A BURRITO WITHOUT INTEGRITY: IS THIS … case collection 2 A BURRITO WITHOUT INTEGRITY: IS THIS...

1st Prize A BURRITO WITHOUT INTEGRITY:

IS THIS CHIPOTLE FOR ME?

Vijaya (Narapareddy) Zinnoury, PhD.,

(Daniels College of Business

University of Denver, USA)

Inspection Copy This is an Online Inspection Copy. Protected under Copyright Law. Reproduction

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Copyright © 2017 by the author. This case was prepared as a basis for class discussion rather

than to illustrate the effective or ineffective handling of an administrative situation.

oikos Case Writing Competition 2017 Sustainable Finance Track

oikos case competition http://www.oikos-international.org/cases

oikos case collection

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ABURRITOWITHOUTINTEGRITY:ISTHISCHIPOTLEFORME?

AbstractThiscase,developedprimarilyfromsecondarysources,describesthefoundingofChipotleMexicanGrill(Chipotle,hereafter)in1993bySteveEllsanditsrapidascenttopopularityasafast-casualrestaurantbasedonitsuniquesociallyresponsibleFoodwithIntegritystrategy.Undertheleadershipoffounder-CEOSteveEllsandco-CEOMontgomeryMoran,ChipotleoutperformedtheS&P500aswellasitsrivalssinceitsIPOin2006.However,in2015,themultiplefoodcontaminationoutbreaksreverseditscourse,plungingitsstockpricetoanall-timelow.InspiteofthepromptactionstakenbyChipotle’sleadership,thecompany’sstockpricedidnotregainitspre-scandalhighsinthestockmarket.However,onSeptember6,2016,newsofactivistinvestor,BillAckman’spurchaseof9.9%ofChipotle’sstockgaveamuch-neededboosttoChipotle’sdepressedstock.Thiscasegivesstudentstheopportunitytostepintotheshoesofayoungindividualinvestor,MichaelJacobs,toassessthepotentialimpactofAckman’sinvestmentonthecompany’sstrategyandperformanceanddecidewhetherornotheshoulddivesthisChipotleholdings.


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Case

ChipotleMexicanGrill(Chipotle,hereafter)wasinthenewsagain.OnNovember18,2016CNBC’sNightlyBusinessReportreportedthatactivistinvestorBillAckmanofPershingCapitalandChipotlehadsignedaconfidentialityagreementthatwouldgiveAckmanaseatonChipotle’sBoard.1

Ackmaninvested$1.2billiononSeptember6,2016.Thispurchaseofabout2.88millionshares,or9.9%ofChipotle’sstockbyAckman’sPershingSquareCapital,gaveanemphaticboosttoChipotle’sstock,ignitingitsrisebyapproximately5.8%to$438.27theverynextday.Thus,mediaanalystsandinvestorsbeganthedebateaboutChipotle’sfuture.

Amongthemwas35-yearoldMichaelJacobswhowasaself-madeentrepreneurandadiligentinvestorbentonmakingmillionsbeforeretiringin15years.HehadinvestedinChipotle’sstocknotonlybecauseofitsuniquepositioningduetoitssociallyresponsiblestrategy,butalsobecauseofthehighgrowthithaddemonstrated.But,Ackman’sinvestmentinChipotleraisedquestions.HowwouldthisnewinvestmentimpactChipotle’sstrategyandrevival?WouldAckmanpressureChipotle’sleadershiptoseverelycutcostsintheshorttermandjeopardizethecompany’slong-termperformance,aspunditshadpostulated?AsanentrepreneurwithbusinessexperienceintherestaurantindustryinCalifornia,USA,JacobswonderedtowhatextentAckmanwouldinfluenceChipotle’sstrategyandbusinessmodelwhichwasbuiltuponastrongfoundationofenvironmentalstewardship.

CHIPOTLE’SHISTORYANDDEVELOPMENT

Chipotlewasnostrangertobeinginthelimelight.Undertheleadershipoffounder-CEO-Chairman,SteveElls,andhisco-CEO,MontgomeryMoran,theChipotlebrandgrewintoahighlyattractivefastcasualrestaurantchain.ItsenviablepositionintheU.S.wastheresultofitsuniquestrategyknownasFoodwithIntegrity,whichreflectedElls’passion2forsustainablesourcingofqualityfoodsupplieslocally.Atatimewhentheterm“sustainability”waslittleknown,positioningtherestaurantusingthisdistinctivestrategygaveChipotlesignificantfirst-moveradvantages.Saleshadgrownto$5billionin2015from$820millionsinceitsInitialPublicOffering(IPO)in2006.Theoverwhelmingdemandforthecompany’ssharesonthefirstdayofits2006IPOresultedinthedoublingofthestock’svaluethatday,makingitthemostlucrativeIPOsince2000.StevenElls,agraduateoftheUniversityofColorado,Boulder,andtheCulinaryInstituteofAmericainHydePark,N.Y.,foundedChipotlein1993afterworkingataSanFrancisco 1http://nbr.com/2016/11/18/bill-ackman-could-soon-have-a-say-in-chipotles-boardroom/2See "Back to the Start" (2:19 minutes) https://www.youtube.com/watch?v=aMfSGt6rHos&nohtml5=False

ThisshortvideoclipcapturesthecontextbehindSteveElls’passionforenvironmentalstewardshipandhis“FoodwithIntegrity”strategy.


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restaurant.Asalinecookearning$12anhour,Ellsfoundhimselfregularly“dining[on]giantburritosatTaqueriasintheMissionDistrict.”3Duringhislunchhours,thelonglineofcustomerswaitingforMexicanfoodday-in[and]day-outsparkedtheideaofstartinghisownMexican-themedrestaurant.ItwasnotuntilJuly13,1993thatEllswasabletoopenhisfirstrestaurant.Armedwithaloanof$75,000fromhisfather,EllsleasedaspacepreviouslyoccupiedbytheDollyMadisonicecreamshopneartheUniversityofDenvercampusinDenver,Colorado,madetherenovationshimselftotheproperty,andopenedhisfirstrestaurant.Therestaurantwasaninstantsuccessgenerating$450onopeningday,$800thenextday,and$1000onadayshortlythereafter.Withinsixmonths,salesperdaygrewto$3,000.4ThishighgrowthfueledbyElls’novelconceptattractedtheattentionofMcDonald’swhichtookaminoritystakeinChipotlein1998,followedbyamajoritystakein2001.ThecapitalinfusionfromMcDonald’sallowedEllstoexpandfromsixteenrestaurantsin1998toover500byOctober2006,whenMcDonald’sliquidateditsequityinthecompany.McDonald’swasrumoredtohavereapedover416%returnonits$360millioninvestmentinChipotle.SociallyResponsibleStrategyEllsenteredthehighlycompetitiveandfragmentedquickservicediningindustrywithasociallyresponsiblestrategythathenamed,FoodwithIntegrity.Hewasthefirstintheindustrytocommittoonlyservingmeatsfromanimalsthatwerenotraisedusingnon-therapeuticantibioticsandgrowthhormones.Dairyproducts,likecheeseandsourcream,wereobtainedfrommilkproducedbypasture-raisedcows.PurchasingingredientsfromfarmersusingsustainablefarmingpracticesreflectedElls’loveforpromotinganimalwelfareandenvironmentalsustainability.SimilarhighstandardswereenforcedwhenChipotlepurchasedmostlyorganically-grownproducefromfarmerswithinaradiusof350milesfromtherestaurantwheretheproducewasserved.Thiscombinationofservingtraditionallycookedfoodwithhighqualitylocally-growningredientsinaquickserviceenvironmentwhileprovidinganinteractivediningexperienceblazedthepathtoChipotle’ssuccess.Therestaurantchain,whichexpandedthroughthestrategyofcompany-ownedstores,attractedcelebritiesanddignitaries,includingPresidentObama.Usingthesamequickserviceconcept,ChipotleopenedthirteenChopHouseSoutheastAsianKitchenrestaurantsservingAsiancuisine,aswellasthreePizzeriaLocalerestaurantsspecializinginpizzaandItalianfoods.Products AkeyadvantagethatChipotlehadovercompetitionwasitsfreshingredients,localsourcing,healthycookingpractices,andeaseofordering.Chipotleofferedavarietyofmenuchoicesfromwhichcustomerscouldchoose.Whenorderingfood,patronscouldcreatetheirownburritowiththeirchoiceofmeats,vegetables,beans,rice,salsa,guacamole,cheeseorsourcreamwrappedinsideaMexican-stylewholewheattortilla(aflatbread)richinfiber.Alternatively,customerswhopreferredagluten-freedietcouldhavetheirfoodservedinabowlwithoutthetortillaandstillreceiveingredientsoftheirchoice.Othermenuchoicesincludedcrispycorntacos,softcorntacos,softflourtacosorsalads.Allingredientswere

3https://web.archive.org/web/20080403013733/http://rockymountainnews.com/news/2006/dec/23/chipotle-founder-had-big-dreams/;retrievedonMarch17,2016.4Ibid.


