SM285 PDF Eng

CASE: SM-285
DATE: 09/17/17
PARADISE BAKERY & CAFÉ:

THE CHALLENGES OF SUCCESS
INTRODUCTION
In July 1999, Daniel Patterson sat in the Aspen airport reflecting on 23 successful years running
Paradise Bakery. As he leaned back, he thought about the tremendous growth he had overseen
as cofounder and CEO. That year, Paradise would serve over eight million customers, and the
company had more than 1,000 employees. Paradise’s performance was beginning to attract
attention. As the overhead speaker blared, announcing “Flight UA 573 to Phoenix is delayed
due to weather,” Patterson’s attention snapped back to the far-reaching decision at hand. He was
scheduled to meet the next morning with his core management team to announce his decision on
a new CFO. All three members of the management team had been with Patterson at least 16
years, and together they had endured the challenges of growing the company. Hiring a high-
level external candidate was controversial. Patterson and the rest of the team had spent weeks
debating the issue, and they were deeply divided. He had decided what to do, and knew he could
face deep resistance. He hoped that none of his team walked away at this critical juncture.
Daniel Patterson: Olympic Athlete to Restaurant Entrepreneur
Daniel “Danny” Patterson was born in Southern California, and early on fell in love with two
aspects of the Santa Monica beach culture: volleyball and hotdogs. On the rare occasions when
Patterson was not playing volleyball with the nation’s best players, he could be found working at
Hot Dog on a Stick, an iconic local fast food restaurant on Muscle Beach in Santa Monica. By
Patterson’s senior year of high school, his dedication to volleyball had earned him a place on one
of the nation’s top indoor volleyball teams. Patterson attended San Diego State University, where
he continued his volleyball career, winning the National Championship and receiving his
bachelor’s degree in business. In 1968, Patterson was selected as a member of the U.S. Olympic
Mark George (MBA 2017) and Adjunct Professor Joel Peterson prepared this case as the basis for class discussion
rather than to illustrate either effective or ineffective handling of an administrative situation.
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This document is authorized for use only in Prof. Deepa Sethi's Communication for Transformation I at Indian Institute of Management - Kozhikode from Jan 2021 to Jul 2021.
Paradise Bakery and Café: Challenges of Success SM-285 p. 2
volleyball team. He was not only the youngest player, but also the shortest. “I’ve always been
the underdog or the ‘little guy,’” said Patterson, who stands 5 feet, 10 inches. “But this has never
kept me from competing at the highest level. If anything, it strengthened my resolve.” 1 Playing
on the U.S. team for 10 years, while rewarding, did not guarantee a salary, and Patterson didn’t
receive sponsorship money. To pay the bills, he worked part-time for the upscale Chart House
restaurants. When it came time to retire from volleyball at the age of 29, Patterson had been
working in the restaurant business for more than 15 years and loved it.
Paradise Bakery: The Early Days
After retiring from volleyball, Patterson considered two career options: go to work full time in
management for Chart House, or take the riskier entrepreneurial path. Consistent with his
appetite for challenges, Patterson opted for the latter. In 1976, along with cofounder Bob
Duggan, he set out to find a “new concept.” Duggan was an astute investor with savvy business
skills and would provide the capital. Patterson would provide the restaurant operating
experience and team-building skills. They wanted a concept that was new to consumers and
could be expanded nationally. In the 1970s, the number of regional malls was growing rapidly
and there was a tremendous growth opportunity for restaurants that could fit into small food
courts. Duggan came across a small cookie shop with a long line of customers at the Fox Hills
Mall in Los Angeles. What caught his eye was that the shop appeared simple, people were
embracing it, and it was a unique concept. When Patterson visited the shop, he noted that the
product was a hit, but the operation was weak. With confidence that there could be real
potential, Patterson drafted a business plan that called for an 800-square-foot shop that sold only
cookies. With his previous restaurant experience, Patterson felt he could launch a successful,
high-margin business. “The intention was to create a national chain that had the feel of a ‘ma
and pa,’ but the controls of McDonald’s,” said Patterson.
In 1976, the first Paradise Bakery opened in Long Beach, California, at the small outdoor Marina
Pacifica Mall. Despite being in a low-traffic area, the store took in $300,000 of revenue in its
first year. Patterson’s brother Mark joined the team as a partner and manager of that first store.
Mall developers soon began begging Patterson to open a second location. Patterson decided
instead to spend the next few years perfecting his recipes and improving his operational systems.
In early 1979, Paradise Bakery was offered the premier food court location in one of the
country’s most exclusive malls, Prestonwood Town Center in Dallas, Texas. Patterson jumped
at the opportunity. “We managed to open the store that same year with an expanded menu of
cookies, muffins, and drinks,” he said. “The additional time we took to perfect the recipes was
critical to our successful launch. You can scale too quickly, and we needed that additional time.”
Annual sales in the Dallas store were immediately ahead of projections and were on pace to
exceed $500,000. Within two months, Patterson had opened two more stores in California, one
in Sunnyvale and another in Fresno.
By 1980, Paradise Bakery had evolved into a café by expanding its menu to include soups,
salads, and sandwiches. The expanded menu was introduced at three of Paradise’s four
1
Interview with Daniel Patterson on August 8, 2017. Subsequent quotations are from author’s interview unless
otherwise noted.
locations, and these additional items increased sales per store by more than 75 percent; sales at
those stores rapidly rose to $1 million per location. Solid management helped ensure quality
control and gave Paradise Bakery the platform to continue expanding. Over the next 18 years,
Paradise grew to more than 35 stores in nine states, establishing the company as the premier
bakery café in the western United States.
HIRING FOR GROWTH
In February 1999, Patterson recognized a new opportunity outside of malls. He recalled:
When we started the business, our model was built on small, premium food-court
locations. With the malls growing throughout the country, there was plenty of
opportunity. Then in the 1990s, due to increased competition for small food-court
locations, mall rents increased significantly, making the financial model less
appealing. The real growth opportunity was in street locations, where operating
