Transcription
The doughnut is a resilient, multi-billion dollar industry fueled by insatiable demand. The average American eats 31 donuts every year. In the United States, it is the battleground of a never-ending war between chains and neighborhood Mom and Pops. Duncan and Crispy K Cream account for 55% of all doughnut shops in the United States. Yet, it is on the West Coast where the industry has gone through the greatest evolution. Here, donuts are canvas for gourmet ingredients, unorthodox flavors, elegant decorations, and provocative designs. In this modern MBA exclusive, we'll break down the business of donuts from the macro lens of the two biggest chains in the world to two West Coast shops looking to disrupt the status quo.
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Crispy Cream elevated the basic donut into a premium branded product with the consistency of a McDonald's and the experience of an Apple Store. Donuts, like most pastries, are handmade. In contrast, Crispy Cream's donuts are automated, and the manufacturing process is as much marketing as it is function. Customers come from far and wide to see the production process, where hundreds of donuts are cut by machine, fried on a river of hot oil, and evenly coated by a waterfall of sugary glaze. In the late '90s, Americans were head over heels for Crispy Cream. The open kitchen was must-see entertainment, the volume and freshness was unprecedented, and the taste was distinct. People didn't want plain glazed; they wanted Crispy Cream. Driven by excitement and potential, the company went public in 2000. They had the product, means to scale, and proven retail experience. All they needed was to meet demand. Crispy K Cream committed scaling to over a thousand stores in 15 years. They made millions selling donuts to the public, selling supplies to franchisees, and collecting royalties. The donut business isn't rocket science; it's a volume game where the more you sell, the more you make. Yet, the bottleneck was demand. Each Crispy Cream production line had the capacity to make 780 to 12,000 donuts every hour. Yet, every store had to constrain production and leave equipment idle. In response, the chain aggressively expanded channels, as the volume of product mattered more than the venue in which the sale took place. By the late 2000s, Crispy Cream was everywhere: in supermarkets, gas stations, convenience stores, and airports. But as they became more widespread, the novelty wore off. Despite an initial surge in revenue, the company struggled to reclaim the same top line in subsequent years. Even as more franchisees signed on, they peaked, and the regressing retail demand was only padded by the wholesale business and sales of supplies to franchisees. The average franchise made less and less due to ever-increasing saturation and cannibalization. Volume took priority over quality. Retailers found carrying Crispy Cream donuts to be troublesome, as they would regularly receive stale, leftover inventory to sell. The number of wholesale accounts dwindled year after year. Facing financial troubles, Crispy Cream was acquired by private equity in 2016, who spent the next 5 years cleaning up the mess. They implemented a disciplined hub-and-spoke model: one factory produces all the donuts as the "Hub" and then directly supplies all the stores and wholesale accounts around it. Most Crispy Cream stores today are smaller, space-efficient fulfillment centers without any kitchens. The hub-and-spoke model enables the company to achieve the same sales coverage as before without compromising on quality or overextending logistics. By being strategic with where hubs are placed and only then building everything else around the hub, they can ensure delivery and sustainability at scale. Crispy Cream has tried to evolve beyond its trademark glazed donut with consumer packaged goods, yet all of those ventures to date have been unsuccessful. While the hub-and-spoke model resolves operational obstacles, it doesn't solve demand. The company has leaned into limited-time flavors that are easy additions to existing products and cheap to source. The scarcity drives purchase urgency, and tie-ins with iconic candies like Oreo, Twix, Hershey's, and Biscoff help maintain mainstream appeal. Crispy K Cream at present is a better-oiled machine with stronger earnings, but growth is still limited and margins remain thin as a single-product company. While adding McDonald's as a win, history shows that offering Crispy Cream where customers are is no slam dunk, and there's no telling when that novelty will wear off.