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openlydisplayed.Severalstaffmembersstandingontheoppositesideofthedisplaycounterfilledtheordersinrealtimeascustomerschosethemainandsideitemswhilemovingdownthelinetowardsthecashregister.Thisopen-kitchenconceptnotonlyshortenedthewaittime,butalsogavecustomersthechancetofeastontheattractivedisplayofthefreshingredientswhiletheirtastebudsreceivedstimulationfromtheexcitingflavorsthatdriftedfromthefreshlymademenuitems.ComparedtootherAmericanquickservicechains,suchasKentuckyFriedChicken(KFC)andMcDonald’s,thefoodChipotleofferedwasfreshlypreparedintherestaurant,nutritious,wholesome,andobtainedfromsustainablesources.ThisnovelmenuconceptbecameChipotle’ssourceofcompetitiveadvantageasbusyyoungprofessionalsandmillennialsweredrawntotheconvenienceofhome-style,high-qualityfoodwhichofferedarangeofchoicesatcompetitivepriceswithoutlongwaittimes.EmployeesBytheendof2015,Chipotlehadatotal59,330non-unionizedemployees,5,100ofwhomweresalariedemployees.Theremaining54,230werehourlyworkers.Thecompanyhiredonlyhigh-performingemployeesandpromotedgeneralmanagersfromwithintheorganizationtoensurethatemployeesembracedthecorporateculture,passion,andvisionwhileworkinginahigh-performanceworkenvironment.ConsistentwithElls’passionforsustainabilityandsocialresponsibility,ChipotleenteredintopartnershipwithLoomsdale,asustainableclothingcompanythatalsoengagedinsociallyresponsibleproductionmethods.Chipotle’semployeesworeorganiccottontee-shirtsandhatsmadebyLoomsdale,whichalsomadeChipotlemerchandise(graphictees,polos,andwovenshirts)whichwassoldonlineandinthestores.PerformanceIn2014,Chipotlerankedfifthinworldwidesales,behindMcDonald’s,Subway,andYumBrands(seeExhibit1).Withsalesof$27.44billion,McDonald’swasthelargestplayerintheindustry.Subwayrankedaclearsecondwith$20billion,whereasYumBrandsandChick-fil-Arankedthirdandfourth,respectively.Chipotle,whichcameinfifthinthiscompetitivesegmenthadsalesof$4.11billionin2014–approximately15%ofMcDonald’srevenues.Chipotlewasalsorankedfifthamongthetoptenmostvaluablequickservicebrandsin2015(seeExhibit2).ThisbrandrecognitionwasconsistentwithitsmarketshareintheUnitedStates.Statista5reportedthatwithamarketshareof2.2%intheU.S.,Chipotlerankedfifthin2015,onlybehindMcDonals’s,YumBrands,Subway,andWendy’srespectively.ThisisnoteworthyasthereweresignificantdifferencesbetweenChipotleanditskeycompetitorsinstrategyandsupplychainpractices.Additionally,whileChipotleexpandedthroughcompany-ownedstores,companieslikeMcDonald’sandBurgerKingbecameglobalbrandsthroughfranchising.

5http://www.statista.com/statistics/196611/market-share-of-fast-food-restaurant-corporations-in-the-us/


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Exhibit1:GlobalSalesOfTop10QuickServiceRestaurantChains

(Source:Statista)

Rankin2014 RestaurantChainNameSales(BillionsOfUS$) Sales

Growth2014 2015

1 McDonald's 27.44 25.41 -2.03

2 Subway 20.00 19.20 -0.80

3 YumBrands 13.28 13.11 -0.17

4 Chick-fil-A 6.00 5.70 -0.30

5 ChipotleMexicanGrill 4.10 4.50 0.40

6 TimHortons 3.16 2.96 -0.20

7 Wendy's 2.06 1.87 -0.19

8 Domino'sPizza 1.99 2.22 0.23

9 PapaJohns 1.75 1.64 -0.11

10 JackintheBox 1.45 1.54 0.09

Exhibit2:MostValuableQuickServiceBrandsWorldwidein2015(Source:Statista)

Chipotlestoodoutfromitscompetitorsbecauseofitsstrongcommitmenttoenvironmentalsustainabilityandsocialresponsibility.FounderElls’culinarybackgroundinfluencedthewayfoodwaspreparedattheChipotlerestaurants.Itwaspreparedinthekitchenusinghighqualityfreshingredientsandtraditionalcookingmethods.Despitethehighcostsofobtainingtheseingredientsfromlocalfarmerswhousedsustainablepracticesaswellasusingorganicingredientswhereverpossible,Chipotleachievedstrongprofitperformance.Thecompany’sindexedperformance(seeExhibit3)indicatedthatitoutperformedtheS&P500IndexandtheS&P500RestaurantsIndexfrom2010through2015.Chipotle’sDebt-Equityprofile(seeExhibit4)revealedthat,asof2013,ithadraisedallthecapitalneededbyissuingstockratherthanthroughdebt.Thiszero-debtstrategywasmaintainedin2015,aswell.ThevalueChipotlehadcreatedforitsshareholderswasalsoevidentfromtheBalanceSheetdata(seeExhibit5).ThisexhibitshowedthatChipotle’sshareholderequitygrew203.7%,fromapproximately$1.04billionin2011to$2.13billionin2015.Thecompany’s


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Profit&Lossstatement(seeExhibit6)indicatedthatcostofrevenue(i.e.,costoffoodanddirectlabor)wereoneofthemajorexpendituresinoperations.Yet,Chipotle’sprofits(i.e.,NetIncome)morethandoubledbetween2011and2015.Exhibit3:ComparisonofCumulativeTotalReturns,2010-2015(Source:Chipotle’sSEC10-Kfilings)

Exhibit4:Chipotle’sDebt-Equityin2013(Source:MorningstarInvestmentResearchCenter)


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Exhibit5:Chipotle’sConsolidatedBalanceSheet,2011-2015Source:MorningstarFiscalyearendsinDecember.USDinmillionsexceptpersharedata. 2011 2012 2013 2014 2015Assets Currentassets Cash Cashandcashequivalents 401 323 323 419 248Short-terminvestments 55 150 255 339 415Totalcash 456 473 578 758 663Receivables 8 17 24 35 38Inventories 9 11 13 15 15Deferredincometaxes 6 9 13 19 Prepaidexpenses 21 27 34 35 40Othercurrentassets 10 4 16 58Totalcurrentassets 501 547 666 878 815Non-currentassets Property,plantandequipment Grossproperty,plantandequipment 1122 1312 1491 1721 1938AccumulatedDepreciation -370 -445 -527 -614 -721Netproperty,plantandequipment 752 867 963 1107 1217Equityandotherinvestments 128 191 314 496 623Goodwill 22 22 22 22 22Otherlong-termassets 22 43 44 43 48Totalnon-currentassets 924 1122 1343 1668 1910Totalassets 1425 1669 2009 2546 2725Liabilitiesandstockholders'equity Liabilities Currentliabilities Capitalleases 0 0 Accountspayable 46 59 59 70 86Taxespayable 16 18 23 16Accruedliabilities 77 128 91 105 179Othercurrentliabilities 18 32 48 Totalcurrentliabilities 157 187 199 246 280Non-currentliabilities Capitalleases 3 Deferredtaxesliabilities 64 49 55 41 32Deferredrevenues 143 Otherlong-termliabilities 16 184 216 248 285Totalnon-currentliabilities 224 236 272 288 317Totalliabilities 381 423 471 534 597Stockholders'equity Commonstock 0 0 0 0 0Additionalpaid-incapital 677 817 920 1039 1173Retainedearnings 671 949 1277 1722 2198Treasurystock -304 -522 -660 -749 -1235Accumulatedothercomprehensiveincome 0 1 2 0 -8Totalstockholders'equity 1044 1246 1538 2012 2128Totalliabilities&stockholders'equity 1425 1669 2009 2546 2725

(1) DataadjustedtoconformtotheFinancialAccountingStandardsBoardAccounting(FASBA)standardsthatrequireddeferredtaxliabilitiesandassetstobeclassifiedasnon-current.