costs were more reasonable. We needed to evolve away from malls and develop
street locations. This required significant capital and financial acumen to pull off.
We had always grown the business by reinvesting our profits. The prospect of
having to open multiple new street bakeries, at a higher investment cost, in a few
years’ time, was a vastly different proposition to anything we had done before.
Patterson needed a strong financial leader in the company to raise the necessary debt and help
structure Paradise Bakery’s growth. Since 1987, Patterson had relied on Tim Halverson as a
consultant for Paradise’s accounting and financial planning. Halverson graduated from Brigham
Young University in 1981 with a master’s in accounting and then went to work as an accountant
for Arthur Anderson. In 1987, he moved to Chart House restaurants as their in-house
accountant. A decade later, Halverson opened his own practice and took on Paradise as a formal
client, overseeing all its accounting needs. Halverson had always performed exceptionally, and
he was well respected by Paradise’s management team.
Despite Halverson’s exemplary work, Patterson felt Paradise was in an unprecedented growth
phase and believed the company should consider hiring a CFO from outside. When Patterson
spoke with Halverson and broached the idea of bringing on a full-time CFO from outside,
Halverson expressed his desire to expand his current contract to include the CFO responsibilities.
His terms were an increase in his retainer, but he didn’t request any equity. Patterson felt
strongly that Paradise should conduct a candidate search.
The search began, and after six months, an executive recruiter showed Patterson the resume of
Laurie Danks, the CFO of the Aspen Ski Company (see Exhibit 1). Following her graduation
summa cum laude from McCombs Business School at the University of Texas, Danks had
worked at Reece Henry & Co. as a CPA for four years. Upon leaving Reece, she spent the next
10 years as CFO of two different private investment companies. In 1997, she joined Aspen Ski
Co. as vice president and CFO. Her responsibilities included financial planning and forecasting
for all ski and retail operations.
Danks would not come cheap. She wanted a salary that was 20 percent more than what Patterson
was paying the three other Paradise partners, including David Birzon, the COO, who had worked
his way up the ladder over 16 years. In addition, Danks’ equity request was several percentage
points higher than what Birzon held, and would put her on par with two of the other partners.
When Patterson compared her salary request to Halverson’s proposed expanded contract, it came
in 40 percent higher. When Patterson told Halverson that he was exploring external candidates,
Halverson urged caution. “Danny, don’t make a rash decision. We’ve worked together for over
12 years. Why don’t I serve as the interim CFO and let’s revisit in a year once we see if the new
stores work,” Patterson recalled Halverson saying. Patterson’s brother, Mark, also a partner,
expressed a similar sentiment. “Can we afford to get this wrong? What if she doesn’t gel with
the rest of the team? It seems risky,” Patterson remembered his brother saying.
Patterson knew Halverson would require no ramp time and was an excellent cultural fit, but he
was convinced that Halverson wouldn’t be able to create the necessary processes and operational
structures to scale the business. After much deliberation, Patterson made up his mind that Danks
was who the business needed, in spite of the reservations of his management team. The
challenge facing Patterson was how he would explain to the team, who had been with him since
the beginning, that Danks’ compensation would be significantly higher than theirs. Furthermore,
Paradise had protected equity throughout its growth, and Patterson didn’t have an equity pool to
draw from to compensate Danks; he would have to dilute himself and the others. Patterson
wondered if some of the leadership team might leave as a result of being diluted. He also
wondered how the rest of the management team would respond when he cut ties with Halverson,
who was a close friend to many of Paradise’s key employees.
WINDS OF CHANGE
In the seven years following Patterson’s CFO decision, Paradise had grown significantly. The
company had closed some mall locations, but had opened 25 new street bakery cafés, with stores
bringing in between $1.5 million and $4 million in revenue each. By late 2006, the company
operated 40 locations in 10 states. Thinking back to 1976, Patterson couldn’t believe the
enormous changes the business had undergone. Paradise Bakery had more than 2,000 employees
and was grossing more than $80 million in revenue annually. As pleased as Patterson was with
the growth, what really made him proud was how he had managed to maintain one of the lowest
attrition rates in the industry. The management and executive team were his second family and
had grown with the company. They had all been a part of the amazing journey and were looking
forward to continuing to grow the business. Patterson had announced plans to double the
number of stores over the next two years (see Exhibit 2). The economy was strong, Paradise was
in high demand with developers, and the team was in place. It was a dream situation.
This success did not go unnoticed in the industry. Patterson received a call from Ron Schaich,
the CEO of Panera Bread. Founded in 1987, Panera Bread was a chain of bakery-café fast casual
restaurants and the leader in the industry. In contrast to Paradise’s slow and deliberate
expansion, Panera had pursued rapid growth, and by 2006 had more than 1,100 cafés in 46 states.
Panera was generating over $2 billion in revenue per year. After several high-level meetings
between Panera and the Paradise partners, Panera made a hard press to acquire Paradise. Panera
offered to buy 51 percent of the company in an all-cash transaction. Panera would buy out the
remaining 49 percent over two years based on an earnout that required Paradise to open an
additional 35 stores in that time. Panera would pay all the costs for the store expansions.
Patterson recalled:
Ron had known about Paradise for years, and was impressed with our culture and
careful expansion. While he admired us, I was not convinced Panera would mesh
well with our unique culture. As a public company, they had a somewhat
different approach than Paradise, and were more focused on growth than
cultivating a culture. However, after lengthy meetings, we came to the conclusion
that the offer on the table was in the best interests of the partners. After 33 years,
it was an opportunity to be rewarded, and at the same time protect what we had
created in the hands of a reputable, financially stable company. The Paradise
partners approved the deal.
Having made the decision to sell, Patterson was saddled with the most difficult decision of his
33-year Paradise career: “How do I tell the team?”
There was a particular complication for Patterson. As a technique to motivate employees,

