Potbelly Skeptics: The Pot Calling the Kettle Black?

Historically, across numerous industries, complete product differentiation is more of a theory than reality. Sure, it would be nice for every company to produce a unique idea, product, or business model that is completely revolutionary and has never been thought about or attempted before. In many cases, though, competitors model themselves around their industry peers and improve on existing products or ideas.

New kid on the block
With less than a month under its belt as a publicly traded company, Potbelly (NASDAQ: PBPB  )  already has many naysayer analysts doubting its long-term potential. Investors likewise are starting to question the valuation of the stock--it has declined over 13% since trading began on Oct. 4, 2013 with a 120% surge.

By Bobak Ha'Eri (Transferred from en.wikipedia) [CC-BY-SA-2.5 (http://creativecommons.org/licenses/by-sa/2.5)], via Wikimedia Commons

The biggest burden being placed on Potbelly by the bears is the company's lack of product differentiation. Potbelly's menu mostly consists of sandwiches, soups, salads, smoothies, and shakes, which echoes places like Subway, Jason's Deli, Quiznos, Jimmy Johns, and Panera Bread (NASDAQ: PNRA  ) . Outside of the food industry, product similarity exists everywhere from your cell phones, computers, cars, appliances, clothing, and everything in between. More importantly, within the food industry, product similarity is even more common.

Domino's, Papa John's, Pizza Hut, Pizza Inn, and thousands of other pizza establishments all co-exist despite the fact that all of their menus are nearly identical. Even a pizza connoisseur would have trouble telling whether a random slice of cheese pizza was from Domino's or Pizza Hut. The same goes for the numerous places that sell glazed doughnuts, coffee, or the ever popular and forever duplicated hamburger.

Taking market share with lower prices?
Expansion has been accelerating during the past few years for Potbelly. In fact, it took the chain two decades to open its second shop in 1997, but just five years to go from 200 (2008) to 300 (2013) locations. Since new shops are estimated to cost $600,000 each , it should be no surprise that Potbelly's profit margin will be low for awhile--it currently sits at 1.89%.

In the meantime, Potbelly's rapid growth should make Panera Bread's management and investors pay attention. With very similar menu selections, the competitive advantages of product differentiation disappear. Instead, low-price strategies could give the edge to Potbelly. Based on the prices below, Potbelly could actually improve its margin by slowly raising prices, thus narrowing the gap between it and Panera Bread.

 

Potbelly

Panera Bread

Most Sandwiches

$4.70-$7.00

$7.09-$8.79

Most Salads

$6.10-$7.10

$5.89-$8.69

Most Soups

$3.20-$4.50

$5.89-$6.99

Most Shakes & Smoothies

$3.00-$3.30

$3.99-$4.09

Data based on Potbelly's Northern Virginia menu prices and Panera Bread's 2013  menu prices.

The flaw of being too different
Too much product differentiation may turn out to be a bigger burden for Noodles & Co (NASDAQ: NDLS  ) . The chain currently has an even lower profit margin than Potbelly, which came in at 0.08% based on its second quarter earnings.  Despite already climbing over 27% since its July IPO, Noodles & Co may find the road ahead difficult.

Even though Noodles also serves soups, sandwiches, and salads, the chain is known for noodles and pasta. Because of the lack of direct menu competition, Noodles & Co will not be able to gauge future menu or location interest.

Changes to the menu will require more investment and market research. A McDonald's competitor can easily see what works and what doesn't before it attempts to make its own version of a popular McDonald's menu item. Burger King, for example, launched its own rib sandwich after seeing the success of the McDonald's McRib earlier this year.

Restaurant expansion for Noodles & Co will require more caution. Existing restaurants that specialize in noodles or pasta are less common than burger and fries joints.

Recently, Noodles & Co launched plans for a new limited-time-only menu offering. Its new fall and winter menu items include the Thai Hot Pot, Spaghetti Alfredo MontAmore, and Pork Adobo Flatbread. Menu changes are typically expensive and often take years of marketing research to get correct. If Noodles & Co has to go this route to improve its menu, its profit margin may continue to stay near zero for quite some time.

Bottom Line
Claiming Potbelly is doomed due to a lack of product differentiation is really the pot calling the kettle black. If product differentiation is a requirement to survive in the restaurant industry, then Domino's and McDonald's would be the only ones left selling pizza and hamburgers. The fact is that the industry historically has always been open to new companies no matter how similar their menus are with existing companies. This trend won't suddenly change for Potbelly.