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Exhibit6:ChipotleMexicanGrillConsolidatedProfit&LossStatement,2011–2015

FiscalyearendsinDecember.USDinmillionsexceptpersharedata. 2011 2012 2013 2014 2015Revenue 2270 2731 3215 4108 4501

Costofrevenue 1680 1991 2360 2991 3327

Grossprofit 589 740 855 1118 1174

Operatingexpenses

Sales,Generalandadministrative 158 195 219 290 267

Otheroperatingexpenses 81 89 103 117 144

Totaloperatingexpenses 239 284 322 407 411

Operatingincome 351 456 533 711 764

InterestExpense 3

Otherincome(expense) 2 2 2 4 6

Incomebeforetaxes 350 458 534 714 770

Provisionforincometaxes 135 180 207 269 294Netincomefromcontinuingoperations 215 278 327 445 476

Netincome 215 278 327 445 476Netincomeavailabletocommonshareholders 215 278 327 445 476

Earningspershare

Basic 6.89 8.82 10.58 14.35 15.3

Diluted 6.76 8.75 10.47 14.13 15.1Weightedaveragesharesoutstanding

Basic 31 32 31 31 31

Diluted 32 32 31 32 31

EBITDA 428 540 629 821 894Source:Morningstar

Inspiteofthehighlycompetitivenatureoftheindustry,industrystatistics(seeExhibit7)indicatedthatrevenuesofthequickserviceindustryintheU.S.grewfrom$159.2billionin2002to$198.9billionin2014.This$40billionrevenuegrowthintheindustrymayhavehelpedChipotlebecomeahouseholdname,butthecompany’sstrategicsiteselectionalsocontributedtoitssuccess.Chipotlerestaurantswerelocatedinornearseveraltypesoflocationsincluding:collegesanduniversities,stripmalls,localandregionalmalls,downtownbusinesscenters,free-standingbuildings,foodcourts,trainstations,militarybases,andairports.Thesiteselectionprocesswasmanagedbyaninternalteamwiththehelpoflocalrealestatebrokers.On-sitevisitsweresupplementedbyrigorousanalysesoftrade,business,anddemographicdataaswellasthepresenceofdirectandindirectcompetitorsalreadylocatedinthearea.


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Exhibit7:RevenuesoftheU.S.Quickserviceindustry,2002-2014(Source:Statista)

Chipotledemonstratedstrongvaluetoitsinvestors.The10-yeargrowthof$10,000investedinChipotlebetween2006andmid-2016outpacedgrowthratesintherestaurantindustryaswelltheS&P500(seeExhibit8).Exhibit8:Growthof$10,000investmentfrom2006toNov31,2016

CMG=Chipotle.Source:MorningstarInvestmentResearchCenterChipotle’sstockpricehadoutperformedcompetitorslikeMcDonald’sandYumBrands(seeExhibit9).


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Exhibit9:StockPriceTrendsofChipotleandCompetitors,Dec1,2006–Dec.1,2016Source:MorningstarInvestmentResearchCenter

CMG:Chipotle;MCD:McDonald’sCorp;YUM:YumBrands,Inc.;SBUX:StarbucksCorp

FOODCONTAMINATION

Inlate2015,Chipotleencounteredmajorfood-borneillnesses,includingE-coliandSalmonellaoutbreaksinitsmultiplerestaurantsintheU.S.ThefirstcontaminationoccurredonAugust20,2015inaChipotlerestaurantinCalifornia.Onthefirstday,17employeesatthatrestaurantwerereportedtohavebecomeillfromthenorovirus,whichwasidentifiedasthesource.AccordingtotheEnvironmentalHealthDivisionofVenturaCountyinCalifornia,atotalof234individualswereaffectedbythefoodcontaminationoutbreakthatsurfacedataChipotleRestaurantinSimiValley,Californiaeventhoughthenumberreportedbythenewsmediawasconsiderablyless.HealthofficialswhohadinspectedtherestaurantonAugust24foundmultipleviolationswhichledto“morestringenthand-washingpolicies”attherestaurant.Similaroutbreaksoccurredinotherstates,includingMassachusettsontheeastcoast.Thenewsofthecontaminationsentreverberationsthroughthestockmarket.Chipotle’sstockpriceplungedfrom$757to$475.Thesuddenlossof$8billioninvaluepromptedclassactionlawsuitsfrominvestorsinJune2016,claimingthatChipotlehadfailedtorevealthatitsqualitycontrolswereinsufficienttosafeguardconsumerand employeehealth.Chipotle’sResponseChipotle’sleadershiprespondedswiftlytothefoodcontaminationcrisisfollowingthereceiptofthefirste-mailfromtheill-fatedCaliforniarestaurantonAugust20,2015.Chipotle’sco-CEOsEllsandMoranfranticallytriedtoturnthecrisisaroundthroughavarietyofmeasuresfromsendingreplacementstocoversickemployeestorestaurantclosures,newtrainingproceduresimplementingstricterhandwashing,andfoodsafetyproceduresatallrestaurants.Employeeswerenolongerallowedtobringpersonalitems,includingcellphones,nearfoodpreparationandhandlingareasinrestaurants.Newtrainingmanualswerepreparedforemployeesassociatedwithfoodpreparationandserving.Co-CEOEllswastednotime.Therestaurantchainranadvertisementsinmajornewspapersapologizingforthefoodcontaminationthatsickenedscoresofcustomersandemployeesinsomestates.Ellsalsoapologizedtothosedirectlyaffectedbythefood-borneillness.Inhismessage,henoted:“Fromthebeginning,allofourfoodsafetyprogramshavemetor


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exceededindustrystandards…Butrecentincidents,anE.colioutbreakthatsickened52peopleandanorovirusoutbreakthat sickenedapproximately140peopleatasingleChipotlerestaurantinBoston,haveshownusthatweneed todobetter,muchbetter.”Inanattempttoregaintheconfidenceofitsconsumersandthepublic,Chipotleissuedcouponsforfreefoodandalsosuppliedfreefoodtovolunteersoflocalpublicradiostationsduringthestations’funddrives.Followingthewatershedin2015,thetopleadershipteamconsistingoftheco-CEOsEllsandMoran,CFOJohnHartung,andtheChiefCreativeandDevelopmentOfficerMarkCrumpacker,tooksubstantialpaycuts(seeExhibit10).Exhibit10:Chipotle’sKeyExecutiveCompensation(Source:Morningstar)

THENEWINVESTOR

PershingCapitalManagement

ThefastfoodindustrywasafamiliarscenetoAckman,whogrewPershingCapital’swealththroughinvestmentsinlargefoodchainslikeBurgerKing,McDonald’s,andTimHortons.However,anewsreport6indicatedthatPershingCapitalManagementwasrecoveringaftera20.5%lossinvaluein2015andalossof14.3%inthefirsteightmonthsof2016.AckmanhadscaleddownhisinvestmentsinZoetis,7MondelezInternational,8andCanadianPacific.9Furthermore,hisrecentfailuresincludedJ.C.Penney,Herbalife,andValeantPharmaceuticalsallofwhichweremiredinhighprofilescandals.

TheSECfilinginSeptemberrevealedthatinadditiontothepurchaseofChipotle’sstock,PershingCapitalhadobtainedtheoptiontoacquireapproximatelyanadditional2.3million

6http://www.nytimes.com/2016/09/07/business/dealbook/bill-ackman-chipotle.html?_r=27ZoetiswastheformeranimalhealthdivisionofPfizer,aglobalpharmaceuticalcompany.8MondelezmakesthepopularOreos.9ItwasreportedthatAckmanresignedfromhismembershiponCanadianPacific’sBoardfollowingdivestitureofhisstockholdingsofCanadianPacific.


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sharesforapriceofabout$974.3million10.ThehedgefundviewedChipotleasanundervaluedcompanywitha“strongbrand,differentiatedoffering,enormousgrowthopportunity,andvisionaryleadership.”11

Chipotle’sFuture

Followingthestockpurchase,PershingSquareindicatedthatitwouldholddiscussionsabout“thegovernanceandboardcomposition,business,operations,coststructure,management,assets,capitalization,financialcondition,strategicplans,andthefuture.”12PershingCapitalwasfollowinguponitspromiseasAckmanobtainedaseatonChipotle’sBoard.

InvestorMichaelJacobswonderedwhatthefutureofChipotleandhispersonalinvestmentwouldbe.Hewasaself-madeentrepreneur,andattheageof35,Jacobswassingle,co-ownedtwobusinesses,andobsessivelyworkedtowardshisambitionof“becomingamillionaire,buyinganisland,andretiringattheageof50.“Hetookprideinhisabilitytoachievehisgoals.Inhisownwords,“Ifocus,makemoney,wakeup,andrepeat[italloveragain].”Andhealsoproclaimedtobe“people-oriented.”