Patterson had begun one of Paradise’s recent quarterly meetings with a fake Restaurant News
headline he’d created about Panera aggressively moving into Phoenix, where Paradise was
headquartered. Before letting the team know the headline was made up, Patterson had asked the
employees whether this news scared them, and what they would do differently with this national
chain coming to their home market. These techniques had created a healthy and vibrant rivalry
with Panera, and Patterson worried how employees would respond to a Panera takeover. He
wondered if his motivational techniques would come back to haunt him when he announced the
decision to sell the company. As he thought about the upcoming quarterly meeting with the
executive team and the company’s 300 management employees, he wondered how he should
break the news. He worried about how the 2,700 dedicated hourly employees would respond as
well.
AND THEN THE SKY FELL
The Panera acquisition closed in February 2007, and for more than a year afterward, everything
was on track. Paradise began 2008 by opening the first of the 17 new street locations scheduled
for that year. Sales at these locations were hitting their forecasted plan. An additional 18 leases
were either signed or in final negotiation, thus rounding out Paradise’s commitment for the two-
year earnout. Spirits were high. Fifty managers and 500 other employees had been hired for the
expansion. Panera, as per agreement, had maintained a hands-off approach to Paradise’s
business, and had committed to honoring this deal as long as the expansion was running
according to plan. The economy had shown signs of volatility in late 2007 and early 2008, and a
housing crisis was growing. Phoenix had been hit hard, but so far Paradise’s sales had not been
affected. As Patterson switched off the light to go to bed on Sunday, September 14, 2008, he felt
good that Paradise was in the midst of its biggest expansion ever.
The next morning, Patterson got out of the shower and flipped on CNN. A headline flashed on
the screen: “Lehman Brothers collapses. Dow drops 499 points to 10,917.” The time was 7:36
a.m. Patterson realized that the financial crisis had just taken a new turn. This was much bigger
than almost anyone had predicted. As he continued watching, it was clear that none of the
commentators knew exactly what was happening or how bad it was going to get. Patterson sped
to the office to get to work before the first employees arrived.
Over the next few weeks, the fear in the office was palpable. As the September sales report
came in, Patterson was shocked to see sales were down 15 percent from a year earlier, with some
markets down as much as 25 percent. As he contemplated his next move, the phone rang. It was
John Cook from Panera’s main office. Patterson knew Panera’s quarterly earnings would be
reported soon. “Danny, we just got the weekly reports in from Paradise and noticed that the
downward sales trend in Paradise is alarming,” Patterson recalled Cook saying. “We know that
this recession is being felt across the country, but we need to know how you intend to address it.
Your reporting is due on Thursday, just three days from now. At that time, we need your plan
for how you are going to reverse the sales trend.”
As the phone clicked, Patterson felt the weight of the moment. He had spent over 30 years
building Paradise and a culture of excellence (see Exhibit 3). The employees were his second
family. He didn’t know how much worse things would get. He had already been through two
recessions in his career, yet this seemed different, more severe. His mind raced through how to
handle this. He not only had to address the company, but now he also had to answer to Panera.
As he mulled things over, another thought hit him: the earnout! Doing some back-of-the-
envelope math, he realized that if sales kept dropping, he could forfeit 35 percent to 50 percent
of his earnout. He was being paid on a formula of seven times EBITDA of the Paradise
business. He wondered what levers he should pull, if any, to address the falling sales and
EBITDA figures.
Patterson had several options, none very attractive. He wondered if he should make significant
cuts to all operating expenses, including ingredient costs and labor (see Exhibit 4). He could
even go so far as to halt the store expansion. Patterson calculated that without an improvement
in sales, he would need to cut expensive ingredients (such as chocolate chips) and the labor force
by as much as 30 percent to protect his earnout in full.
A more moderate approach would entail reducing some of the workforce, while eliminating
high-cost menu items. Patterson calculated this would ensure most of his staff would remain, but
he would likely suffer some sustained sales losses and forfeit 15 to 20 percent of his earnout.
Some members of the leadership team preferred a more wait-and-see approach, with no drastic
changes. It was possible that sales were only going to be down temporarily. Patterson shared
the concerns of his leadership team that if he cut staff and stores, and the economy recovered, it
would take months or years before they could rehire and make back the lost sales. In this
scenario, he would be giving up a significant part of his earnout as well.
As the week wore on, the deadline to respond to Panera loomed large, as did his responsibility to
address the company and his partners. He wrote on the pad on his desk, “How do I properly
address our employees and partners with a plan to combat the recession that is impacting all of
our lives?” Patterson wondered if there was another scenario he had not considered that would
protect the company and his earnout.
Exhibit 1
Laurie Danks’ Resume, 1999
Source: Daniel Patterson
Exhibit 2
Paradise Bakery Expansion Locations 2007-2008
Source: Paradise Bakery & Café.
Exhibit 3
“A Culture of Excellence”
Paradise Bakery & Cafe

