Picture from Memphis Daily News
Panera Bread Company (NASDAQ:PNRA) has been in the news recently with the decision to remove 150 different artificial additives from its menus. This move mirrors recent changes in the food industry such as Kraft Foods Group, Inc's. (NASDAQ: KRFT) removal of artificial ingredients in its Kraft Mac and Cheese and is a result of changing consumer demands and an all-natural food trend.
This has created a lot of positive PR buzz for Panera since many artificial ingredients are being portrayed as unhealthy and even harmful. As millennials gain more purchasing power, restaurants will continue to cater to their changing demands which include customizability and healthier food. Although this change may seem small it will have a major impact on the profitability and mechanics of the Panera business model.
The Millennial Effect
The millennial generation is a trendsetter with regards to food and the restaurant experience. Millennial Marketing has determined that "food trends tend to trickle up the generational ladder." Essentially, what is common for millennials now, will become popular for most consumers in the future.
Already, Millennials have radically changed the way restaurants operate as evidenced by the shift in consumer preferences from fast food to "healthier" fast casual dining. Panera is not the first fast casual chain to transform its menu in light of the healthy eating trend in the US. In fact, competing fast casual restaurants like Chipotle Mexican Grill Inc. (NYSE: CMG) recently made major menu changes by deciding to remove GM (genetically modified) ingredients from its meals.
The shift towards healthier eating can be seen in the drastic growth of Panera and other fast casual restaurants like Chipotle over the past five years.
Additionally, consumers' shift away from fast food restaurants like McDonald's Corp. (NYSE: MCD) to healthier dining options can be shown by McDonald's recent plateau and decline in revenues.
As Panera continues to become "healthier" in the eyes of consumers, total traffic and revenue should continue to increase. But at what cost?
Increased cost of "healthier" ingredients
It is common knowledge that using artificial ingredients is cheaper than using all-natural or non-GMO ingredients. For example, when Panera first decided to only use antibiotic-free chicken in 2004, it cost "dollars more per pound" according to CEO Ron Schaich. So, Panera is going to increase the cost of producing its own products with the hope that the positive PR and health conscious approach it is taking will boost sales enough to offset the higher costs.
In addition, net income in FY2014 for Panera dropped partially due to large increases in the cost of ingredients and R&D for reformulating the Panera menu.
The No-No List
Panera has released its list of 150 artificial additives that it will no longer allow on its menu, dubbed the "No-No List." After removing these artificial ingredients, Panera will be able to offer seemingly higher quality, healthier food options. The resulting positive PR and reputation will increase exposure and consumer's demand for Panera.
The recent mass movement towards "all-natural," and "no artificial additives," for many companies lends itself to the question of whether this maneuver is just a PR stunt. Especially because if Panera is truly concerned with healthy eating, the removal of 150 artificial additives only masks the true source of unhealthy products in Panera's restaurants: the calorie dense, high sugar meals.
The idea that it is a PR stunt is further backed up by the fact that many of the ingredients on the No-No list are not unhealthy and are completely harmless according to the International Food Additives Council. Many of the additives have been used for decades with no negative consequences such as calcium propionate; a safe food preservative and mold preventative. It seems that Panera is simply removing many ingredients that are unfamiliar or difficult to pronounce for PR purposes.
Moreover, what will the ultimate cost of switching recipes and ingredients be? I'm sure Panera can get incredible prices on natural additives by purchasing wholesale, but doubtless it will be more expensive than buying the cheaper artificial alternatives.
Adapt or Die
With Panera's removal of artificial additives, there must be a change in Panera's business model. Two major areas come to mind: Pricing and Efficiency.
Currently, Panera's business model is providing really tasty food at an affordable price. You can get a full meal for $7-$10.
Picture from Rabbit's Garden Blog
Now that the artificial additives are gone Panera can go one of two ways with its menu. Either Panera can maintain current price levels and make less profit per sale, or Panera can increase its prices to maintain current profit margin. If Panera increases its prices, many current regulars will no longer see the value in going to Panera as often and Panera will have to adjust to serving a new, upscale target market.
The other major change is with regards to efficiency. Now that Panera no longer uses artificial additives, many of its products will have a much shorter shelf-life. With this in mind, if Panera does not effectively handle the shorter shelf-life there will be increased expenses and losses in the short run as products spoil and cannot be used. This will directly cut into the bottom line profit of Panera, especially as costs for natural ingredients rise due to an increase in demand for them.
Conclusion
As a result of increased costs to bring "healthier" meals to consumers, I see Panera taking at least a short-term hit to profits. Additionally, with the changes in costs, prices will likely increase to offset the higher cost of ingredients. Furthermore, Panera will not suffer too much because it is such a strong brand and the increased publicity from removing these additives will likely speak to millennials and other consumers.
Panera is in a spot where the leadership will have to navigate carefully, but look for Panera to come out on top like it did in 2004 after announcing it would only use antibiotic-free chicken. All in all, the positive PR from removing artificial additives makes this move worthwhile, especially since it is better to be an innovator rather than a follower in the eyes of consumers.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
