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Chipotle Feels the Financial Impact of its Ongoing Food Safety Crisis

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This is a Supply Chain Matters update commentary regarding Chipotle Mexican Grill, specifically efforts to address its ongoing food-safety challenge that not only threatens the restaurant chain’s value to its brand and to its investors, but on perceived quality risks in its farm to fork supply chain.   Chipotle logo

This week, the restaurant chain posted its first quarterly financial loss as a public company amid a nearly 30 percent reduction in same store sales. Total revenues were down 23.4 percent while net income dropped by $122.6 million. Operating margin dropped to 6.8 percent from just over 28 percent a year earlier due to what was described as higher marketing, waste and food testing costs.

In a previous February commentary, we observed that the restaurant chain had entered a new critical phase, one focused in rebuilding its brand integrity along with assuring that food safety practices were re-addressed across the supply chain and within its individual restaurants. In our mid-March commentary, we highlighted reports that seemed to put a different twist to the ongoing crisis. At the time, The Wall Street Journal citing informed sources, reported that the restaurant chain considered stepping back from the food safety changes touted back in February. Rather than conduct high-resolution DNA testing on a multiple of inbound supply ingredients, the plan was apparently to test only certain foods. Further reported was that the chain’s beef supplies would be pre-cooked in centralized kitchen facilities to insure that E.coli was eliminated, and then packaged in vacuum-sealed bags and shipped to local outlets where the product could be marinated and grilled.

We speculated that the decision to scale back DNA testing may have been brought about by further process and supply chain focused analysis.  Yet, the restaurant chain later announced the hiring of a noted meat industry food safety expert to be its new director of overall food safety.  We questioned whether such decisions for scaling back testing should have been made so early in the process, without the insight or input of the chain’s newly hired food safety expert, and without allowing more time to address consumer concerns regarding uncertainty in food sourcing and handling practices.

Our stated belief was that restoring consumer trust in a badly damaged brand is not a one-time marketing or financial budgeting challenge, but rather a systemic management challenge to address quality and food safety practices among all farm to fork processes and activities.

The chain has since stepped-up training within local restaurants on food safety and food handling practices as well as the assistance of a field leadership program to assist local managers in managing and auditing food safety and handling practices.

Chipotle’s co-CEO, Steve Ells indicated to investors that rebuilding trust with customers would take some time. While we found that that admission insightful and somewhat overdue, we were taken back by a subsequent statement:

We will continue to make it our top priority to entice customers to return to Chipotle through effective promotions and marketing, and when they do return, we’re committed to providing the very best experience that we can to help ensure that they will keep coming back.”

Not a mention of testing and assuring consistent food safety practices as the top priority.

Further noted in business media reports are even further changes in food preparation and sourcing practices after apparent customer feedback indicated a decline in the quality of certain ingredients. Customers complained that produce or lettuce no longer tasted as it should. For instance, now the chain claims to have refined its washing of lettuce which will once again allow local restaurants to cut lettuce locally while still ensuring that it is safe. Similarly, bell peppers will be blanched and sliced in local restaurants rather than the previous change to do so in central kitchens.

On a positive note, customers apparently have endorsed the process for cooking organic beef in vacuum sealed bags within central kitchens because the meat is now perceived to not as dry to the taste.

As Chipotle customers may now be aware, the chain is attempting to incent customers to return by offering free burritos and other promotions. Over 5 million free burrito offers were issued followed by a direct mail promotion distributed to over 20 million households. Judging from the customer traffic statistics to-date, the chain’s most loyal consumers may not be completely convinced as of yet to return, although data seems to point to return by some not as loyal but cost conscious customers. One equity analyst has indicated that couponing is a short-term rather than a more sustainable strategy for restoring traffic.

In recent weeks, both Glass Lewis & Co. and Institutional Shareholder Services, both influential proxy advisory firms have weighed in on management. ISS is recommending a vote against re-election of certain current Chipotle board members at the upcoming annual stockholder meeting in May. The firm questions whether the ongoing food safety issues have exposed a flawed board succession process that nominated directors who have the management skill sets to keep pace with a chain’s size and complexity. Further stated was a failure of risk oversight by the firm’s Audit Committee.

