High margins down the drain

Dunkin' started as a lunch truck.

Bill Rosenberg borrowed $5,000 against his life insurance in 1946 and started driving pastries and sandwiches out to construction sites around Boston. He did that for two years before he opened a single store.

He noticed pretty quickly that coffee and donuts were about 40% of his revenue, and also happened to be the best margins on the whole menu.

So the first shop sold only coffee and donuts. (He named it Open Kettle, which is a bad name, then renamed it after the thing he'd watched his customers actually do with the product.)

Here's the part I keep thinking about.

Any coffee that didn't sell within 18 minutes got dumped out.

He was pouring his highest-margin product down the drain all day long, on purpose.

This is either ridiculous or brilliant, depending on your timeframe.

If you’re Bill Rosenberg, you’re playing the long game. 

You’re throwing out 19-minute-old coffee all day, because you’re keeping your customers happy for the long term. Like, decades long term. 

But like all these stories end, private equity bought it in 2006. The coffee got staler. And the donuts started getting shipped in from a factory. 

Because in the short term, they’re looking for ways to optimize the balance sheet. 

Then, of course, they piled on debt, added a dividend, went public in 2011, and the sponsors sold down. 

They’re both rational courses of action (whether you like them or not). They’re just running on different clocks. (And one of them tastes crappier.)

Thinking in clocks

Here’s an exercise worth considering before you make agreements: 

Before you sign anything, write down the exact event that pays the other guy. Not what their goal is, but what their trigger is. 

A franchisor gets paid on your gross sales, not your profit. That one sentence explains most of the fine print telling you to upgrade your store.

Then ask the second question: what happens to him if this goes badly for you? If the honest answer is "nothing," you're the only one holding risk, and you should be pricing it.

I watched a batch of Dunkin' franchises open here in San Antonio in the 2010s and then close. Corporate was very good at selling franchises. Less interested in how the franchisees made out.

Charlie Munger said it better than I can: show me the incentive and I'll show you the outcome. If you've never read Poor Charlie's Almanack, start with the chapter on human misjudgment.

Thanks,
Michael