Dunkin' Donuts, on the other hand, has performed much stronger than Crispy Cream over the years, with six times the amount of stores worldwide and seven times greater earnings per store than its main rival. Dunkin's strategy has been to treat donuts as a building block to selling higher-margin, higher-price products. The chain has been on a steady path of transformation over the past 10 years, evolving from a regional doughnut concept into an all-day drink destination with baked goods and sandwiches. Drinks are the main growth engine for Dunkin', with over 60% of sales in the US being beverages. As they've grown, donuts have only become even more of an afterthought. They're regularly given away for free, they're packed as loss leaders for promotions, and have been stripped out of the company logo and name. While international stores are Crispy Cream's fastest-growing division, it's the domestic stores that are Dunkin's strongest performers. And just like their number two rival, Dunkin' operates on a hub-and-spoke model where centralized production facilities make and distribute all the product to each store, who then receive, reheat, and sell individually to the public.
There are more doughnut shops in California than there are in any other state in the country. Los Angeles is home to roughly 1,600 independent doughnut shops, most of which are no-frills, neighborhood Mom and Pops run by Southeast Asians that have been serving generic $1 donuts in pink boxes for generations. They've been able to sell donuts for so cheap and for so long because they're family businesses with no outside workers or hourly wages. They all use the same industrial commercial mixes, glazes, and fillings for easy production at the expense of taste. "We're going to be using the Dawn exceptional Cho apple filling to top our donuts. It's just the Dawn thaw-and-serve donut. We do use prepared mixes, and I'm a big advocate of prepared mixes. You either needed to have people that were highly trained or master bakers, and so, you know, it's kind of cut down on labor, helped with consistency, and helped in the production process itself." But competition drives innovation. To survive at higher price points, modern LA donut shops focus on product, the one area where the chains and first movers can't compete. This influence has spread to neighboring cities like Portland, Seattle, and Las Vegas. Yet, when you're in the trenches trying to claim market share from Crispy Cream, Duncan, and the old-school Mom and Pops, product alone isn't enough to win.
It's 5:00 a.m. in Portland, and the city is just waking up. On this dark and sleepy block, Makiko Mochi Donuts, one of the hottest doughnut shops in Portland and a pioneer of Mochi Donuts in the state, is opening. As a young, single-location small business, Makiko grosses more in a year than the average Crispy Cream with a significantly smaller donut-first menu. Their timing as a first mover and their Japanese-American fusion flavors are fleeting advantages, as their success in 2 years has invited endless copycats and competition. Instead, Makiko's business is built on product, where their donuts have been engineered from the ground up for experience, efficiency, and profits. Conventional donuts are leavened dough made from wheat flour and yeast, cut into rings, and fried. As is the case with all fried foods, donuts are unmatched fresh out of the fryer but suffer from a radically short shelf life. In contrast, Makiko, by design, eliminates all the time-consuming, error-prone preparation and high perishability that come with conventional donuts. There's no need to wait for the dough to rise, and no fuss with frying, and the product stays fresh for days, not hours. Their donuts are made from butter, mochi, and rice flour without any rising agents. The wet batter is piped into molds and baked in an electric oven. Because Makiko's donuts are baked, they travel better, the shop can hold inventory for longer, and the product peaks in quality and texture 6 hours in, whereas a conventional donut would have gone stale in the same time frame. And their labor and space requirements are radically simpler. There's no need for commercial hood vents, proofing cabinets, massive dry storage, walk-ins, friers, or even gas. Their shop runs entirely on electricity, with the only equipment being a microwave for heating glaze, an oven for baking, and three mini-fridges for cold storage.
