Investors of Chipotle Mexican Grill (NYSE:CMG) aren't having very much fun right now. The burrito chain is suffering from a massive sales decline, driven by multiple health scandals that have made customers think twice about frequenting the company's restaurants. Comparable sales plunged nearly 30% during the first quarter of 2016, leading to Chipotle's first quarterly loss as a public company.
The optimists among Chipotle investors are betting on seeing the company quickly fix its problems and return to growth. But customer loyalty is something that's hard to win and easy to lose. Warren Buffett, famed value investor and CEO of Berkshire Hathaway, has dispensed countless nuggets of wisdom over the decades. One particular quotation from the Oracle of Omaha describes the pickle that Chipotle finds itself in perfectly:
"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."
Can free burritos make customers forget about the health scares?
Chipotle has been wildly successful since its founding more than 20 years ago for a lot of reasons. The menu is simple, the restaurants are generally pleasant, and the food is relatively inexpensive. The most important factor, though, has been the company's brand.
Chipotle has successfully convinced consumers that its food is simply better. Its ingredients are fresh, natural, and held to strict standards. In 2015, the company stopped serving pork entirely for a time because of its inability to find suppliers that met its animal welfare standards, a move that only reinforced the company's message. Likewise, GMOs are a big no-no at Chipotle.
In terms of quality, there's no question that Chipotle's food is superior compared with many of its competitors. Chipotle strategy is aligned with the general trend away from processed foods, which has helped propel the company's sales and profits higher in recent years. Chipotle didn't need to do much, other than continue to offer the same simple menu, to attract and retain customers.
Chipotle's reputation is its most important competitive advantage. It's what makes Chipotle stand out from the countless other options presented to consumers each day. The worst thing that could have happened was for an event to bring Chipotle's reputation into question.
In July of last year, five people in Washington state contracted E. coli from eating at Chipotle. If the problems had stopped there, I doubt the company would have been affected all that much. But a series of additional health crises over the following months pointed to a systemic flaw in Chipotle's safety procedures. In August, hundreds of customers and employees in California contracted norovirus. In Minnesota, 64 people were sickened by salmonella. More E. coli cases later popped up in multiple states spread across the country. And norovirus popped up again, this time in Massachusetts.
For all of these outbreaks to happen at roughly the same time required some serious bad luck in addition to the weaknesses in the company's procedures. Another factor is Chipotle's supply chain, which is complicated by the company's efforts to source ingredients locally when possible. Chipotle has taken steps to reduce the risk of future outbreaks, but the damage to its reputation has been done.
Chipotle's challenge is not simply winning back customers. The company has to pry customers away from its competitors, which have collectively absorbed the business fleeing the burrito chain. Chipotle has handed out tens of millions of coupons for free burritos in an effort to get customers to come back, and it's starting a loyalty program, at least temporarily. That's despite the fact that, less than a year ago, Mark Crumpacker, Chipotle's chief creative and development officer, stated in a conference call that the company doesn't believe that loyalty programs work:
"We've studied this in-depth, and we don't believe the general supposition that loyalty will make less frequent customers more frequent. We've studied that and just simply don't believe that to be true."
Times have changed, of course, and the company can no longer count on organic customer loyalty to drive sales.
I don't doubt that Chipotle will eventually recover, but I think it's going to take a lot longer than the most optimistic Chipotle bulls assume. Customer loyalty is a fickle thing, and it's much easier to drive people away than it is to bring them back. All the free burritos in the world won't rebuild the trust that Chipotle's health crises destroyed.