Krispy Kreme's Dough Shortage

In a current full-page magazine ad for CIT Group, outgoing Dunkin' Brands Chairman and CEO Jon Luther is quoted as saying that the company's recent successes are thanks in part to his realization that Dunkin' Donuts had been "a coffee shop disguised as a doughnut shop."

Rival Krispy Kreme is not disguised as anything: It's a doughnut shop. And just now, that means trouble. While Dunkin' has rebranded—becoming a destination venue where coffee and other drinks are as much a draw as the doughnuts—Krispy Kreme relies almost exclusively on its core product.

People are eating fewer doughnuts, and the costs of making them are rising.

On Thursday, Krispy Kreme reported continued losses in its third quarter and said it expects that a "significant" number of franchised stores will close.

The company lost $5.9 million. Revenue fell by 9 percent, to $94.3 million. Same-store sales plummeted by 12 percent. Company-owned stores, which make up 20 percent of the total, lost $4.5 million, up from $1.9 million, which is $2.6 million more than it lost in last year's third quarter.

Aping Dunkin' at this point probably wouldn't make sense. The timing is off: As Dunkin has rebranded, McDonald's has begun introducing coffee bars in its stores. There is only so much of the struggling Starbucks business that can be snapped up by newly coffee-centric existing chains. Krispy Kreme is stuck with its widely beloved doughnuts. (For my part, I think Dunkin's doughnuts are vastly superior to Krispy Kreme's, which taste like sugar-coated kitchen sponges. But that's just me.)

So Krispy Kreme is left to bide its time until costs go down and demand picks up. The former seems likely; the latter is far less certain

In the meantime, the company is taking small steps. Besides curtailing store openings and closing some shops, the company says it may also downsize the shops themselves.

In a conference call with analysts, executives said that some franchisees have recently opened smaller shops with much lower costs and wider margins, and that the system may take that as a model for future stores.

And as a way to appeal to people who are trying to eat less fat and sugar, it is planning to offer smaller versions of its most popular doughnuts.

Any return to the company's former growth is probably at least a year away, and probably more, said CEO James Morgan, who characterizes the company's plans as a "transformation."

Meanwhile, Dunkin' is stepping up the competition, in part by opening more stores in the American Southeast, Krispy Kreme's home base. Still, same-store sales in Krispy Kreme's company owned shops, which are highly concentrated in the Southeast, fell by just 1.3 percent in the third quarter—which can be interpreted as a success in this climate.

Howard Penney, an analyst at Research Edge, told Dow Jones that the relative success of company-owned shops means that Krispy Kreme should hunker down even more. "They need to shrink their store base down to the core markets," he said.