Glass Lewis has reportedly taken issue with the board’s pay-for-performance model. As we noted in our March commentary, senior executive bonuses were recently changed to be pegged to increases in the firm’s stock price alone. ISS has also opined that the majority of discussion with major investors has focused on improving share price and changing executive compensation as opposed to addressing food safety.

The reality of losing the trust of loyal customers is indeed an ongoing challenge and Chipotle management must by our lens, have as its collective top priority means and methods to address food safety and quality from farm to fork. Management compensation not directly tied in some fashion to that goal, and management briefings and direction-setting that continues to lead with marketing and sales tactics are not going to convince this past Chipotle consumer that issues have been addressed and the quality and safety of food is industry-leading. Apparently we are not alone in that perception.

Bob Ferrari

© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.


Major Automotive Supplier Component Safety Snafu is Another Supplier’s Strategic Gain

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As far back as 2014, Supply Chain Matters provided commentaries relative to the defective air bag inflator crisis that was impacting multiple global automotive brands. Even then, the product recalls involving airbag inflators supplied by Takata Corp. of Japan were estimated to be in the millions.

In an October 2014 posting, Supply Chain Matters echoed business media reports that brands such as Honda, were undertaking steps to seek out alternative suppliers, not only to provide augmented supplies of air bag inflators required to retrofit millions of recalled vehicles, but also to become a replacement supplier for current and future production needs. We noted that rival air bag suppliers that could benefit from the ongoing crisis included Autoliv, DaicelKey Safety Systems and TRW Automotive Holdings, which at the time was being acquired by German based ZF Friedrichshafen. We further pointed out that switching suppliers that support one or several global product platforms is somewhat more challenging from a timing perspective.

Flash forward to today and specifically a recent Bloomberg Businessweek report titled: The Company That Came out on Top After Takata’s Air Bag Mess. The report indicates that largest automotive-safety parts company in the world has successfully been able to step in and respond to the Takata focused crisis. This supplier actually began supplying air bags as far back as 1980. Amid the current wave of product recalls, Autoliv produced inflators are noted as emerging relatively unscathed in the crisis.

The overall scope of the defective air bag inflators is massive, with upwards of 60 million recalled vehicles on a worldwide basis. Noted is that about 28 million Takata air bag inflators have been recalled in the U.S. alone.

Autoliv expects to produce 20 million replacement inflators since alternate production began in 2015, and extends through 2017. Once more, the supplier indicated to Bloomberg that it had won about half of all frontal air bag orders for newer cars last year. This supplier is forecasting sales growth of 7 percent annually, a fairly healthy rate for a lower-tiered automotive supplier.

Once more, Bloomberg points to Autoliv’s newer focus on the supply of more sophisticated safety components for autonomous vehicles such as radar, vision sensors and other crash avoidance safety systems ranging from standard sedans to luxury vehicles.  According to a recent Boston Consulting Group study, within the next decade, one in eight cars sold around the world will have autonomous features. Bloomberg reports that Autoliv components are contributing to autonomy features in cars like Daimler’s new Mercedes-Benz E-Class, which can steer itself in auto-pilot mode, brake in emergencies and evade obstructions. The company is also reportedly partnering with Volvo AB in a project called Drive Me that aims to have 100 self-driving cars on the roads in Gothenburg, Sweden next year.

In essence, this alternative supplier is not only benefitting from its abilities to step-up and respond to an immediate industry defective component crisis, but indeed, positioning from a product design strategy perspective to be a preferred supplier for future safety systems in multiple branded global vehicle platforms.

We have called reader attention to the ongoing Autoliv case study because it provides an ongoing example of how a major supply crisis and safety snafu can indeed lead to another supplier’s opportunistic gain. More importantly, thinking beyond the tactical crisis window at-hand with a focus on what will be the alternative technology.


Further Business Media Expose Related to Product Composition

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In mid-March, Supply Chain Matters called attention to a business media expose focused on when a consumer product contains what it is supposed to. The Wall Street Journal had published a report reflecting on the importance of knowing your product, your supplier management and oversight practices along with supporting your core product marketing strategies. Today, the WSJ added another dimension to this topic, one that perhaps has more implications for regulatory oversight.