"In the food industry, your product is typically either high food cost, low labor, like uh steak, or uh low food cost, high labor, like making croissants or something like that. Our advantage is that we're low labor and low food costs. Because of that, we're able to capture much better margins and build better wages in and just do a lot more with less revenue. Since our equipment needs are so simple, we can go into a really small space. Our cooking equipment is all electric, so we aren't required to have a hood vent. It really simplifies the cost of the build and, uh, this space is only 650 square feet, and we're able to do really good volume out of here. This is our, this is actually an extra fridge that we added after, after the fact, when we realized we were going to be kind of busy here. We have a couple little small equipment items, you know, we have a little countertop, uh, ice machine off of Amazon for making cold drinks in the summer. We have a little induction burner for making, uh, fillings on the fly. We have a little countertop fryer for making fried chicken and waffles on the weekend. But as far as large cooking equipment, you know, all, all those small pieces combined are probably less than $1,000. This, this is the most expensive piece of equipment in here, $3,500 electric oven. You know, most people spend 10 times that on a hood vent and at least that on a fryer. And then this is the refrigeration we started with. We store all of our batter in this fridge, got it all on display here, ready for the weekend. And then, uh, uh, we store all our fillings and glazes in this fridge. And between these two, we can hold about $3,500 worth of product. That's usually plenty for us to get through the day. And, uh, everything has its place, as it should, in a small space like this. If you run gas equipment, at least in our locality, you're required to have a hood vent, which, if you're doing a new construction build, adds a lot of cost. It adds a lot of expense. You know, average hood vent probably costs about $30,000. We did this whole build for, including the equipment, about $95,000. So it would be a huge line item if we were required to do that. But because we're able to control all these other things, we can keep things really low risk by mitigating a lot of these costs that people fall into when they're starting up a business."
Similar to how the McDonald's Brothers turned hamburgers into an exact science in the 1960s, Alex has done the same with donuts at Makiko. Efficiency is the name of the game, and there is no wasted movement. Donuts are made in batches of 80. When the donuts are 10 minutes away from being completed in the oven, they start heating the glaze. Glaze is pre-portioned into pints, and a single pint tops 30 donuts. Fillings are portioned into 12 oz bottles, and one bottle fills 30 donuts. "My stuff is all gathered in the same place, so that after I put in my first tray of donuts, I have 9 minutes instead of 6 minutes, and I can use that extra 3 minutes to cry coffee, do a whole bunch of different stuff." Given that it only takes 20 minutes to make donuts from piping to finish, Makiko never runs out. In contrast, conventional donut shops are forced to overproduce, as they cannot easily replenish their inventory based on demand without incurring greater risk or waste. This is why most shops would rather just sell out and ask customers to come back tomorrow, given how many hours it takes them to make donuts and the constraint of being able to only produce one flavor or one shape at a time. "Some guy came in yesterday, bought almost everything we had at like 1:00, but because the operation is so efficient, we can restock in 20 to 30 minutes, which, you know, that's a $125 order. Like, if we're not able to fill that, we're lose $125 for the day. It's like a slow Monday, that might be all the profit we make on on a Monday. It's the difference between break-even and making money."
At Makiko, the only real complexity is in their breakfast sandwiches, which takes 4 minutes from assembly to service. While the sandwiches drive check sizes as a hot, savory compliment, they were also put on the menu to maximize utilization, as the buns are made from unglazed day-old donuts. Alex's relentless pursuit of optimization is not to cut payroll to the point where every worker becomes replaceable. In his mind, success is execution in service as much as it is about execution in product, day in and day out. But being an inviting neighborhood destination is something that only Makiko can accomplish, especially as his competition remains dead set on hiring grumpy teenagers at minimum wage and opening up storefronts anywhere they can fit a display case, especially in Southern California.
"If you've seen Donut King, there's a huge culture of Cambodian and Laotian families coming over to open these shops and like sponsoring other family members to come over and help out. And because it's a family business, you know, they're not really subject to the same thing where they're just hiring staff and paying prevailing wage. So a lot of these businesses that rely on family labor are able to get by on a lot less because they have such low overhead, and so they are able to set the market down there by competing on price." For that reason, the premium donut market in LA is sort of a challenge because there's such a precedent and such an established culture. In the counter-service context, a lot has been lost in the customer experience. In Portland, in a lot of places, there's a lot of apathetic service, and I think when people find a place where they actually feel welcome and have a good experience, they're much, much more likely to return. And a big part of ensuring that is making sure that our staff are happy. Everybody who works for me full-time at any level at the donut shop made over $50,000 last year. You know, we start everybody at at least $20, $21 an hour, and it's a small tip pool, so we try to do everything we can to create good pay for our staff so that they feel invested and they care. I want any job that we create to be a, a living wage role."
