manufacturing Solution

The holes in this strategy became apparent as franchisees filed for bankruptcy protection, stores were shuttered and Krispy Kreme's stock price plummeted from a high of nearly $50 in 2003 to $6 only two years later.

And yet… Krispy Kreme is still among us. Better than that, the company is again flourishing, nabbing an impressive 18 spot on Entrepreneur's 2017 Franchise 500 list. The story of how Krispy Kreme and other companies got from peak to valley to peak again is more than the tale of firms that faltered, recovered and thrived. It's an object lesson in how companies of all sorts can avoid hitting the skids, how prospective franchisees can avoid companies that are heading for trouble and most important, how with the right leadership and timing, even the most damaged brands can be revived and made stronger and more profitable.

Lesson 1: Get your hands dirty

Julie Hall remembers the day she had to work the fry-o-lator at McDonald's. She hadn't signed up for the job; she was a public relations pro with past experience representing Dunkin' Donuts, Baskin-Robbins, Au Bon Pain and others. But when her company took on the Golden Arches as a client, Hall and all her colleagues were required to work in a store for a week. I went to college for this? she recalls thinking as she made yet another batch of fries. But looking back on it now, she says, "It was the best experience I could have had, because I understood the challenges the people in the store had. It was brilliant."

Ask any franchising expert for advice, and they'll tell you this: If you're a franchisor, hire people with experience and make sure they get down into the trenches every now and again; if you're a franchisee, buy into systems run by leaders who truly understand their franchisees' challenges. These are pieces of advice that seem so obvious, they're hardly worth mentioning. But they are worth mentioning, and here's why: Despite what the International Franchising Association estimates is its $1.6 trillion annual economic impact in the United States, "nobody teaches" franchising in business school, says Joe Mathews, CEO of the consultancy Franchise Performance Group. "It's not on anybody's radar screen."

That's not entirely true. There are franchising schools, and an industry of consultants for hire to help companies at critical times. But compare that to the reams of academic studies and serious researchers who study the minutiae of other industries and produce well-educated graduates who are practically bred for success atop certain kinds of companies and you see just how underreported franchising is. One of the most comprehensive studies of the industry, by a professor at the Weatherhead School of Management at Case Western Reserve University, looked at 157 franchise businesses in 27 industries over 12 years -- and it dates back to the 1990s.

This means that few future business leaders are schooled in mastering the franchise model. Instead, franchises are often led by people who were successful in other realms -- like those who debuted the concepts in the first place. "What you see is someone who comes up with a great idea for a restaurant. They're hearing more about franchises, so they say, "This idea is great. I can make money by having other people do the same thing and pay me royalties,'" says Scott Ratchick, a lawyer in Atlanta who represents franchisees. "Well, they know how to run their restaurant. But they have no earthly idea how to run a franchise operation."

And sometimes franchises are managed by people who were successful in completely unrelated industries, which doesn't necessarily translate to being savvy about the business they're in now. Especially if they don't make a point of getting into the trenches like Hall did. A succession of chief financial officers who paraded through Krispy Kreme headquarters, for instance, included one who had worked for a kitchenware retailer and another who was an investment banker. The private equity firm that bought the now-defunct Hollywood Tans installed the former head of a tutoring service as CEO. "I know franchise companies that are being run by attorneys," says Don Welsh, a Sonic Drive-In franchisee in Philadelphia who is also a consultant to franchise companies and partner of Franchise Performance Group. "They don't know anything about the core business."

Franchising certainly isn't void of smart leaders. It has plenty. But all these people tend to have something in common: They've experienced franchising from many angles -- working as everything from fry cooks to senior executives -- and have developed a personal understanding of exactly what's required to be successful. That's why it's so critical for prospective franchisees to study up on the backgrounds of the people in charge -- to ensure not only that they are credible businesspeople but that they empathize with the challenges of franchising, understand the business on a molecular level and know how to provide a level of support their franchisees require.

