GREAT TASTE, BUT AT WHAT COST?

Chipotle strives to reinforce its strategy

by Matthew Blong, Richard Kim, Rebecca Knowles, Wei Li, Eri Miyagi and Ryan Scalise

Stephen Lindner’s eyes lit up as he pulled a hefty burrito

wrapped in foil out of a brown bag covered with the catch
phrases “I think about Chipotle every time my stomach growls”
and “one delicious bite left in the bottom!”

When asked what he liked so much about Chipotle, the

graduate student at Thunderbird School of Global Management
in Glendale, AZ – famished as he began to devour his burrito –
immediately responded, “because it tastes good!”
Screen shot from Chipotle’s webpage, 12/11/2010

Without knowing it, Lindner exemplifies the effect that Chipotle’s strategic advantage has on its
customers. Namely, that Chipotle tastes great because it serves classic Mexican entrees made from organic
and locally sourced meats and produce, all under the banner of the company’s motto, “Food with Integrity.”
And like Lindner, few Chipotle customers realize that good taste is, in fact, a direct result of organic
ingredients.

Founded by Denver chef Steve Ells in 1993, Chipotle Mexican Grill’s vision is to provide
traditionally-cooked, convenient, delicious and affordable food made from high-quality ingredients, while
avoiding the image of being a stereotypical “fast food joint.” With 37% market share, Chipotle is the market
leader in the Mexican fast-casual sector, netting an impressive $126 million in income in 2009.

Few of Chipotle’s customers are aware that well over half of its meats are organic and locally
sourced, and much of its produce is grown on small farms. This, Chipotle believes, is its strategic
advantage – that organic and natural foods are higher quality than their conventional counterparts,
resulting in greater tasting food.

“They're not asking for free-range meat or organic beans,” said Ells of his customers in a September
22, 2009 interview with The Wall Street Journal. “Ultimately, if you give people great-tasting food, they'll
come back.”

And customers do come back in droves (as evidenced by Chipotle’s 30% compound annual growth
since 2003), seeking a delicious taco or burrito, not aware that the organic sourced ingredients, as Ells
believes, are the crux of great taste, as well as a barrier to imitation by its closest competitors.

Yet there are challenges to “Food with Integrity.” Chipotle is having difficulty sustaining what its
executives recently described in its earnings conference call as its “commitment to building a unique food
culture based on making better food from more sustainably raised ingredients.” Chipotle’s high-quality
food supply chain, based on a network of over 45 organic farmers, is costly to maintain and even more
costly to imitate. In order to sustain its competitive advantage, Chipotle will need to expand its organic
food supplier base in order to meet its goal of sourcing 100% of its ingredients organically.

For most players in the quick service restaurant (QSR) industry, the balance of bargaining power
rests with food suppliers, who provide commodity-priced products that are subject to fluctuations in price.
And given the higher costs of organic farming, many large farmers have not found it economical to pursue
the natural food business model, limiting Chipotle’s supply options.

This is why Chipotle is seeking to actively expand its list of “approved” suppliers, particularly
seeking out more small and mid-sized farms, which pass muster with its quality assurance department. But
the process of identifying and securing these relationships with organic farmers takes time and money.
Chipotle hopes to consolidate its position vis-à-vis its competitors through an expanded supplier network.
One solution might be to establish exclusive relationships, thereby creating an even stronger barrier to
imitation.

Unlike many of its direct competitors, Chipotle maintains full ownership over its more than 1,000
stores. This is unusual in the QSR industry, which is dominated by franchises. Yet Chipotle eschews the
franchise model, underscoring its commitment to maintaining full control over product quality. In return
the trade-off that Chipotle has accepted is increased reliance on debt financing. Normally this would also
slow Chipotle’s growth, yet this is not apparent against the backdrop of approximately 120 new store
openings in 2010. Many of these feature the company’s new and lower fixed-cost “A-Model stores,” which
are defined by their LEED-certified architecture and reduced energy costs, environmentally friendly
features that are consistent with Chipotle’s natural, activist image and that provide cost savings that it can
apply towards supplier costs.

