This Franchise Chatter Guide on the Panera Bread franchise system was written by Brian Bixler.

Investors in the Panera Bread franchise system have been on a roller-coaster ride over the last year, with the Wall Street darling now down more than 20% from its 52-week high; and there are likely to be a few more bumps and bends along the way as the company tries to re-accelerate growth.

Panera is a very strong brand and always mentioned in the same breath as Chipotle when analysts talk about the leading restaurants in the fast-growing, limited-service, fast-casual category. But Panera Bread’s same-store sales growth took a sharp drop during the third quarter of 2013. When Panera announced fourth quarter results, the comparable-store sales figures were slightly better over the prior quarter, but indicated a big drop from year-to-year.

“That suggests the company still has plenty of work to do in getting its locations back to their industry-thumping growth levels,” says Demitrios Kalogeropoulos, a contributor to the Motley Fool investment website.

Analysts have been keeping a watchful eye on management’s actions to see if Panera can get its mojo back. The company’s financial woes carried into 2014. Panera Bread Company reported that net income decreased 11.9 percent to $42.4 million for the first quarter ended April 1, down from $48.1 million in the same period last year. System-wide comparable sales increased by only 0.1%, lower than 3.3% in the year-ago quarter and 1.1% in the fourth quarter.

Best Days Still Ahead

Adam Galas, a contributor at SeekingAlpha.com, shared his thoughts about the company earlier this year. He predicts that Panera Bread’s best days still lie ahead.

“It seems that menu expansion and overly high traffic overwhelmed the staff and kitchen capabilities. This resulted in longer lines, decreased customer satisfaction and decreased same store sales from its traditional 4-8 percent annual growth down to just 1.7 percent.”

“Management is aware of the problem and dedicated to maximizing customer experiences above all else,” Galas continued. “CEO Ronald Shaich is famous for personally visiting stores to speak with employees and customers and receive their feedback.”

Panera’s ‘Food Policy’

Indeed, management is responding swiftly and creatively in finding a solution to its lackluster sales growth. Just this month, the team announced a new “Food Policy” whose boldest aspect is a company-wide move toward serving only natural ingredients—no artificial colors, flavors, sweeteners and preservatives—in its menu items.

The plan is already halfway executed, according to some reports, and Panera aims to complete the goal by 2016. The Chipotlean move could shore up sales while satisfying the public’s current and likely long-term desire for healthier foods. That trend dominates the restaurant sector.

Panera also introduced its Panera Lose It! Challenge this year to drive sales of its formerly secret Power Menu.

With $4.1 billion in sales last year, Panera leads the bakery cafe category, according to Technomic market research firm. And in the firm’s analysis of top fast-casual restaurants, Panera also leads the pack in sales and number of units, besting even Chipotle (a non-franchise entity), which had the second-highest numbers.

Panera dates back to 1981 as Au Bon Pain Co. Today it operates under three retail banners: Panera, St. Louis Bread Co. and Paradise Bakery & Cafe. The chain of some 1,800 units comprises both Panera franchises and company-owned stores, about equally split.

Despite its dominance in the bakery cafe category and respectable sales, growth has slowed considerably over the last few years, according to Business Insider. Last year, Panera’s sales rose 2.6 percent at company-owned locations open at least a year. That was down from 6.5 percent in 2012 and 4.9 percent in 2011. The St. Louis-based company is projecting sales growth of just 2 to 3.5 percent for 2014.

Latest Sales Initiatives

Even with its plan to go all-natural already underway, Panera isn’t putting all its eggs in one basket in terms of new company initiatives to keep customers coming back. This year, it also introduced a new ordering system that it says should reduce customer confusion and speed up the ordering and delivery process. Panera 2.0, as it’s called, “brings together new capabilities for digital ordering, payment, operations and, ultimately, consumption to create an enhanced guest experience for ‘to go’ and ‘eat in’ customers,” the company announced in March.

Among other things, the system allows for Panera franchises to accept online/mobile ordering for takeout in advance, as well as satisfy customers who prefer the sit-down experience, ordering with devices right from their table. The company will also continue introducing in-store kiosks for even quicker service with ordering and payment handled simultaneously and features that will allow patrons to use tablets that will store a person’s ordering information in the system for even quicker service on subsequent visits. It will also make menu suggestions, including customization choices, based on previous orders.

Kiosks Replace Cashiers

According to reports, Panera Bread and sister company St. Louis Bread Co. will spend $42 million to launch mobile and kiosk ordering company-wide. The company is also testing locations in Louisville that are take-out and delivery-based only.

Not all Panera Bread franchisees are happy with every aspect of the plan, however. With about eight kiosks planned per store, units will need to cut back cashier positions. And perhaps the quick change in technology has some owner/operators insecure.