Leadership can come in other forms, too. Increasingly, successful franchisees have been taking matters into their own hands by organizing themselves into franchisee associations. They protect their interests by, among other things, sharing best practices and helping one another deal with emerging issues corporate may not have a good handle on. If business schools aren't going to study franchising, the thinking goes, franchising will study and educate itself. Strong top-down leadership is critical, but "one of your best tools is a strong franchisee association," says Ratchick, the lawyer in Atlanta.

Lesson 2: Evolve, but wisely

Krispy Kreme may have undergone a series of damaging changes, straying from its strengths, but some franchises make the opposite, yet equally damaging, mistake: They stay the same for far too long. Sbarro, for example, went through two bankruptcies in three years and has long failed to update its menu or decor, or to move beyond its principal locations in shopping malls, where traffic has been dropping. RadioShack was similarly stagnant, and in 2015 it filed for its first of two bankruptcies. In the late '90s, Hardee's adopted a try-anything approach, larding its menus with everything from cheap burgers to fried chicken to hot dogs, surrendering any sort of brand identity, before shifting to focus on big burgers and finding lasting success.

How could once-dominant brands fail to change with the times? "What I think a lot of brands don't understand is how to balance heritage with innovation," says Hall. Squaring what people love about your brand and what you need to do to stay relevant is not easy, she admits. The largest franchises, after all, are beloved for their familiarity. They've built something steady, reliable, and time-tested that fans can count on no matter where they are.

Related: Can a Brand Bring Back Its History and Make It Relevant?

The smartest brands are always evolving, experimenting with ways to keep people's attention and stay relevant. "You need to have an innovation team that is really empowered to try new things," Hall says. Taco Bell, for example, has a food development lab that routinely cranks out crazy ideas -- some of which, like the Doritos Locos Tacos, become international phenomena. Other brands rely on their franchisees to help guide innovation, like Domino's, which has unit owners weigh in on new pizza recipes. This helps corporate keep up with changing customer preferences.

Domino's, in fact, is right up there with Krispy Kreme among turnaround successes -- all thanks to a willingness to change wisely. In 2009, when consumers ranked its pizza dead last among national chains, tied with Chuck E. Cheese's, the brand responded with a stunningly self-deprecating ad campaign, in which Domino's gave voice to its angry customers. ("Worst excuse for pizza I ever had," one said, in a review read aloud by a company exec.) That was followed by new recipes, expanded menus, a new name (the "Pizza" was dropped as the company added sandwiches and pasta), a new logo and a heavy use of social media for promotion. Sales soared.

But even though Domino's seemed to be reinventing itself, its core value proposition remained untouched -- quick food, cheap and with a bit of an irreverent attitude. That's always the key to a successful evolution: adding and improving, not replacing your core.

Today the same tension is playing out with Sonic Drive-In. The franchise made its name as "America's drive-in," trading on nostalgia for an old mode of food service. That's worked well; Sonic has 3,526 units in 45 states, each ringing up an average of $1.28 million in sales. But one nagging thing has long inhibited growth: the weather. The drive-in concept loses its appeal when the weather turns cold. So for the past few years, the company has been experimenting with the previously unthinkable idea of indoor seating.

Is that a change to its core, or is its core really the food and atmosphere? Opinions vary. "They're diluting the drive-in idea, which was their biggest strength, and that's a mistake 99 percent of franchisors make," says Welsh of Franchise Performance Group. Then again, in Chesapeake, Va., after one Sonic opened a dining room this year, the owner gushed about it to his local newspaper. Sales were up, he said. His customers had been asking for it for years.

This tension, no doubt, is why Sonic is rolling out its experiment slowly; so it can learn, but safely.

Lesson 3: Partner smart

So, yes, sometimes a brand can go off the rails after a long period of success by hiring the wrong people or messing with the core product. There are other times, however, when a franchisee or franchisor never got the chance to succeed at all. That's because a more elemental mistake had been made: starting with the wrong partner.