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Read/Post Comments (8) | Recommend This Article (1)

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  • Report this Comment On October 21, 2013, at 12:58 PM, zack777 wrote:

    The thing about Potbelly is the taste and quality of their food. Comparing them to Subway is kind of ridiculous and I have to assume that anyone implying Potbelly is just another Subway has never eaten at one or both of them. The thing I hear a lot of the television talking heads bash it about is that their menu isn't as healthy as Chipotle or Panera. It may be slightly less healthy than either, but you know what, of the 21 meals I eat per week, I can splurge 1 or 2 meals that aren't just vegetables, fruit and lean protein. I first ate at Potbelly about 6 weeks ago, have eaten at one twice a week since then, and the "unhealthy" food hasn't hurt me at all.

  • Report this Comment On October 21, 2013, at 2:47 PM, mikecart1 wrote:

    Thanks zack777 for comment. I have read about the Subway/Potbelly comparison a lot since it went public and it makes no sense. Also if you look at the Potbelly location map on their latest annual report, they have a lot of expansion room left. With expansion, I see IMO a lot of revenue growth and as a consequence much higher share prices. Will it be the next Chipotle? Who knows. Maybe not. Does it matter though? A win is a win and doubling from today's price isn't that bad.

  • Report this Comment On October 22, 2013, at 10:02 AM, kevbo34 wrote:

    Wreck Sandwich with cheese, mayo, mustard, oil, seasoning, lettuce, tomato, pickles

    Fat: 39 Calories: 744 Sodium: 2364

    Steak burrito with white rice, black beans, sour cream, cheese, lettuce and hot sauce

    Fat: 40 Calories: 1035 Sodium: 2160

    I will grant you a burrito is more filling than a wreck but throw in a bag of chips and it's still pretty comparable.

    Note that you can eat a fairly healthy lunch at both these places by mixing the right ingredients. For example, at Potbelly, I get a Mushroom Melt with not cheese and all the fixings. I am not a vegetarian but the toasted bread, mushrooms and fixings is delicious. At Chipotle I get a steak salad with all the fixings. Both around 550 calories.

    My point adds to the theme of this article and the comments. Chipotle calling Potbelly unhealthy is the kettle calling the coffee black. Furthermore, I say irresistibly delicious snacks are more to blame for the obesity epidemic then places like Chipotle and Potbelly.

  • Report this Comment On October 22, 2013, at 12:28 PM, sandiegoman wrote:

    The issue I see with Potbelly (vs Panera and Chipotle) is perceived value. When I'm in Potbelly, I feel like the ingredients are not as fresh (yes, I know they claim cut fresh every morning) but it just doesnt seem that way. I also feel like the "value" of Potbelly has decreased over the past few years. The sandwiches seem to be getting smaller and smaller and there's really no innovation within the sandwiches. They throw bacon on a sandwich and call it a new sandwich? Non innovative sandwiches and ideas are what keeps me away from this

  • Report this Comment On October 22, 2013, at 3:03 PM, mikecart1 wrote:

    kevbo34,

    Good point. I eat at Chipotle weekly but one can easily make a place that is supposed to be healthy very the opposite. Add a ton of sour creme and cheese on a double serving of steak and you got over 1000 calories easily without a drink or chips added on. I also say though that I'm cutting for a fitness related contest and that I've been doing the cutting and still eating at Chipotle 1-3x a week lol. It isn't Chipotle or Potbelly, it is everything else people eat and either refuse to admit or just forget.

  • Report this Comment On October 22, 2013, at 3:06 PM, mikecart1 wrote:

    sandiegoman,

    I don't go to Potbelly often so I can't really tell the difference (actually 2x ever), but innovation to sandwiches might not be a requirement. Subway's core lineup has remained the same for years and they continue to expand. Chipotle really hasn't changed anything in a long time. I would recommend removing the need for innovation and realizing the ability for expansion as a reason to monitor this stock. While profit margins may be dismal for several quarters, revenues is what will drive this stock up and there is plenty of room to go higher.

  • Report this Comment On October 23, 2013, at 8:00 AM, kevbo34 wrote:

    Yes,

    What analysts don't understand is most people prefer simple, recognizable foods. Food manufacturers know this. This is why I think Potbelly's will win over Noodles. When you want something simple at lunch you aren't going to get a bowel of speggeti and meatballs. I've been working in Chicago for 13 years and I think I had pasta maybe five times at lunch for going away lunches.

  • Report this Comment On January 13, 2014, at 6:11 PM, sandiegoman wrote:

    Well, I think I pegged this IPO...and Kevbo -- what is speggeti?

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