is a “people” driven company
whose strength depends on an
uncompromisingly high level of ethics
and a dedication to excellence.
This is ensured by sincerely caring about

every individual who comes in contact with
Paradise, whether an employee or a customer
and treating them with due respect.
We strive to listen vs. speak, to solve vs. complain,

encourage vs. reprimand, persist vs. give in
and succeed vs. make excuses.
The success of a culture is not how well you

explain it, but more importantly, how you live
it and demonstrate it every day of your life.

You either do it or you don’t!
Danny Patterson
Founder
Est. 1976
Exhibit 4
Paradise Bakery Food Cost %, 2008

35%
30%
25%
20%
15%
10%
5%
0%
Sandwiches Soups Muffins Salads Cookies Coffee Soft Drinks
Food Cost Percentage = Cost of Ingredients/Menu Price x 100

Note: For an introduction to food cost percentage calculations, see https://youtu.be/SDXa_UeF1NQ

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CASE: SM-285

PARADISE BAKERY & CAFÉ:

Daniel Patterson: Olympic Athlete to Restaurant Entrepreneur

Paradise Bakery: The Early Days

HIRING FOR GROWTH

In February 1999, Patterson recognized a new opportunity outside of malls. He recalled:

There was a particular complication for Patterson. As a technique to motivate employees,

AND THEN THE SKY FELL

Source: Daniel Patterson

Source: Paradise Bakery & Café.

Paradise Bakery & Cafe

This is ensured by sincerely caring about

We strive to listen vs. speak, to solve vs. complain,

The success of a culture is not how well you

it and demonstrate it every day of your life.

Source: Paradise Bakery & Café.

Paradise Bakery Food Cost %, 2008

Food Cost Percentage = Cost of Ingredients/Menu Price x 100

Source: Paradise Bakery & Café.

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