The first place this plays out is with financing. Franchisors may need more money to scale up, and franchisees may need it to open new locations. But some investors -- particularly private equity firms and some equity investors -- may expect immediate results. "That's antithetical to what a franchisee wants to do, which is look to the long term," says Robert Purvin, of the American Association of Franchisees and Dealers. "An operator has a 10-, 15-, 20-year horizon, based on the usual terms of a franchise agreement," says Joyce Mazero, co-chair of the global supply network group at the law firm of Gardere Wynne Sewell in Dallas, and an editorial adviser to the book Franchising for Dummies. "And the investor has a five-year horizon." Public companies can come under similar pressure from shareholders.

Haste like this can lead to bad decisions, such as expanding too quickly or oversaturating a market. Franchisors, forced to raise quick cash, may be tempted to get it through unfriendly deals with their franchisees -- such as leasing or selling them overpriced equipment and ingredients.

Experts say the key is to seek out capital partners who have patient and realistic plans over achievable timelines -- value investors and mutual fund managers, for example, who are happy to wait for their returns to play out. Not only are they out there; mutual fund managers with the most patient investment strategies actually tend to outperform their benchmarks, according to research at Rutgers and the University of Notre Dame.

Hot doughnuts: Now and forever

Krispy Kreme hatched a turnaround plan in 2005, under a revamped board of directors and a new CEO, Stephen Cooper (who had previously led embattled Enron out of bankruptcy). The company began raising cash to repay its creditors, stabilizing the business and keeping it going. In May of last year came word that the chain would be acquired for $1.35 billion, or $21 per share, by JAB Holding Company, the Luxembourg firm that owns Keurig, Einstein Bros. Bagels, Caribou Coffee and Peet's Coffee & Tea. In other words: a company that knows food service. The deal was completed in July 2016, making Krispy Kreme a private company again, built for the long haul.

Related: 5 Ways Leaders Must Evolve Business and Reinvent Industries for the 21st Century

After its long and tortured journey, its peaks and its valleys, Krispy Kreme is growing again -- but wiser and more judiciously this time, careful to not repeat the mistakes of the past. Which isn't to say things are boring. Indeed, there may be still some fun ahead. Among other places, the reinvigorated company is eyeing seven new locations in New England. That was the site of its ugly defeat at the hands of Dunkin' Donuts, back in Krispy Kreme's days of heedless expansion. These places still run on Dunkin' -- that brand is based in the Boston suburbs and is beloved across the region -- but with the right strategy in place, the addictive smell of Krispy Kreme could signal heated competition soon enough.

Want to be an Entrepreneur Leadership Network contributor? Apply now to join.

Editor's Pick

Related Topics

Business News

Woman Allegedly Fired for 'Theft' After Eating a Sandwich That Was Leftover From a Meeting

Gabriela Rodriguez worked as a cleaner at Devonshires Solicitors in London for two years.

Business News

A 29-Year-Old CEO Quit Microsoft To Build His Startup — And Just Scored A Deal on Shark Tank

Aabesh De tapped into a niche need during the pandemic and founded Flora, a houseplant care startup.

Growing a Business

The Owners of This Texas Farmers Market Took a Big Gamble. Here's How It Paid Off Bigger Than They Dreamed.

A Texas farmers market educates customers about the importance of shopping local for a healthy lifestyle and an even healthier small business community.

Business News

A Billion Dollar Startup Is Trying To Resurrect A Woolly Mammoth — And You Can Watch It Happen

Filmmakers will go behind the scenes of billion-dollar startup Colossal Biosciences, which uses genetic engineering for de-extinction projects.

Employee Experience & Recruiting

Avoid Costly Hiring Mistakes With These Five Essential Tips

From using an AI-powered video platform to posting more precise job listings, these strategies will help hiring managers spend less time, energy and money finding the right candidates.