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Dunkin' Donuts and Its Belief in No Frills
Posted by: Gaurav Das (IP Logged)
Date: March 11, 2014 04:23PM

They are relatively new in the multifaceted U.S. coffee industry. Yet, they have been able to maintain their No. 2 position behind Starbucks (SBUX). Canton-based Dunkin' Donuts (DNKN) is now a global brand with 10,000 stores in 32 countries and sales of $9 billion.

How charging as much as $6 for a cup of coffee could have worked for Starbucks is a case study in itself. However, competing with a company like that, yet maintaining its cheap and affordable brand image, has certainly earned a lot of brownie points for Dunkin'. The strategy has been simple: Keeping the frills out!

The No-Frills Offering

Unlike at Starbucks which has many products on its menu like gourmet coffee and whole bean coffee, the offering list from Dunkin' is precise and short. While at Starbucks, you are paying more for the experience than the coffee; at Dunkin' you pay for the coffee and have a good experience too. So instead of fancy names like tall, grande and venti, you have more conventional small, medium and large at Dunkin' Donuts.

The No-Frills Strategy

Among other things, the main strategy for Dunkin' has been to copy Starbucks. This is most relevant in terms of location selection. Across the U.S., wherever there are Starbucks outlets you are likely to find a Dunkin' Donuts close by. This has really worked well for Dunkin' as the aggressive expansion strategy of Starbucks has at times forced Dunkin' to expand as well just to keep up.

Starbuck was the first coffee shop to offer an upscale atmosphere to its customers with complimentary services like Wi-Fi. While Dunkin' attracts a more middle-class, less tech-savvy crowd, adopting the “me too” strategy here seems to have worked well for Dunkin', whose customers now spend more time at the store. This has increased the number of orders and pushed up the average bill value per customer.

Competition Heating Up

The dynamics of the industry are seeing a sea of change with new players posing a challenge to the established players.

McDonald’s (MCD) is beginning to take the coffee business seriously. Instead of coffee being just another offering, the fast food giants are now positioning their coffee as premium roasted coffee.

More than anyone else though, Canada-based Tim Hortons (THI) is going to pose the biggest challenge for Dunkin'. The biggest coffee operator of Canada, Tim Horton’s, also like Dunkin' stands for the same values of affordability and no-frills coffee. With 900 stores already up and running in the U.S., it is going to give Dunkin' a good run for its money.

So Which Coffee Stock Would You Keep?

The market cap of Dunkin' is around $5 billion. Starbucks enjoys a market cap of well over 10 times that amount. So while Starbucks is the safer bet in terms of revenues, Dunkin' is catching up with every passing quarter.

In terms of valuation, however, Tim Hortons is more attractive with a price/earnings-to-growth (PEG) ratio of 1.63, compared to Dunkin' Donuts' PEG ratio of 1.75.

So in the short run I would probably go for Starbucks and in the long run, Tim Hortons.

Stocks Discussed: DNKN, SBUX, MCD, THI,
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