To Alex's point, delivery and online orders make up just 10% of their sales and have been trending down for months. The vast majority of his business today is still walk-ins from regulars and first-timers. Yet, efficiency doesn't take precedence over experience. All glazes and fillings are made in-house, and every donut is filled and garnished to order. And while the competition serves the safe crowd-pleasers like standard chocolate and plain glaze, Makiko never serves basic flavors. Of course, to hit that $1.50 per donut price point, you have to be using the same commodity ingredients as the grocery store, as Crispy Cream, and you're going to get a pretty analogous product. "We make everything from scratch here. The black sesame and marionberry jam, I think, is a great example. If you're not familiar with sesame, you wouldn't really know where to start with that flavor, but we say it's like a PB&J for fancy little kids, and you might want to try it. Then, so if we do like a chocolate flavor, we're going to jazz it up somehow, but try to keep it approachable enough for your five-year-old. We have our niches as well, where they're all gluten-free and dairy-free and nut-free, which is just a bonus because they stand on their own merits, they're good for everybody. But being able to capture a good chunk of the population that isn't otherwise able to eat your average grocery store donut, that's important. And when those people find something that is actually good and reliable, they're a loyal customer for life."
Alex's precision in product and operations extends into pricing and packaging. Makiko's donuts are priced at $3 to $4 each, which sits between the cheap $1 to $2 Mom and Pop or chain donut and the $4 to $5 artisan donuts from local high-end patisseries. With eight flavors on the menu, people have a hard time narrowing down their purchase to just two to three. The best deal, instead, is to get one of each for just $25. You get to try everything, the most bang for your buck, and the lowest price per donut. Their average order size is $15 on weekdays and $18 on weekends. Ultimately, this pricing wouldn't work without a compelling product, as every flavor must be enticing enough to generate demand for volume purchases. Labor costs sit at 35%, despite paying every worker above-market wages. Rent is 5%, and food costs are 15%. Makiko's operating profit margin sits at a healthy 45%, higher than Crispy Cream and comparable to Duncan, all without the luxury of lobbying, franchising, million-dollar advertising budgets, and economies of scale. Alex is a rare breed; he's a progressive owner who is as much a donut connoisseur as he is a shrewd restaurateur. Alex didn't invent butter mochi; he wasn't the first to bake it in the shape of donuts, nor did he work in donut shops before Makiko. But like a good businessman, he saw an opportunity and ran with it. Alex experienced his first Mochi Donuts years back at a random coffee shop during a vacation in California. He found the product compelling enough to bring to Portland, looked up some recipes online, tweaked the product, and then built a business around it. In just four years, Makiko has gone from an idea to the leading Mochi donut shop in Portland, with a second store underway in Beaverton.
"I think there's something to be said for the concept of enough. If you can retain a 30% net margin and pay all your people extremely well, why would you not do that instead of making 40% and, you know, having to rehire every month, having constant turnover, having to deal with all of the, you know, stress that trying to penny-pinch entails. I think, you know, it's worth investing in people at the end of the day." The key elements of a business are product, pricing, talent, and market, but not every small business and not every doughnut shop gets it right. Few owners ever reach the success of Makiko, even when operating in bigger markets and with deeper domain expertise. As one of the wealthiest cities and the donut capital of the country, Los Angeles is where the competition is fiercest, but the opportunity is also the greatest. People in LA embrace food innovation faster than other cities, where simple desserts like cupcakes, ice cream, and donuts have been elevated into upscale indulgences. Peter has followed this trend and has just opened his shop selling $5 to $6 artisan yeast donuts with gourmet organic ingredients and elaborate toppings. He's built his business on product. Peter makes everything from his brioche to his cream glaze and frosting from scratch every morning at 3:00 a.m. He uses the recipes he's honed over the years working at various donut shops around the country, and he's devoted to details, no matter how laborious: dicing fresh apples for fritters and whipping graham cracker buttercream for deeper flavor. All the hours and effort Peter spends making his donuts is how he justifies pricing. It's quality over quantity. Would you rather indulge in six generic donuts made from tubs of artificial glitter glazes and bag mixes, or two of his for the same cost? Peter is chasing after the connected, affluent Los Angeles upper-middle class and elite. Yet, catering to this niche brings its own challenges.