The March WSJ report focused on actress Jessica Alba’s co-founded company, the Honest Company, which has soared to a reported $1.7 billion in private valuation in less than four years. The stated core mission of this consumer goods company is to offer cleaning products that do not knowingly contain harsh chemicals found in mainstream marketed and sold products. One of the harmful compounds of question is that of sodium lauryl sulfate, referred to as SLS. The Honest Company’s claims to consumer are that its products are free of SLS.  However, in its report, the WSJ indicated that it commissioned two independent testing labs to analyze Honest’s liquid laundry detergent only to determine that it contained significant amounts of the chemical.

Today’s WSJ report (Paid subscription required) reflects on one of largest producers of natural shampoos and skin cleaners in the United States, that being Hain Celestial Group. That company is reportedly in the process of reformulating dozens of products and dropping claims that do not contain SLS. Like Honest Company, Hain had long declared that its products contained no harsh chemicals.  Instead, some products reportedly use the ingredient sodium coco sulfate (SCS), which actually contains SLS.

What adds more interest to this development is the WSJ indicating that it actually commissioned independent laboratory testing last fall on several branded consumer products containing the SCS compound. A product general manager for Hain Celestial indicated to the WSJ that it had begun to review product formulation last spring and decided in November, after being contacted by the WSJ of its findings, to remove the “no SLS” claims on products that contain SCS.

In its latest reporting, the Journal points out that there are no current regulatory guidelines for what makes household and personal-care products “natural.” Instead, producers have termed their products as natural if they are derived from natural ingredients, even they have been chemically processed. The notation that other consumer brands were tested is perhaps an indication that more revelations or revised product claim declarations may be forthcoming.

Our readers might recall that product ingredients and product specifications are increasingly under the public looking glass. Recall the Lumber Liquidators expose in 2015 forcing that company to suspend all of its China sourced laminate flooring products after 60 Minutes, an investigative news television program turned a public light on suspected high levels of formaldehyde from certain China based flooring offered by this retailer.  While not of the same severity of concern related to natural products claims, it does reflect the relationships among product management teams and suppliers. Lumber Liquidators is still dealing with both the consumer perceptual and financial implications of that prior incident.

The takeaway from these ongoing developments is that today’s traditional and social media outlets are holding consumer goods producers to a high standard of transparency as to product formulation and declaration claims. These ongoing revelations run the risk of triggering added calls for more regulatory oversight of producers as well as suppliers, one that obviously the industry wants to avoid.

Thus the importance of a rather close relationship among product design, management, marketing and supplier sourcing teams to insure that there is total transparency of product formulation and composition declarations.

 


Supply Chain Matters Highlights from the MIT Crossroads 2016 Conference

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Supply Chain Matters had the opportunity to attend the 2016 Crossroads Conference hosted by the Massachusetts Institute of Technology (MIT) Center for Transportation and Logistics (CTL). Crossroads is an annual event that began 12 years ago for the benefit of MIT CTL corporate sponsors, and each year the conference brings together leading-edge industry and global supply chain trends and insights developed by MIT and external academic focused research. This Editor has been fortunate to be invited to this event for many prior years, and this year was no exception.

The agenda included a presentation by Sertac Karaman, MIT Assistant Professor of Aeronautics and Astronautics on the timely topic: Autonomous Vehicles: Driving Change in Logistics Networks. In the talk, Professor Karaman traced the recent history of self-driving cars after Google developed the first autonomous vehicle. What was most interesting was his predictions for what’s next in this area, which he indicated would be broader deployment of autonomous vehicles operating in distribution and logistics centers within the next two years, and within what he described as suburban focused driving environments within the next six years. One of the remaining challenges to be addressed, according to Karaman, was urban delivery and logistics requirement. Here, he referenced efforts underway from UK based Starship Technologies directed at a specialized autonomous delivery vehicle that can navigate urban landscapes. The summary conclusion is that there has been substantial technological advancement in autonomous vehicles over the past decade and the forthcoming two-year immediate impacts in supply chain environments will be in low-speed, low complexity environments in existing distribution centers and warehouses. Beyond that, there are many other opportunities as technology advances continue.