WasChipotlewithAckmanon-boardgoingtoremainagoodopportunityforhim?JacobsspeculatedaboutwhatwasgoingtohappenwithChipotle’sFoodwithIntegritystrategy,thecornerstoneofthecompany’scorporatesocialresponsibilityinitiative.AfoodconsumeradvocacygroupgaveChipotleandPaneraBreadhighmarksfortheuseofantibiotic-freemeatswhilegivingafailinggradetootherrestaurantchainslikeWendy’s,BurgerKing,Denny’s,andSubway.13WhatifAckmanpersuadedChipotletoabandonitsFoodwithIntegritystrategyinanefforttocutcostsdrastically?Thatwouldalterthecompany’sbusinessmodelsignificantly!

JacobsreminiscedaboutwhatheheardonMadMoneyinNovember,whereJackHartung,Chipotle’sCFO,inhisinterviewwithhostJimCramerhadacknowledgedthat:“thedialoguewe’vehadsofarwithPershinghastalkedaboutdrivinglong-termshareholdervalue,talksaboutrecoveringthebusinessmodelandfromwhatthey’vesaidsofar,theybelieveChipotleisaspecialbrandandwe’regoingthroughatoughtimerightnowandtheywant,justlikeeveryoneelse,toseeusrecoveroursales,recoverourbusinessandifwedothatwe’regoingtogetbacktoourpreviousstockpriceandaddshareholdervaluefromthere.”14

WhileJacobswashappytolearnaboutChipotle’seffortstoincreaseshareholdervalue,hewasunsureofChipotle’sprospectsforaquickresurgenceofitsstockprice.KnowingAckman’spropensityforseekingshorttermgain,couldheposeathreattoChipotle’sinnovative,yetcostly,supplychainstrategy?WouldChipotlesuccumbtotheinvestors’ 10https://www.sec.gov/Archives/edgar/data/1058090/000119312516702094/d233755dsc13d.htm11http://finance.yahoo.com/news/chipotle-expects-meet-soon-ackman-173522106.html12http://www.forbes.com/sites/michelinemaynard/2016/09/07/chipotle-gets-a-1-2-billion-investor-can-he-shake-up-a-stale-menu/?utm_source=yahoo&utm_medium=partner&utm_campaign=yahootix&partner=yahootix&yptr=yahoo#4b7ae4e11fec13AsreportedonTheDoctorsTVshowairedinJune2016.14http://www.cnbc.com/2016/11/09/chipotle-exec-sheds-light-on-conversations-with-billionaire-bill-ackman.html


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pressuretocutcosts,boostearnings,anddrivestockpriceandmakedrasticchangestoChipotle’scoreFoodwithIntegritystrategy?Heknewthatseveralofhisfriendswerehard-coreChipotleloyalistsbecauseofthequalityoffoodthatwasassuredbyChipotle’ssupplychainstrategy.Hehimselfenjoyedthehigh-qualityburritosmadewithnon-GMOingredientsandantibiotic-freemeat.HewincedatthethoughtofaChipotleburritothatwouldbejustlikeonemadeatanyotherfastfoodrestaurantchain.WhatcouldhappenifFoodwithIntegritywasabandoned?WouldtheChipotlebrandloseitsappealamongyoungprofessionalsandmillennials?Jacobswasindecisive.HewonderedifChipotle’sdistinctivesociallyresponsiblestrategynolongersustainedtheadvantagesithadoriginallyenjoyed.WasittimeforhimtodivesttheChipotlestockheownedornot?

»Ω«


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TeachingNote

LearningObjectivesAfterreadinganddiscussingthiscaseinclass,studentswouldbeableto:

1. Examineanorganization’sstrategiesanditsperformancethroughmultiplelenses(i.e.,strategicpositioning,CorporateSocialResponsibility(CSR)performance,andfinancialperspectives);

2. EvaluatethevaluethecompanycreatedtoitsstakeholdersthroughtheTripleBottomLineapproach;and

3. Decidewhetherornotindividualinvestors(likeMichaelJacobs)shouldselltheirstakeinChipotleMexicanGrill.

CoursesThiscaseissuitableforgraduateandundergraduatecoursesin:

• SustainableFinance;• CorporateStrategy;and• CorporateSocialResponsibility

TeachingPlanAnearlierversionofthiscasewastestedinseveralcourses.--AnundergraduatecapstonecourseinahospitalitymanagementclassinSpring2016andwasreceivedwellbystudents.ThepopularityofChipotleMexicanGrillamongstudentsmakesitahighlyengagingdiscussion.--AnMBA“EnterpriseSolutions”(asecond-year)capstonecourse.--FourundergraduatecapstonestrategycoursesintwobusinessschoolsduringSummer2016intheWesternregionoftheUnitedStates.Threeofthesecoursesweretaughtasonlinehybridformat,withcasesdiscussedsynchronously.Thefourthcoursewastaughtintraditionalon-campus(face-to-face)format.Itwasreceivedwellinallfourcourses,includingtwothatweregearedtoworking/non-traditionalundergraduatestudents.FeedbackreceivedindicatedthatstudentsenjoyedreadingthecaseastheywerefamiliarwithChipotleMexicanGrillandthechallengesitfacedfollowingthefoodcontaminationepisodes.Studentsassertedthatthecasesparkedtheircuriosityandthediscussionthatensuedwasengagingtothem.Theyalsoindicatedthatthewritingstyle,includingtheopeningparagraph,piquedtheirinterest.So,theythoroughlyenjoyedreadinganddiscussingthecase.Thiscaseisintendedforadiscussionof90-110minutes.Itlendsitselfwelltogrouppresentations,wherepre-assignedgroupsmaybeaskedtopresenttheiranalysisandrecommendations.Instructorsmayalsouseitasafinalexamcase.ThecaseauthoruseditasafinalexamcaseinoneMBAcoursetaughtinFall2016andthreeoftheaboveundergraduatecapstoneStrategycoursestaughtinSummer2016.MaximumbenefitcanalsobeobtainedifthiscasewaspairedwithacaseonMcDonalds’orBurgerKingasstudentswillhavetheopportunitytocompareandcontrasttherespectivebusinessmodelsofcompetitorswithChipotleandtheoverallvaluecreatedbyeachofthem.Insummary,thiscaselendsitselfwelltoallformats,i.e.,instructor-facilitatedcasediscussioninbothtraditionalandonlineformats,studentpresentations,andafinalexamcase.Thefollowingdiscussionwascraftedforaninstructor-facilitatedopendiscussionofthecaseinclass.VideoResources:InstructorsmaywishtoshowoneorbothofthefollowingYouTubevideosbeforediscussingthecaseinclass.1. "BacktotheStart"(2:19minutes)

https://www.youtube.com/watch?v=aMfSGt6rHos&nohtml5=False


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ThisshortvideoclipcapturesthecontextbehindSteveElls’“FoodwithIntegrity”strategy,thebackboneofChipotle’sbusinessmodel.

2."ChipotleStory-HowItAllStarted"(5:11minutes)https://www.youtube.com/watch?v=wmH73Diqf5QThisfive-minutevideoprovidesthebackgroundstoryofhowSteveEllscreatedChipotleMexicanGrill.Thestory,narratedbythefounderhimself,givesanoverviewofthecompanyanditsstrategy.Italsotakesviewersbehindthescenestoshowhowthecompanywasrun.ResearchMethodologyThecasewasdevelopedprimarilyfrompubliclyavailablesecondarysources,includingnewspaperarticles,mediareports,SECfilingsbythecompany,andtheVenturaCounty’sEnvironmentalHealthDivisioninSimiValley,California.Nonamesinthecasehavebeendisguised,includingMichaelJacobs,themillennialinvestorfeaturedinthecase.Theauthorhasnorelationshipwiththecompany.TheoreticalFrameworksLeadership&CorporateGovernance:1. Cremer&H.Bettignies,“PragmaticBusinessEthics,”BusinessStrategyReview,vol.24,no.2,2013,

pp. 64-67. Also in in Thompson A.A. et al., Crafting and Executing Strategy: The Quest forCompetitiveAdvantage.NewYork,NY:McGrawHillEducation,2016(20thEd),ppR-114-116.

2. Hamel, G., “Leaders as Stewards,” Leadership Excellence, vol.29, no. 8, 2012, p. 5. Also inThompsonA.A.etal.,CraftingandExecutingStrategy:TheQuestforCompetitiveAdvantage.NewYork,NY:McGrawHillEducation,2016(20e),ppR-117-118).