"You know, I want people to take pictures of their box of donuts and be like, 'Oh, they're so pretty, I don't even want to eat them.' Especially in LA, people want to be trendy and be the first on things. So people eat with their eyes. They, if they don't look that good, why would I spend $5 on it? People care about their physique maybe a little bit more here, or a little bit more health-conscious. If I'm going to eat a really fatty cheeseburger, it might as well be like Shake Shack versus McDonald's in terms of however many calories I have left in the day, like might as well make it worthwhile." A dozen of his donuts cost $45, three times more than a dozen from Crispy Cream and Duncan, and nearly twice as much as a flight of eight from Makiko. Peter's donuts are not only aesthetically pleasing but also heftier, denser, and richer. While conventional shops pay 50 cents or less per box, Peter spends six times that on packaging. He pays $2 to $3 each for custom boxes with dividers just so his donuts look as good at home as they do in the shop. "If you're going to charge somebody four bucks a donut, five bucks a donut, they want to get a box of them, like they should look very pretty when they get to their destination. People appreciate the fact that things don't touch. It's just kind of like a, a value add versus here's $50 for all these donuts, but kind of just get them all in like a big container. By the time I get to wherever I'm going, my cinnamon's on the chocolate, my maple's on the glaze."
Peter's shop, Lola's Donuts, has been open for just two months. He's chosen to situate in a popular mall, and by being right next to Starbucks and Urban Outfitters, he hopes to tap into their foot traffic. While high prices equal high margins, the donut business is still a volume game. So, in my mind, it's kind of just like brand recognition. If you're in a lot of people walk by, more people are going to see your name and be like, 'Okay, see people walking out of there with donuts, I should go check it out.' I'm looking for larger orders. The people that are going to come and order a couple dozen donuts for their office, four dozen donuts for their kids' class, or what have you. I mean, I'd rather have a 100 people collectively buy a hundred dozen donuts from me versus having to find 650 people to do the same amount of sales. From a production standpoint, Peter can only make what he can sell, even though it would take him roughly the same amount of time to proof, fry, and glaze 10 donuts as it would a 100. Because no one else is spending as much time as he is on product and past shops he's worked at have all treaded water before taking off, success is only a matter of time.
"My price points are like Crumbl Cookies' price point. So if they're successful, people are buying their cookies, I don't see why my donuts would be any different. I briefly dabbled as a, a real estate agent. What I learned from that is just like, if you send one mailer out or you talk to somebody one time and then never follow up with them or they never see you again, they're not going to call you up out of the blue and be like, 'Hey, you want to sell my house?' You got to be able to be in the business long enough to have people remember you so they do reach out to you for their parties or what have you. So, um, yeah, you just got to anticipate like, you know, a couple, couple more months of being kind of slow." This is how Peter sees his business. His expertise is undeniable as a passionate craftsman who's been in the game for decades, but being good at your craft and being good at business are two different things. When we first spoke with Peter, the shop had just opened, and he was optimistic for the future. But as we spent more time with Peter, the cracks in his business became apparent. Sales are so slow that he typically doesn't make a sale until 1:00 p.m. He grosses at most $2,000 a week, or $8,000 in a month, which would be tolerable if he wasn't burning $12,000 every month on rent. He sells 50 to 60 donuts and grosses $150 to $350 on most days. The typical customer buys just two donuts for an average order size of just $11. With these sluggish sales, Peter can't hire anyone, but he also can't afford to cut production any more than he already has. He has to keep making and remaking donuts every morning, even if there are leftovers. As a result, his shop lacks the enticing, colorful spread needed to properly dazzle shoppers passing by. While the mall brings Peter's shop the foot traffic and visibility, it also comes with greater headaches. While conventional donut shops and bakeries open in the morning and then close early in the afternoon, Peter is contractually required by the mall to follow standard business hours. He pulls 14 to 18-hour workdays every day, waking up at 3:00 a.m. to make donuts, opening at 10:00 a.m., and twiddling his thumbs for walk-ins until the entire mall closes at 9:00 p.m. Peter's shop didn't come with the necessary ventilation or refrigeration to support production. His production instead takes place off-premises at a shared commissary 20 minutes away, where he fries and glazes and then transports over the mostly finished product in his car to the mall. As he opens, Peter does the final toppings, but the logistical inefficiencies of this arrangement are apparent. He has to fry as late as possible in a single huge batch before opening, with zero flexibility in inventory and freshness as the day progresses.