A presentation by Matthias Winkenbach, Director of the MIT Megacity Logistics Lab at CTL addressed the topic: Big Data and the Journey to a More Efficient Last Mile. Winkenbach reminded the audience that 60 percent of future GDP growth will emanate from 600 global cities, and that the logistics industry must tackle the current huge density of retail outlets that exist in mega city landscapes through more advanced use of big data integration techniques involving geographic, delivery requirements, physical sensor and other pertinent data sources. By combining publically available data such as income demographics, density of commercial establishments, road network density and capacity, with transactional data related to orders, MIT researches have been able to plot and simulate logistics needs for the delivery of food and beverage deliveries in some of the world’s most dense mega-city complexes. The integration of this data was described as the ability to correlate customer stops with special delivery services, to optimally identify delivery person walking time needs (off-vehicle operations) along with providing drivers information on optimal parking locations or congestion points to avoid at certain times.

A rather interesting insight from the Q&A session of this presentation was actual audience polling that revealed that a lot of data is actually being collected by organizations but is not being currently leveraged because of a number of challenges related to data accuracy, understanding, size and complexity as well as technical competence.

A fascinating but very concerning presentation came from Retsef Levi, Professor of Operations Management, MIT Sloan School of Management whose topic was: Adulteration Risks in Global Food Supply Chains Emanating from China. He addressed MIT research spanning over two years which was funded by the U.S. Food and Drug Administration. Observed was that imports of food shipments into the United States have dramatically expanded to include upwards of 80 percent of seafood, 70 percent of honey and other basic food commodities. The FDA sponsored Food Safety Modernization Act signed into law in 2011 was passed to prevent food safety problems rather than regulatory agencies having to merely react and respond to growing incidents. The act clearly shifted the responsibility and accountability for food safety with the industry, including validation of the food supply chain. MIT assembled a cross-departmental research team to address how does the structure of the food supply chain impact risk?  Because of the FDA sensitivities related to this research, we will refrain from sharing more of details. Suffice to note to our readers that the research identifies compelling risk drivers that include unmonitored stakeholders, overall dispersion of food supply chains, regulatory strength and the targeting of key strategic commodities that are common to many food products.

An industry focused presentation came from Joel LaFrance, Supply Chain Visibility Lead at General Mills. The day before the Crossroads conference, a group of CTL corporate members identified supply chain visibility as their most important and compelling challenge. That theme was addressed as LaFrance addressed the importance of defining supply chain visibility lexicon, as contrasted with transparency and traceability. He described the new influences impacting General Mills supply chains including unprecedented complexity and volatility as well as the convergence of physical and digital processes. The consumer goods producer started it supply chain visibility journey nearly 18 months deploying a series of use cases and initiatives directed at supporting line-of-business needs. Further shared were top four learnings that included realization that connected data is critical, that insuring end-to-end supply chain visibility changes that way work is performed, along with prioritizing end-to-end visibility needs as opposed to targeting specific functional needs.

This author had to cut-short his attendance for the full agenda, because of a previously scheduled client commitment. However, we did obtain a copy of CTL Executive Director Chris Caplice’s presentation: Transforming Professional education: An Update from the Front Line. Addressed was MIT’s ground breaking efforts in delivering an online ‘Micro-Master’s’ Program for Supply Chain Management that features open enrollment, online certification and no admissions criteria. While the program is characterized as not an MIT degree program, it does provide a faster path towards a degree. The curriculum will include courses such as Supply Chain Fundamentals, Supply Chain Analytics, Supply Chain Design and Technology. The online learning experience includes on-demand, ‘bite-sized’ video segments of 3-9 minutes coupled with quick reinforcing questions and extensive practice problems after each section. Current enrollment in this online program now exceeds 28,000 and includes student representation from 181 countries which is quite a testament to the global interest levels in acquiring supply chain management skills. This innovative program was described as helping organization’s to identify supply chain talent because MicroMasters provide a proxy for grit. It further helps to recognize and foster high-potential achievers by recognition.

This was another informative Crossroads conference one providing broader perspectives on the direction of supply chain management.

Bob Ferrari

© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All Rights Reserved.