3. Knights,J.,“EthicalLeadership:HowtoDevelopEthicalLeaders.”http://tandf.msgfocus.com/files/tfinf_tandf/project_662/WP-TL1V2-2016_Transpersonal_Leadership_WP_1_r4.pdf;downloadedonMay30,2016@1:15pm.

Strategy&FinancialAnalysis

1. Porter,M.E.,CompetitiveStrategy.NewYork,NY:TheFreePress,1980,pp.34-41.2. Wheelan,T.,etal.,ConceptsinStrategicManagementandBusinessPolicy:Globalization,

Innovation,andSustainability.PearsonEducation,NJ.,20153. Evans,M.H.,“EvaluatingFinancialPerformance,“downloadedfrom

www.exinfm.com/training/pdfiles/course01.pdf

TEACHINGPLAN

Videos(10min)(optional)DiscussionQuestions 1. HowdidChipotlesucceedintheUnitedStates?(10min)2. EvaluateChipotle’ssuccesspriortothefoodcontaminationsinDecember2015.(15-20min)3. WhatactionsdidChipotle’sleadershiptakeafterthewidespreadfoodcontaminationsoccurred

inCalifornia,Massachusetts,andotherStates?(10-15min)4. EvaluateChipotle’sleadershipandCorporateGovernance.(15min)(OnlyforStrategycourses)5. WhataretheStrengthsandWeaknessesofChipotle?(15min)6. ConductathoroughanalysisofChipotle’sfinancialstatements.Howwouldyouratethe

company’sperformance?(30min)(OptionalquestionforcoursesinCorporateSocialResponsibilityaswellasHospitalityManagement)

7. ShouldMichaelJacobsselloffhisstakeinChipotleornot?(10min)


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ThetablebelowaresuggestedquestionsforthevariouscoursesincludedaboveFinance Strategy CorpSocialResponsibilityQuestions1/2/3/6/7 Allquestions(1through7) Questions1/2/3/5/7

TeachingTip1:PosttheabovediscussionquestionsatleastaweekinadvanceandrequirestudentstogenerateanswerstoQuestion#6.Askthemtodoathoroughfinancialratioanalysisandpreparethecommon-sizestatementsforChipotle’sIncomestatementandBalanceSheetinpreparationforthediscussionofthecaseinclass.Thisstrategyalsoworkswellwhenthiscaseisusedinonlineclasses.TeachingTip2(optional):Letstudentsknowthatyouwouldgivebonuspointsforthosewhosubmittheresultsbeforethecaseisdiscussed.Thebonuspointscouldbebasedonthedepthandbreadthofthedata,analysis,andsynthesisofresultssubmittedbystudents.

DiscussionQuestionswithAnswers:Q1.HowdidChipotlesucceedintheUnitedStates?Chipotlesucceededinthehighlycompetitiverestaurantindustrythroughastrategyofdifferentiation.MichaelPorterinhisseminalbook15proposeddifferentiationasoneofthethreegenericcompetitivestrategiescompaniesusedtocompeteagainstrivals.Accordingtohim,differentiationistheabilityofacompanytoprovideuniqueandsuperiorvaluetothebuyersintermsofproductquality,specialfeatures,orafter-salesservice.Wheelenetal.,(2015:170)statethat“Differentiationisaimedatthebroadmassmarketandinvolvesthecreationofaproductorservicethatisperceivedthroughoutitsindustryasunique...Differentiationisaviablestrategyforearningabove-averagereturnsinaspecificbusinessbecausetheresultingbrandloyaltylowerscustomers’sensitivitytoprice.“FounderJeffEllsimplementedthisdifferentiationstrategybypositioningthecompanywithauniqueconcept(freshMexicanfood,withtheoptionforcustomerstochoosetheirowningredients),acommitmenttoenvironmentallysustainablesourcingpractices,andservinghighqualitywholesomefoodthatwasfreshlypreparedonpremisesusingtraditionalcookingmethods.Additionally,Chipotledelighteditscustomersbyprovidinganinteractivediningexperienceforitscustomers.ThefourpillarsthatbecamethefoundationsuponwhichChipotlebuiltitssuccessintheU.S.marketarecapturedbelow.Instructorsmaychoosetoprintthisexhibitorprojectitontothescreenintheclassroom.PowerPointslidesareavailableforinstructorswishingtoadoptthiscase

15 Porter, M.E., Competitive Strategy. New York, NY: The Free Press, 1980, pp. 34-41.


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Q2.EvaluateChipotle’ssuccesspriortothefoodcontaminationsinDecember2015.Eachofthefourpillars(displayedabove)werepracticesthatdidnotexistintheindustryuntilChipotleopeneditsfirstrestaurantinDenver,ColoradoonJuly13,1993.Assuch,Chipotlewasabletogarnersignificantfirst-moveradvantages,whichresultedinitshighsuccess,asmeasuredbythefollowingmetrics.

A. SalesgrowthB. ProfitgrowthC. NumberofrestaurantsD. OverseasexpansionE. NumberofemployeesF. BrandrecognitionandMarketshareG. IPOsuccessH. Valuecreatedtoitsone-timeinvestor(McDonald’s)I. ValuecreatedtoitsshareholderssinceitsIPO

A. SalesGrowth:ThecasenotedthatChipotlewasahitfromdayone.Onthefirstdayofitsopening,itssaleswere$450,followedbysalesof$800thenextday,reaching$1000adaymarkshortlythereafter.Furthermore,withinsixmonthsofitsopening,salesperdaygrewto$3,000.Salesgrowthcontinuedwellinto2015.• CaseExhibit1showedthatby2014,Chipotle’sworldwidesalesgrewto$4.11billionmakingit

thefifthlargestU.Squickservicerestaurantchainsintheworld.• CaseExhibit6supportsthistrend.Seeannualgrowthratesgiveninthetablebelow.

2011 2012 2013 2014 2015

Sales 2270 2731 3215 4108 4501AnnualGrowth -- 20% 18% 28% 10%

B. Profitgrowth:

Inspiteofthehighfoodcostsstemmingfromitssustainabilitystrategy,knownas“FoodwithIntegrity,”andcookingpractices,Chipotleremainedprofitable.

UniqueConcept

•FastcasualMexicanfood

SustainabilityStrategy

•Pricedtoreflectqualityinsteadoflowcost/valueapproaches•Company-ownedrestaurantsinsteadoffranchises•SustainableFinancialStrategy

QualityWholesomeFood

•Highquality(mostlyorganic)ingredients•Fresh locallysourcedsupplies•Non-GMO&antibiotic-freemeats•Traditionalcookingmethods

InteractiveExperience

•Menuitemsdisplayedinbuffetstyle•Servicestaffpreparingtheorderascustomerselectsmainandsideitemsfromfooditemsondisplay


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• CaseExhibit6showsthatthecompany’sprofitsincreasedfrom$215millionin2011to$476millionin2015,a2.2xgrowthinprofitsinfiveyears.Annualgrowthratesgivenbelowareequallyimpressive,exceptfor2015(theyearinwhichthefoodcontaminationcrisisoccurred).

2011 2012 2013 2014 2015NetIncome

215 278 327 445 476AnnualGrowth -- 29% 18% 36% 7%

C. NumberofRestaurants:

ChipotlegrewintheU.S.throughcompany-ownedrestaurantsinsteadoffranchises.Asof2015,Chipotlehadatotalof2010operatingrestaurants,excludingthe13Shophouse-SoutheastAsianKitchenrestaurantsservingAsiancuisine,and3PizzeriaLocalerestaurantsservingpizzaandItalianfoodthatitowned.

D. OverseasExpansion:ThecasestatedthatChipotleopeneditsfirstforeignrestaurantinToronto,Canada,in2008.In2010,itexpandedtotheU.K.,toFrancein2012,andtoGermanyin2013.Bytheendof2015,Chipotleownedatotalof23restaurantsoverseas.

E. NumberofEmployees:Employmentdatagiveninthecaseindicatedthatbytheendof2015,Chipotlehadatotalof59,330employeesonitspayroll.Detailsareasfollows.

