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Fool on Call: Chipotle's Leadership Leads the Way

Chipotle Mexican Grill (NYSE: CMG  ) is still cooking, as indicated by its solid third quarter. Today's Fool on Call will dig deep into the Mexican quick-serve specialist, by focusing in on its most recent quarterly conference call.

Some time was spent describing the fruitful relationship between Chipotle and former partner McDonald's (NYSE: MCD  ) , which benefitted Chipotle in many ways. The obvious advantage of the partnership is McDonald's financial investments, which helped expand Chipotle from a tiny concept with 15 restaurants to a high-powered growth story with more than 500 units. Beyond this, we also know that Chipotle was able to learn from the best in the fast-food biz, gaining insights from its parent company's decades of knowledge, as while benefiting from "talented and experienced people" that came from the ranks of McDonald's.

The key to the relationship between the two is that McDonald's gave Chipotle the freedom to dance to its own beat. As Ells remarked, "[The partnership] allowed us to build Chipotle in accordance with our own vision, to show that food served didn't have to be a traditional fast-food experience."

The company's pursuit of "constant improvement" drives this vision. These two words not only set the tone of this conference call, but also establish the benchmark for the entire company.

The importance of good leadership
One area of importance for Chipotle over the past year was its restaurant management structure, or what it refers to as its Restaurateur Program, which it discussed extensively in this conference call.

Every restaurant aims to have good food and good customer service. But to make that a reality, the importance of good leadership cannot be overlooked. Chipotle was therefore intent on making a career out of the manager position, in order to retain its "best managers in the stores where they can continue to positively impact the food and the customer experience."

To accomplish this, the company implemented a new "staffing structure" over the past year that improved the opportunities for hourly workers to move into management. It's too early to fully judge the results, but as of their last meeting with regional directors, each region is seeing an increase in the number of "crew members" being promoted into management positions. Throughout the company, internal promotions have increased from a third "earlier this year to nearly 50% today."

The key advantage here is that less money, time, and resources are spent on hiring new managers, as management turnover is being significantly reduced; management turnover is down to 30% from the 40% level at this same time last year. A related benefit is that Chipotle is less reliant on area managers, operations directors, and regional directors since less hiring and training is needed for restaurant level management. This will save the company on its general and administrative expense line, helping it to maximize its profit potential.

The monetary benefits are not immediate, however. In the question-and-answer portion of the call, we learned that in each new restaurant that implements the new hiring program, there is actually a one- to two-month period where there is "upward pressure on labor." After this period, the costs normalize.

To see how the program can positively affect the company, investors should look to operating margins. Year-to-date operating margins have improved to 7.7% from 5.4% in 2006, but little of this gain so far is attributed to leveraging of the G&A line. But looking ahead, we find that management believes it has "flattened out" the negative impact of labor costs to its margins in 2006, and that the company is expecting to leverage its stabilized labor costs, "if not in the fourth quarter, hopefully early next year."

Better management, better service, better investment
Beyond simple monetary gains, perhaps the greatest gain for Chipotle is its ability to improve its service to customers. An independent research firm found that 84% of Chipotle customers are now spending "less than five minutes in line, whereas only 70% got through that fast a year ago." "We're using our crews better," explained President and COO Monty Moran.

Improved service no doubt was a contributing factor in the 11.6% increase to comparable same-store sales in the third quarter; this gain was on top of a double-digit increase in this metric in the year-ago period.

The service is better because the crews are better; the crews are better because the management is better ... all of which adds up to a better investment opportunity.

More Foolish views on the food service industry:

Buffalo Wild Wings is a Motley Fool Hidden Gems recommendation.

Fool contributorJeremy MacNealyhas a player rating of 97.64 and is ranked 290 out of 12,259 participants atMotley Fool CAPS. He has no financial interest in any company mentioned. The Motley Fool has a niftydisclosure policy.

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