Is Chipotle a Starbucks or a Whole Foods?

Chipotle Mexican Grill has increased its prices, but continues to bring in customers -- what's the secret?

Jul 23, 2014 at 6:12PM

Addiction is an interesting thing, and for corporations, it means that customers can be squeezed a bit harder. The banker addicted to cigarettes, the writer with his coffee, or the doctor with her... burrito? Apparently we're going to have to reconsider the list of addictive substances, as Chipotle Mexican Grill (NYSE:CMG) has found a way to raise prices without suffering any ill effects.

In Monday's second-quarter earnings release, Chipotle said that it increased its average ticket by 5%, with 2.5 points of that due to raising prices. On top of the increase in average ticket, the company also saw a foot traffic increase, pushing total comparable-store sales up 17.3% over the same quarter last year. Charge more and get more -- that sounds like a winning business strategy. 

Where have we seen this before?
There are two other companies that have managed to numb their customers to price. Starbucks (NASDAQ:SBUX) and Whole Foods Market (NASDAQ:WFM) might offer some insight to Chipotle's success. Starbucks is the closest comparison, in that it sells a consumable that people love and seem to crave. Last month, Starbucks announced its most recent price increase, with some of its drinks rising by as much as $0.20.

The company did a similar thing in June 2013, and if the newest increase is anything like that one, Starbucks isn't going to be hurting. Annual comparable sales grew by 8% in 2013, with revenue rising 12% and earnings per share up 26%. Starbucks found the sweet spot that allowed it to charge more and still get customers through the door, just like a certain burrito chain.

On the other hand, let's take a look at Whole Foods, which has had a slightly more difficult time over the last few months. The company got a knock on the chin from some bad press a few weeks ago. Analysts are now worried that Whole Foods is fighting for market share with other, more price-competitive brands. That's got the market worrying that it won't be able to just keep pushing prices up and up. Instead, the competition will force the company to compete more specifically on price, pushing margins down.

There have already been some signs of this depression this year. In its last earnings release, Whole Foods announced a lowered forecast for operating margin and comparable sales. So the question for Chipotle is, can it keep running with the Starbucks model or will it end up fighting the Whole Foods fight?

Where Chipotle can go from here
While comparing Whole Foods and Starbucks, we don't have to get too technical to figure out that Chipotle is a bit more like the coffee empire than it is like the grocery store. Chipotle and Starbucks both trade on their brand in order to support prices in a way that Whole Foods can't. While Whole Foods does sell its own-brand items, much of its inventory is products that you can find at other retailers, meaning customers can compare prices directly.

Chipotle and Starbucks also have the benefit of reselling raw materials, which means that price increases can be linked directly to increased costs -- a spoonful of sugar for the medicinal price increase. Customers always find it easier to accept changes that they can understand.

That Chipotle is more akin to Starbucks in this way doesn't mean that it's destined to have the same future success, but it does give the company a potential path to follow. Chipotle's stock is trading at an all-time high and the stock's valuation has been dragged along. This is not a cheap stock, but if it can continue to work its brand magic, it just might be worth it.

Will Apple's brand magic strike again?
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple, Chipotle Mexican Grill, Starbucks, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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