Employmenttype NumberSalariedEmployees 5,100HourlyEmployees 54,230Total 59,330

F. BrandRecognitionandMarketShare:

AsadifferentiatorinahighlycompetitivesegmentoccupiedbyglobalgiantslikeMcDonald’s,Subway,andYumBrands,Chipotleachievedtheimpossible.CaseExhibit1showsthatChipotlerankedfifthbyglobalsalesamongquickseviceresturantswhileCaseExhibit2showsthatChipotlerankedfifthworldwideamongthemostvaluablebrandsintheindustry,behindMcDonald’s,Starbucks,Subway,andKFC.Furthermore,salesgrowthdatadisplayedinCaseExhibit1indicatesthatChipotle’ssalesincreasedfrom$4.1billionin2014to$4.5billionin2015inspiteofthefoodcontaminationcrisiswhereassalesfor8ofthetop10,includingMcDonald’sexperienceddeclineinsalesinthesameyear.Thecasealsoindicatesthatin2015,ChipotlerankedfifthinmarketshareinthefastfoodindustryintheUnitedStates.

G. IPOSuccess:Accordingtothecase,Chipotle’sIPO(initialpublicoffering)in2006washailedasthe“bestIPOsince2000.”Theoverwhelmingdemandforthecompany’ssharesonthefirstdayofitsIPOonJanuary25,2006sentthestockpricesoaring.Ineffect,thestockpriceonthedayoftheIPOdoubledindicatingtheenthusiasmandoptimisminvestorshadforChipotle’sbrandandthecompany’sdistinctivepositioning.

H. ValueCreatedtoItsOne-TimeInvestor,McDonald’s:McDonald’sinvestmentinChipotlesignaledtheconfidenceMcDonald’shadinSteveElls’leadershipandthemeritofChipotle’suniquebusinessmodelintheindustry.McDonald’swouldhavenotinvestedintheyoungcompanyunlessitsawhighpotentialforreturnsonitsinvestment.EventhoughthepartnershipbetweenMcDonald’sandChipotlelastedonlyfrom


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1998toOctober2006,therewasmutualvaluecreated.ChipotlegainedthecapitalneededforrapidexpansionwhileMcDonald’sinitialinvestmentof$360millionreapedanimpressive416%return.

I. ValueCreatedtoItsShareholdersSinceitsIPOin2006,Chipotlecreatedstellarreturnstoitsshareholders.AccordingtocaseExhibit3,evenwiththedeclinesexperiencedfrom2014to2015,Chipotle’scumulativestockreturnsexceededboththeS&P500andtheS&PRestaurantsreturns.CaseExhibit5showedthatthevaluecreatedbyChipotletoitsshareholderswassuperior.EarningsperSharerosefrom$6.89in2011to$15.3in2015.TheannualgrowthratesofChipotle’sShareholders’Equityaredisplayedbelow.

2011 2012 2013 2014 2015

TotalShareholders'Equity 1044 1246 1538 2012 2128AnnualGrowthrates -- 19% 23% 31% 6%

Q3.WhatactionsdidChipotle’sleadershiptakeafterthewidespreadfoodcontaminationsoccurredinCalifornia,Massachusetts,andotherStates?Inresponsetothefoodcontaminationcrisis,Chipotle’sleadersengagedinoperationalandstrategicactionstoavertthecarnage.OperationalResponsestotheCrisis:Chipotletookimmediateactionafterthefoodcontaminationsoccurredinthevariouslocations.Itsentemployeestoreplacethosethatweresick,closeddownrestaurantsuntiltheywereclearedbylocalhealthofficials,compliedwitheverythingtheywereaskedtodo,quicklyinstitutedadditionalfoodsafetypoliciesandprocedurestobefollowedbyitsemployeesinanattempttoavertmoreproblems.Italsodevelopedstringenttrainingmanualsandrequiredadditionaltrainingforallitsemployees.Newpoliciesprohibitedemployeesfromhavingpersonalitems,suchascellphones,inclosecontactwhilepreparingorhandlingfood.StrategicResponsestotheCrisis:Inadditiontoinstitutingnewandstricterinternalpoliciesandprocedures,FounderCEOEllssentapologyletterstothoseaffectedbythefoodcontaminationassuringthemofhigherstandardsinplace.Thecompanyalsoranadvertisementsinthelocalnewspapersadmittingtheirmistakeandengagedinavertingapublicrelationscrisis.Inall,thecompany’smanagementdemonstratedgoodleadershipincrisisandpromptlymadeeveryattempttocorrecttheirmistakesandkeepthepublicinformedofchangesbeingmade.TheyalsotriedtoregaintheconfidenceoftheconsumersbyissuingcouponsforfreeburritosandprovidingfreefoodforvolunteersoflocalpublicTVstationsduringtheirfundraisingdrives.Furthermore,asCaseExhibit10showsthatChipotle’sexecutivestookpaycutsamountingto$34.95millionin2015.ThissignalshighintegrityonthepartofChipotle’sleadersastheytakeresponsibilityforthewidespreadfoodcontaminationproblemthatoccurredin2015.Q4.EvaluateChipotle’sleadershipandCorporateGovernance.StudentswouldhavenohesitationingivinghighmarkstoChipotle’sFounder-CEO,SteveEllsandhismanagementteamfortheirsuccessinthefollowingareas.

A. PositioningChipotleinahighlycompetitivefast-casualdiningindustryusingasociallyconsciousandenvironmentallysustainableFoodwithIntegritystrategybysourcingfromlocalfarmerswhopracticedorganicandsustainablefarmingpracticeslongbeforeenvironmentalsustainabilitybecameabuzzwordinthebusinessenvironment.


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B. Growingthecompanythroughstrongbrandmanagementpracticesandsuccessfullycompetingintheindustrythroughcompany-ownedrestaurantsinsteadoffranchisingaswasthenormintheindustry.

C. OutperformingthepeersintheindustryandS&P500instockreturnsandoverallshareholdervaluecreated.

D. Controllingtheeconomicrisksbyholdinglittleornodebtinitscapitalstructure.E. Institutingahigh-performanceculturethroughcarefulselectionandtraininghuman

resourcepractices.F. Creatinghighvaluetoallitsstakeholdersandlocalcommunities.

Thus,Chipotle’stopmanagementteamembodiedpositiveleadershipasnotedbyleadershipandstrategyscholarslikeKnights(2016)16,Hamel(2012)17,andCremer&Bettignies(2013)18,whocallforarevolutioninthevaluesdemonstratedbycorporateleaders.Inacapitalisticworldwhereshareholdervaluecreationreignssupremeinallcorporatedecisionsevenattheexpenseofthegeneralwell-beingofhumanityandtheenvironment,itisrefreshingtoseehowSteveEllsbuiltasuccessfulcorporateempireonthefoundationsofsocialresponsibilityandenvironmentalstewardship.Furthermore,thetransparencyandcrisismanagementoperationsalsocommandhighmarksincorporategovernance.Thefactthatthetopleadershiptookasignificantpay-cutthetuneof48.1%followingthefoodcontaminationcrisisin2015istestamenttothestrongpositivecorporategovernanceandvaluesthatformthebedrockoftheleadershipcultureatChipotle.

Q5.WhataretheStrengthsandWeaknessesofChipotle?Strengths:

• Clearandconsistentbusinessconceptwithauniquestrategy.• HighpositionasapopularandsustainableU.S.chainbrand(seecaseExhibit1).• Strongbrandimage(seecaseExhibit2).• Strongbrandmanagementpractices.• Non-franchisedmodelensureshighercustomerexperiencewithgreatermanagerialcontrols.• SolidSalesandprofitperformance(seecaseExhibits4&6,anddiscussionpresentedearlier).• Goodreturnstoinvestorsalongwithhighstockperformancemadethiscompanyattractive

toinvestors(seecaseExhibits3,4,6,8&9anddiscussionpresentedabove).• Strongtrackrecordofattractingcapitalfrominvestorsandthestockmarket.• Nodebtinitscapitalstructure(seecaseExhibit5).• Management’sabilitytocreateasupplychainusinglocalandsustainablesourcingpractices• Leadershipexpertiseindealingwithuncertaintiesinthesupplychainassociatedwithdealing

withlocalsmallfarmersusingorganicand/orsustainablefarmingpractices.• Creatingvalueinlocalcommunities.• Uniquecultureofpromotingahigh-performancecultureaswellasenvironmental

stewardshipandsocialresponsibility.• Stronghumanresourcepractices,includinghiring,training,andpromotionfromwithinthe

organization.• Maturerestaurantchainoperations.• ConvenientfoodservicesystemsthatmeetstheemergingneedsoftheurbanChina

16Knights,J.,“EthicalLeadership:HowtoDevelopEthicalLeaders.”

http://tandf.msgfocus.com/files/tfinf_tandf/project_662/WP-TL1V2-2016_Transpersonal_Leadership_WP_1_r4.pdf;downloadedonMay30,2016@1:15pm.

