Chipotle CEO Niccol Brings Fast Food Lessons From Taco Bell

(Bloomberg View) -- At first glance, Chipotle's decision to hire Taco Bell's Brian Niccol as its new CEO might just look like a struggling company's effort to find new leadership. Actually, it's probably the end of an era.

Companies like Chipotle promised consumers fresh, organic, locally-sourced food at an affordable price. Their rise coincided with the explosive growth of smartphones, social media, and the mobile internet, perhaps giving the impression that the two trends might be related. But with the economy at full employment and bottlenecks in places like freight popping up, the era of cheap organic food at scale might be over.

Chipotle became a darling of Wall Street when the labor market was bad. When the rapid ascent of its stock price tapered off in the summer of 2014, the unemployment rate was still above six percent. Labor costs comprised 21.8 percent of revenues, according to its earnings report for the second quarter of 2014. By the fourth quarter of 2017, labor costs had risen to 27.5 percent of revenues.

One reason for Chipotle's growing labor share is the lasting damage done by the norovirus outbreaks at its restaurants in the summer of 2015. If you don't have lines out the door during peak hours, then your workers won't be fully utilized, hurting profitability. The outbreaks illustrated Chipotle's struggle to handle supply chain issues as it grew: Managing large quantities of fresh, organic, locally-sourced ingredients is a much more difficult proposition than managing pre-packaged ingredients full of preservatives from centralized distribution facilities.

Chipotle has also struggled with pricing. It recently increased menu prices by five to seven percent, due to rising food and labor costs. Earlier this month, the company said wage growth is running at five percent, and that since early 2014, it has increased wages and benefits cumulatively by 29 percent, while prices rose only 12 percent. Even if Chipotle offers better quality than traditional fast-food restaurants, customers will pay only so much for a burrito bowl. In the fourth quarter, paid buyer traffic declined.

So Chipotle is dealing with sustained wage inflation, supply chain issues, expensive ingredients, rising prices, slowing growth and squeezed profitability. It makes sense that it would turn to a fast food executive to fix the company, because those are all the pain points that led to the creation of the fast food industry in the first place.

When McDonald's introduced its "Speedee Service System" in 1948, the unemployment rate had been below 4 percent for most of the year. As the fast food industry boomed in the early 1950s, the unemployment rate dropped as low as 2.5 percent. Cost control, efficiency, and supply chain management were critical. The organic food industry has never had to deal with economic conditions like this until now.

Chipotle may be the most prominent organic-food business to struggle with costs and logistics, but they're not alone. Whole Foods, now owned by Amazon, is cracking down on smaller suppliers who can't meet its demands. Walmart, in competition with Amazon, is pushing suppliers to meet delivery windows in response to the tight freight market.

Life is just different when the economy is at full capacity. Finding workers is harder. Sourcing raw materials is harder. Acquiring freight capacity is harder. Maintaining profitability when your costs are rising and you're not sure what prices your customers will tolerate is harder. Consumers might prefer organic food to pre-packaged, processed food, but there's a reason the latter was the standard in American diets for decades. It's cheap. It has economies of scale, robust supply chains, and consolidated management. If organics are going to keep growing, they'll have to learn a thing or two from the industry they sought to disrupt.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg View columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.

To contact the author of this story: Conor Sen at csen9@bloomberg.net.

To contact the editor responsible for this story: Mark Whitehouse at mwhitehouse1@bloomberg.net.

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