"In business, how you interpret your failures is the difference between finding success or digging a deeper hole. Peter's shop at the mall has been open for just 2 months, but he's been trying to get this concept off the ground for much longer. Before the storefront, Lola's Donuts had initially started years ago as an online brand, but after a year, he clocked in just three orders a month and constantly struggled maintaining inventory and flavors. Peter's conclusion was that the problem was product-market fit and that the neighborhood of South Los Angeles didn't have the appetite for his donuts. He pivoted to selling in person at farmers markets, where he could showcase his product, get closer to his target audience, and build relationships one donut at a time. Yet, in 6 months, no one ever came back, leading Peter to believe that he needed to be in a place with more eyeballs and foot traffic. This was when he settled on the mall and jumped headfirst into the first vacancy."
"Maybe a little slower, but I still like learning the market. I don't really get too many like calls asking about stuff. Yeah, either just need more visibility or just be there longer and get people to think about you more. The product's not good, your marketing doesn't really even matter. I'd rather have the product be bomb, and that'll bring people in, hopefully." Like many engineers and craftsmen, Peter's unshakable conviction in his product is so fanatical that it blinds him from seeing the gaps in his business. His shop is unfinished and is still under construction, even though it's been 2 months since opening. There are no chairs, tables, menu labels, or even a new coat of paint. You can still see the self-service frozen yogurt dispensers in the wall left by the prior tenant. Yet, Peter's unbothered by any of this. He talks about selling horchata coffee and hot chocolate next month, despite not having refrigeration or cups, fried chicken sandwiches once he orders a $45,000 ventless fryer, and finally some tables but not chairs because he doesn't want customers lounging all day. He's paid a marketing agency to start advertising his shop through supermarket coupons, which seems counterintuitive given his positioning.
"I just signed up with, uh, advertising firm. You know how on the back of grocery store receipts, there's all those coupons? I'm going to be on that for two grocery stores right by the shop, so that should drive some business my way. Some mall marketing to get people that are on the other side of the mall or down below to come up to get some donuts. I wasn't expecting anything crazy out of the gate, but right now, I think it's just more like having to be open at the mall for all these hours, even when you're not doing any sales, kind of hinders your ability to go out and connect and network with people. Every so often, it's slightly discouraging, but I know the product's good, and people that have them enjoy them. So you got to work a little bit harder to make it happen. But, uh, yeah, again, I think just, you know, grinding it out and not, you know, not letting the slow days, you know, still make, still make really good donuts, even if you're only going to sell like three dozen. You never know who's going to come in and be like, 'Oh, I want you to do this for me,' or 'These are really good.' So, um, yeah, kind of just always, always bring your A-game, and, uh, yeah, as long as, just work, and it should work out."
Ultimately, the fate of Lola's Donuts lies with the people of Los Angeles. Perhaps Peter is right; maybe there is that sudden virality that will lift his business, like he's seen for the other donut shops that he's worked at across the country. Every company takes on the personality of their leaders, for better and for worse, and it's there that every business finds its edge, whether that's the precision of Alex at Makiko, the product focus of Peter at Lola's, the economies of scale of Crispy Cream, and the ruthless numbers optimization of Duncan. But business is unforgiving and punishes the unprepared and unlucky alike. Even in the world of donuts, product is not everything. Passion is no indication of success. Hard work is not a moat, and being good at your craft and being good at business are two different things.
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