17Hamel,G.,“LeadersasStewards,”LeadershipExcellence,vol.29,no.8,2012,p.5.18Cremer&H.Bettignies,“PragmaticBusinessEthics,”BusinessStrategyReview,vol.24,no.2,2013,pp.64-67.


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• Affordablepricingstrategyofquickcasualrestaurantalongwithhighqualitylocalnon-GMO,organic,andantibiotic-freemeatsisattractivetoyoungprofessionalsandmillennials.

• Themenuvarietyprovideswidechoicesforcustomerswithdifferenttastes.• Effectiveorderlinecanservemorecustomersduringthebusyrushhours.• Quickresponsebyexecutivestothefoodcontaminationcrisisandsignificantexecutivepay

cutsdemonstratesresponsibleleadership.Weaknesses:

• Thepresenceoftwo(co-)CEOsincreasescosts,duplication,bureaucracy,andconstrainsthecompany’sabilitytoreactquicklytochangingmarkettrends.

• Highlaborcosts(asapercentageofsales):rangingfrom22%to24%.Takeninthecontextofthelargeproportionofhourlyemployees(91.4%)incomparisontosalariedemployees(8.6%),itsignalstheexistenceofapotentiallaborproblemsintheformofhighlaborturnover.

• Thehigh-performancecultureintheorganizationmayincreasestresslevelsatwork,thuspotentiallyleadingtotheriskofhighlaborturnover.

• Promotingfromwithintheranksoftheorganizationconstrainstheabilityofthecompanytohirethestaffandtalentrequiredtopursuehighgrowthaswellashiringmanagerialstaffwiththenecessaryexpertiseandexperiencetoseekaggressiveexpansion.

• Non-franchisedmodelinhibitsgrowth.Q6.ConductathoroughanalysisofChipotle’sfinancialstatements.Howwouldyouratethecompany’sperformance?Assignthisquestioninadvancetostudentsandconsidergivingbonuspointstoelicitathoroughpreparation.SeeTeachingTipsincludedearlier.Irequiremystudentstoanswerthisquestioninthreesteps.Instep1,IaskthemtotranslatethefinancialstatementsintoCommon-sizestatementsandanalyzetheresultsbasedonthedatatrends.Instep2,Iaskthemtogenerateacompletesetofratiosforallthefiveyearsofdataincludedinthefinancialexhibitsandevaluatethetrendsinthedata2.Ineachofthetwosteps,Irequirethemtosystematicallypresenttheirconclusionsforeachratioorgroupofratios.Step1:AnalysisofCMG’sCommon-sizestatementsCHIPOTLE'SCOMMONSIZE(INCOME)STATEMENT(Source:MorningStar)FiscalyearendsinDecember.Datafor12months. 2011 2012 2013 2014 2015Revenue 100.00% 100.00% 100.00% 100.00% 100.00%Costofrevenue 74.04% 72.89% 73.41% 72.79% 73.91%Grossprofit 25.96% 27.11% 26.59% 27.21% 26.09%Operatingexpenses Sales,Generalandadministrative 6.96% 7.15% 6.82% 7.05% 5.93%Otheroperatingexpenses 3.56% 3.26% 3.20% 2.86% 3.19%Totaloperatingexpenses 10.52% 10.42% 10.02% 9.91% 9.12%Operatingincome 15.45% 16.69% 16.57% 17.30% 16.96%InterestExpense 0.13% Otherincome(expense) 0.09% 0.07% 0.05% 0.09% 0.14%


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Incomebeforetaxes 15.41% 16.76% 16.63% 17.39% 17.10%Provisionforincometaxes 5.94% 6.58% 6.44% 6.55% 6.54%Netincomefromcontinuingoperations 9.47% 10.18% 10.19% 10.84% 10.57%Netincome 9.47% 10.18% 10.19% 10.84% 10.57%Netincomeavailabletocommonshareholders 9.47% 10.18% 10.19% 10.84% 10.57%Earningspershare(EP Basic 6.89 8.82 10.58 14.35 15.3Diluted 6.76 8.75 10.47 14.13 15.1Weightedaveragesharesoutstanding Basic 31 32 31 31 31Diluted 32 32 31 32 31EBITDA 18.84% 19.77% 19.56% 19.99% 19.86%

CommentsandConclusions:1. Inspiteofsomevolatility,thecostofrevenuehastrendeddownwardfrom74.04%in2011to

73.91%in2015.2. Thisdecliningtrendisevidentinalloperatingexpenditures,includingSG&A.3. Grossprofit,operatingincome,netincome,andEBITDAshowanincreasingtrendbetween2011

and2015despitethesmalldipfrom2014to2015resultingfromthecontaminationcrisis.4. Thetwoitemsthatarenoteworthyaretheabsenceofinterestexpensesince2012andthe

consistentriseinEPS,year-after-year.

CHIPOTLE’SBALANCESHEETINCOMMONSIZEFORMATFiscalyearendsinDecember.Datafor12months. 2011 2012 2013 2014 2015ASSETS Currentassets Cash Cashandcashequivalents 28.15% 19.33% 16.09% 16.47% 9.10%Short-terminvestments 3.86% 9.01% 12.69% 13.30% 15.24%Totalcash 32.01% 28.34% 28.78% 29.77% 24.34%Receivables 0.59% 1.01% 1.20% 1.37% 1.40%Inventories 0.63% 0.66% 0.65% 0.60% 0.55%Deferredincometaxes 0.44% 0.53% 0.66% 0.74% Prepaidexpenses 1.50% 1.64% 1.70% 1.37% 1.47%Othercurrentassets 0.58% 0.18% 0.65% 2.13%Totalcurrentassets 35.16% 32.76% 33.16% 34.50% 29.89%Non-currentassets Property,plantandequipment Grossproperty,plantandequipment 78.73% 78.60% 74.19% 67.58% 71.12%AccumulatedDepreciation -25.97% -26.66% -26.25% -24.10% -26.45%Netproperty,plantandequipment 52.76% 51.94% 47.94% 43.47% 44.67%


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Equityandotherinvestments 9.00% 11.44% 15.62% 19.48% 22.86%Goodwill 1.54% 1.31% 1.09% 0.86% 0.81%Intangibleassets Otherlong-termassets 1.54% 2.55% 2.19% 1.68% 1.77%Totalnon-currentassets 64.84% 67.24% 66.84% 65.50% 70.11%Totalassets 100.00% 100.00% 100.00% 100.00% 100.00%

CommentsandConclusions:1.Cashandcashequivalentsdeclinedsignificantlyfrom28.15%ofTotalAssetsin2011to9.1%in2015.Thisisnotbadinlightofthefactthatshort-terminvestmentsrosedramatically3.86%to15.24%duringthesameperiod.However,TotalCashdeclinedapproximately24%infiveyears,from32.01%in2011to24.34%in2015.ThismaybecauseforsomeconcernasReceivablesmorethandoubled,from0.59%in2011to1.4%in2015.However,overallthedeclineofTotalCurrentAssetsisonlyapproximately15%between2011and2015.ThesetrendsdoraisesomeredflagsandChipotle’sliquiditywouldneedfurtherscrutiny.2.WhileChipotle’sFixedAssetbase(NetProperty,Plant,andEquipment)hasdecreasedfrom52.76%ofTotalAssetsin2011to44.67%in2015,thecompany’sequityandOtherInvestmentsasapercentageofTotalAssetsrosesharply,from9%in2011to22.86%in2015.Thisincreasehasbeensteady,alsooccurringin2015.Overall,datashowsagradualshiftfrominvestmentsincurrentassetstonon-currentassetsfrom2011to2015.CHIPOTLE’SBALANCESHEETINCOMMONSIZEFORMAT(continued) 2011 2012 2013 2014 2015LIABILITIES&STOCKHOLDERS'EQUITY Liabilities Currentliabilities Capitalleases 0.01% 0.01% Accountspayable 3.25% 3.52% 2.94% 2.73% 3.15%Taxespayable 1.15% 0.87% 0.90% 0.57%Accruedliabilities 5.37% 7.67% 4.54% 4.13% 6.55%Othercurrentliabilities 1.26% 1.57% 1.89% Totalcurrentliabilities 11.05% 11.20% 9.92% 9.65% 10.27%Non-currentliabilities Capitalleases 0.20% Deferredtaxesliabilities 4.52% 2.93% 2.76% 1.59% 1.19%Deferredrevenues 10.05% Otherlong-termliabilities 1.12% 11.00% 10.77% 9.73% 10.45%Totalnon-currentliabilities 15.69% 14.14% 13.53% 11.32% 11.64%Totalliabilities 26.74% 25.33% 23.44% 20.97% 21.91%Stockholders'equity Commonstock 0.02% 0.02% 0.02% 0.01% 0.01%Additionalpaid-incapital 47.47% 48.94% 45.78% 40.80% 43.03%Retainedearnings 47.11% 56.90% 63.55% 67.64% 80.65%Treasurystock -21.36% -31.25% -32.87% -29.41% -45.31%Accumulatedothercomprehensiveincome 0.01% 0.06% 0.08% -0.02% -0.30%


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Totalstockholders'equity 73.26% 74.67% 76.56% 79.03% 78.09%Totalliabilitiesandstockholders'equity 100.00% 100.00% 100.00% 100.00% 100.00%CommentsandConclusions:1. TotalCurrentLiabilities,expressedasapercentageofTotalLiabilitiesandStockholders’Equity

showedagradualdecliningtrenduntil2014,butroseslightlyin2015,mainlyduetoasmallincreaseinAccountsPayablefrom2014to2015.TotalLiabilitiesshowasimilartrend.