 


Report That Chipotle is Stepping Back from Recently Announced Supply Chain Wide Food Safety Assurance Practices

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Supply Chain Matters features an update commentary regarding Chipotle Mexican Grill, specifically ongoing efforts to address a food-safety challenge that not only threatens the restaurant chain’s value to its brand and to its investors, but on perceived quality risks in its farm to fork supply chain.  Chipotle logo

In our February commentary, we observed that the restaurant chain had entered a new critical phase, one focused in rebuilding its brand integrity along with assuring that food safety practices are re-addressed from farm to fork. We opined that the quality and safe food perception crisis remains ongoing and that Chipotle must now convince it’s once loyal customers that it serves safe food with integrity.

Current developments put a different twist to the crisis. This week, The Wall Street Journal citing informed sources, reported that the restaurant chain is considering stepping back from the food safety changes touted back in February. Rather than conduct high-resolution DNA testing on a multiple of inbound supply ingredients, the plan is apparently to test only certain foods, according to this report. The chain’s beef supplies are now being pre-cooked in centralized kitchen facilities to insure that E.coli is eliminated, and then packaged in vacuum-sealed bags shipped to local outlets where the product is then marinated and grilled. The firm’s website indicates that local outlet workers are to marinate beef and chicken in sealed bags after restaurants are closed to avoid possible contamination with any food prepared during the day.

Supply Chain Matters can speculate that the decision to scale back DNA testing may have been brought about by further process and supply chain focused analysis.  Yet, this week, the restaurant chain further announced the hiring of a noted meat industry food safety expert to be its new director of overall food safety.  We can only question whether such decisions for scaling back testing should have been made so early in the process of restoring consumer confidence. After all, this is an ongoing crisis of perceived trust in the overall safety as well as quality of food served.

On the financial front, the restaurant chain warned this week that it would likely book its first quarterly loss as a public company with sales at existing outlets dropping slightly over 26 percent last month. This sales drop came while the chain was offering a wide-scale free burrito promotion to lure customers back to Chipotle. According to business media reports, many equity analysts are now scaling back 2016 and 2017 earnings estimates for the firm, signaling a prolonged process of restoring sales and profit growth.

Another concerning development was a recent securities filing indicating that senior executive future compensation plans would be directly tied to share price performance, specifically a stock price of above $700 for 30 consecutive days in order to trigger additional stock awards.  We cite a specific paragraph in the firm’s Schedule 14A SEC filing:

“In light of the challenges we faced during the second half of 2015 and the resulting decline in the price of our common stock, in February 2016 the Compensation Committee of the Board awarded performance shares to our executive officers that will be tied solely to highly challenging absolute stock price performance goals over a three-year performance period. We believe this will align executive officer compensation with restoring and further enhancing shareholder value.”

As we pen this commentary, the chain’s stock price closed slightly over $485 which implies that the stock has to rise by approximately 44 percent over the next three years to trigger executive stock awards.

Further, according to a prior WSJ report, the firm’s two co-CEO’s have already felt the implication of the incurred brand crisis with total compensation having declined by more than 50 percent with no bonuses being rewarded.  However, according to the report, the base salaries of both executives increased by roughly $100,000 in 2015.

Supply Chain Matters reviewed the Compensation Plan outlined in the latest Schedule 14A security filing and could not find any specific indication of other operational metrics tied to executive compensation, other than stock performance.  We noticed a response to a recurring shareholder proposal calling for additional measures related to the firm’s sustainability and food with integrity metrics with a Compensation Committee response indicating that such an effort would involve too much time and expense and a diversion of management resources.

At face value, we find the revised executive compensation plan troubling in its sole emphasis on stock performance without any indication of cited metrics related to either customer value or the firm’s food with integrity core mission.  Then again, this seems to be evidence of the continued over emphasis on stock and shareholder value that is apparent in so many industry settings today, an emphasis whose impact cascades down and up respective industry supply chains.

Our belief remains that restoring consumer trust in a badly damaged brand is not a one-time marketing challenge, but rather a systemic management challenge to address quality and food safety practices among all farm to fork processes and activities. These latest developments related to early scale-back in testing efforts coupled with revised executive compensation plans tied directly to stock price performance reinforce the perception that the sole mission is one of accelerated growth.

Bob Ferrari

© 2016 The Ferrari Consulting and Research Group and the Supply Chain Matters® blog. All rights reserved.

 


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