Another defining feature of Chipotle’s unique strategy is its caring approach to its 25,000
employees, which is costly and difficult to imitate. “Our culture appeals only to high performers,” said Ells
in an October 2008 interview with Reader’s Digest, explaining Chipotle’s policy of providing performance-
based bonuses to all employees, a rarity in the industry. “We want our folks… to think like owners,” Ells
said, noting that Chipotle promotes a stock option plan for its non-executive employees.

One local Chipotle kitchen manager praised his company for fostering a team-based environment
by cross training all employees. Indeed, all employees are expected to perform service line duties from
chopping vegetables, preparing food, to serving customers at the register. Furthermore, Chipotle
empowers its managers to identify line employees who have leadership potential. This provides the line
employees an incentive to perform their best as they prepare menu items in front of the customer’s eyes,
creating a strong fit and reinforcing Chipotle’s quality-based strategy.

Consisting of just four basic items – salads, tacos, burritos and burrito bowls – Chipotle’s simple yet
focused menu is the epitome of what Harvard Business School professor Michael Porter calls “variety-
based positioning.” Competitors in the Mexican fast-casual sector, such as Qdoba Mexican Grill, Baja Fresh
and Moe’s Southwestern Grill, offer more varied menu items than Chipotle does. Nevertheless, Chipotle
notes that its line cooks can offer more than 65,000 unique entree combinations, given the customer’s
ability to customize each menu item.

Chipotle’s narrowly focused menu allows it to concentrate on obtaining the high-quality meat and
 produce that help it to realize its strategy. Furthermore, the menu is intuitive and efficient, facilitating a
customer turnover rate of over 300 customers per hour – many of whom are extremely loyal to Chipotle.

National exposure on television programs such as Jamie Oliver’s “Food Revolution” has helped
Chipotle to establish itself as a pioneer in serving natural food in QSR industry. Recently Chipotle has
invested a great deal in its brand, emphasizing its close ties with the organic and “slow-food” movement.
Should “Food with Integrity” prove to be successful over the long run, competitors will find it very difficult
to match the brand loyalty and superior quality food that Chipotle has so carefully crafted.

Yet this spotlight on Chipotle’s business model is risky. Attention from food activists opens the
company to scrutiny and criticism, should supply issues or a change in strategic tack force it to move away
from natural and organic ingredients. Nevertheless, Chipotle’s advocacy and consumer education efforts
within the natural and organic food movement maintain Chipotle’s high visibility profile among its
competitors.

These competitors are hot on Chipotle’s heels, having imitated Chipotle’s strategy by promoting
their use of fresh ingredients to prepare entrees geared towards a sophisticated and health-conscious
clientele. Qdoba emphasizes reduced carbohydrate and caloric intake with its “Naked Meals,” tacos and
salads served without tortillas. Baja Fresh emphasizes fresh and healthy meals, subtly attacking Chipotle
with its “No Compromises” slogan, which underscores Chipotle’s inability to meet its publicized goal of
offering 100% organic foods in all of its restaurants.

As a result, Chipotle has forced itself to re-emphasize its original and most characteristic advantage:
the “Food with Integrity” philosophy. Early in 2010, Chipotle hired its first Chief Marketing Officer to
upgrade its marketing strategy in an attempt to more clearly communicate how its food differs from that of
its competitors. It recently launched an ad campaign, “Straight Talk,” to speak directly on the radio and
online about the company’s commitment to providing natural food and reinforcing customer loyalty to
Chipotle’s brand.

“With our continued focus on developing our extraordinary food and people cultures, and the
renewed commitment to bringing our marketing in line with the progress we have made in these other
critical areas, we believe Chipotle remains well-positioned for long-term growth and will continue to
provide value to our shareholders,” said Ells in a recent quarterly earnings call.

The company believes that its “Food with Integrity”

strategy will continue to bolster demand for natural foods
over the long-term, insisting that better quality ingredients
lead to better tasting food. Although Chipotle may have thus
far fallen short in effectively communicating this to customers,
the taste speaks for itself. Chipotle believes that demand for
its food will increase in the long-term and will continue to
attract the interest and capital investment of larger farms and
suppliers – a key aspect in Chipotle’s ability to maintain its
Screenshot from Chipotle’s website, 12/11/2010
strategic advantage.