2. ItappearsthatChipotlehasincreaseditspoolofRetainedEarningsfrom47.1%ofTotalAssetsin2011to80.65%in2015whilescalingbackitsTreasuryStock.TheneteffecthasbeenasteadygrowthinTotalStockholders’Equityfrom2011to2015inspiteofaslightdeclinein2015.

Step2:FinancialRatioAnalysisProfitability 2011 2012 2013 2014 2015NetMargin% 9.47 10.18 10.19 10.84 10.57AssetTurnover(Average) 1.78 1.77 1.74 1.8 1.71ReturnonAssets% 16.88 17.97 17.81 19.55 18.04FinancialLeverage(Average) 1.36 1.34 1.31 1.27 1.28ReturnonEquity% 23.17 24.28 23.52 25.09 22.97

CommentsandConclusions:Overall,Profitabilityratioshaveshownsteadygrowthfrom2011to2015.However,thedeclineshownin2015isclearlyaresultofthefoodcontaminationcrisisexperiencedthatyear.Liquidity/FinancialHealth 2011 2012 2013 2014 2015CurrentRatio 3.18 2.93 3.34 3.58 2.91QuickRatio 2.95 2.67 3.04 3.29 2.71FinancialLeverage 1.36 1.34 1.31 1.27 1.28CommentsandConclusions:Inspiteofthefluctuationsintheliquidityratios,thesharpdeclinein2015isconsistentwiththeconclusionspresentedearlierinthediscussionofChipotle’scommon-sizestatements.However,thehighliquidityinthiscompanyisduetothezero-debtstrategyitemployed.Inotherwords,Chipotlehasfinanceditsgrowththroughinternallygeneratedfundsratherthandebtorequity.Efficiency 2011 2012 2013 2014 2015DaysSalesOutstanding 1.13 1.68 2.32 2.61 2.96DaysInventory 1.74 1.83 1.87 1.73 1.67PayablesPeriod 8.7 9.63 9.1 7.85 8.52ReceivablesTurnover 323.14 216.86 157.52 139.61 123.12InventoryTurnover 209.9 199 195.51 210.78 219.06FixedAssetsTurnover 3.18 3.37 3.51 3.97 3.87AssetTurnover 1.78 1.77 1.74 1.8 1.71

1. CommentsandConclusions:


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2. NotethattheDaysSalesOutstandinghassteadilyincreasedfrom1.13daysin2011to2.96daysin2015.Thismaybesymptomaticofincreasingcompetition,maturityofthemarketandindustryorachangeinthecustomerbasefromindividualstootherbusinesses.OveralltrendintheDaysinventoryisfavorablesinceithasdeclinedfrom2011to2015(despitesomefluctuations)indicatingefficientinventorymanagement.

3. TrendsinthePayablesperiodalsodeclinedmodestlyinspiteofthefluctuations.ThislownumberisinthesingledigitswhichindicateshowquicklyChipotlepaysitssuppliers.Thislownumberisconsistentwiththecompany’ssociallyresponsiblestrategyoftreatingitslocalsupplierswellbypayingthempromptly.Theincreasefrom7.85daysin2014to8.52daysismodestconsideringtheseverityofthefoodcrisisexperiencedbyChipotle.

4. TheReceivablesTurnoverdataandtrendsareconsistentwith“DaysSalesOutstanding.“5. ThecontinuousincreaseinFixedAssetTurnoverisconsistentwithsalesgrowthaswellasthe

declineinfixedassetsdiscussedearlier.6. Overall,thecompanyappearstobeoperatingefficiently.

Q7.ShouldMichaelJacobsselloffhisstakeinChipotleornot?ThisquestionallowstobringthediscussiontoaconclusionbyhighlightingthekeyprosandconsofdivestingChipotle’sstock.ArgumentsinFavorofDivesting:• ItisriskyforMichaelJacobstocontinueowningChipotle’sstockpendingtheJustice

Department’sprobeandclassactionlawsuitsthecompanycurrentlyfaces.• Divestingwillminimizethepotentialdownsideriskofunfavorableoutcomesfrompending

litigation.• DivestingwillfreeupJacobs’investmentdollarstoseeklessriskyinvestmentalternatives.• JacobsshoulddivestimmediatelyifChipotledecidestofocusoncuttingcostswithouttaking

appropriatestepstogrowrevenuessimultaneously.• JacobsshoulddivestifhesensesthattheFoodwithIntegritystrategywouldbediscontinuedas

thatwouldnotonlyerodeChipotle’sbrandbutdoirreparabledamagetothecompany’sfuture.Chipotle’sbusinessmodelwithoutthisuniquesupplychainstrategywouldwipeoutitsdistinctivedifferentiationadvantageinthishighlycompetitivefragmentedindustry.AChipotleburritosansIntegritywouldtantamounttoanexpensiveburritoàlaTacoBellorMcDonald’s!

ArgumentsAgainstDivesting:• Strongstockperformancefromthebeginningaswellascontinuingstrongperformanceas

indicatedinCaseExhibits8and9aswellastheothersdiscussedearlier.• Continuingstrongstockperformanceascomparedtorivalsevenafterthefoodcontamination

crisisasseenfromcaseExhibit9.• Salesincreasein2015whenmajorcompetitorslikeMcDonald’shaddeclineinsales.• Rallyinthestockmarketfollowingactivistinvestor,Ackman’sstockpurchase.Inadditiontoa

positiveimpactonChipotle’scashflow,itsignalsoptimismthatAckmancouldbringnewinsightsandbringaboutthenecessarychangesinanexpeditiousmanner.

• Thefastandappropriateresponsestothefoodcontaminationcrisisthatoccurredinlate2015demonstratesthatChipotle’sleadershiphassoundcrisismanagementskills.Additionally,thefactthatChipotle’stopmanagementtooksignificantpay-cutsspeakstotheremarkablecorporategovernancemechanismsinplaceatChipotle.

• UnderElls’leadership,thecompanycontinuestodemonstratepositiveandresponsibleleadershipthroughitssociallyresponsiblestrategyofFoodwithIntegrity,earningittherespectofconsumeradvocacygroupslikeTheConsumerUnion.TheConsumerUnion,aswastheCenterforDiseaseControl(CDC),wasconcernedwiththeadverseeffectsofelevatedlevelsofantibioticsintheAmericanfoodsupplychain.


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Belowisanexhibitsummarizingtheprosandconsdiscussedabove.

Attheendofthisdiscussion,takeavoteandrecordhowmanystudentsareinfavorofChipotlekeepingtheFoodwithIntegritystrategy.90%ofbothundergraduateandgraduatestudentsvotedinfavorofChipotlecontinuingitsFoodwithIntegritystrategyandJacobskeepinghisChipotlestockownership.However,theypointedoutthatJacobsshoulddivestChipotle’sstockifthecompanywasforcedtoabandonitsuniquesupplychainstrategy.EpilogueAsofFebruary2017,thecaseagainstChipotlewascontinuingintheCourts.TherewasnodecisionhandeddownbytheDepartmentofJustice.Chipotletriedtoengageinquickdamagecontrolthroughaggressivemarketing,spendingabout$2millioningivingcouponsandfreefoodtolurebackitscustomers,andpostednewvideosaboutthesafetyofitsfood.AsthecasepointsoutChipotle’sstockisontheupswingandAckman’sinvestmentwasseenasawelcomemove,butthereisuncertaintyaroundthefutureoftheFoodwithIntegritystrategy,whichoffueledthebirthhealth-foodconsciousnessandamovementintheUSagainsttheuseofGMOandantibioticsinthefoodsuppliesprocuredbytherestaurantindustry.

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