The Panera franchise plan is different from most others, requiring investors to commit to area development agreements, opening as many as a dozen or more stores over a certain time period–typically 15 units within six years. It is estimated that Panera has only about 40 franchisees and each one operates an average of 22 stores. After the kiosk plans were unveiled, a Piper Jaffray poll showed that 30 percent of a large sample of Panera franchisees were concerned about paying for the necessary new equipment to implement the corporate plan.

Industry Overview

Despite Panera’s problems, the overall bakery cafe franchise segment is performing very well, surging ahead since the recession and outperforming the overall food service sector, according to a report from IBISWorld. Over the next four years, industry revenue is expected to grow 5.9 percent annually reaching $9.1 billion in 2018.

Many of the franchise models are similar, with baked goods and fresh produce constituting the main ingredients in menu items, including sandwiches made with specialty artisan breads like pumpernickel, sourdough and ciabatta. Bread and sandwiches make up about 50 percent of product segmentation in the restaurants, while beverages such as gourmet coffee make up about 20 percent. The category also includes businesses that specialize in pastries, croissants, brioches and even gourmet cupcakes.

The sector is dominated by Panera Bread franchises, with companies such as Einstein Bros. Bagels and Au Bon Pain trying to gain a larger share of the market. The four industry leaders share nearly 70 percent of the market with Panera alone capturing more than 53 percent. While the companies tend to compete against themselves, external competition also includes coffee shops such as Starbucks.

Even fast-food restaurants put up a good fight against the higher-priced bakery offerings, but the sector’s major players have also been successful at attracting customers away from fast-food establishments by offering what are considered to be healthier options, with ingredients such as antibiotic-free chicken and turkey, whole grain breads and some organic or natural ingredients as in the case of Panera, according to IBISWorld.

Overall, the bakery cafe industry is growing at a much faster rate than Gross Domestic Product with growth coming primarily from the opening of new units by various companies and consumer preferences for high-quality, affordable, healthy cuisine. It is considered a growth industry characterized by rapid technology and process changes, a rapid introduction of new products and brands, and growing customer acceptance of the product.

Trends

• Gluten-free options are becoming increasingly popular among consumers and the industry is responding by providing more gluten-free items in place of wheat products. As consumer health consciousness increases, the trend is expected to continue.

• Because high-quality coffee and other beverages make up a large portion of bakery cafe offerings, expect companies to continue improving those product lines in hopes of luring customers in at breakfast when they can sell them breakfast sandwiches, bagels and muffins, capturing a bigger share of the daypart.

• IBISWorld says that quality continues to drive sales in the sector and the differential between quality and price is marginal. The average check at Panera, for example, is $10. “Consumers have demonstrated an increased willingness to spend a few extra cents or an extra dollar for a higher quality product,” the report states.

• Pastries, pies and cakes are showing up increasingly on bakery cafe menus. Keeping consumer demand in mind, brands are expected to develop and introduce healthier pastry and cake choices, as well as offer healthy snacks like fruit and light meals such as soups and salads.

Major Players

Einstein Noah Restaurant Group

Based in Lakewood, Colo., the Einstein Noah Restaurant Group is the largest chain bagel store in the country, operating under a number of brands, including Einstein Bros. Bagels, Noah’s New York Bagels and Manhattan Bagel Company.

It began in 1993 as an operator and franchisor of coffee shops. Through acquisitions, especially that of the Einstein/Noah Bagel Corp., the company has undergone five different name changes in 15 years, including New World Coffee and Willoughby’s Coffee and Tea before settling on Einstein Noah Restaurant Group in 2007.

With about half of its branded locations being company-owned, the chain has expanded primarily through its franchise program during the last five years. The company’s system consists of approximately 860 restaurants (459 company-owned and operated restaurants, 115 franchised restaurants and 288 licensed restaurants) in 42 states and the District of Columbia.

The publicly traded company also operates a dough production facility.

Its most recent financial results for the first quarter of 2014 portend further growth. During the first three months of 2014, the company opened 13 restaurants and it hopes to have a total of 85 new units by year’s end. Among other first-quarter highlights, revenues increased $3.5 million, or 3.3 percent, to $109.9 million from $106.4 million. System-wide comparable store sales increased 1.6 percent and company-owned comparable store sales increased 1.7 percent.

IBISWorld estimates ENRG’s market share to be 6.8 percent.

Au Bon Pain

Once the parent company of what is now Panera, Au Bon Pain now operates under its own brand. Boston-based, it was founded in 1978 and opened its first unit outside of Beantown in 1984 in New York City. Since then it has grown to more than 250 units, not just in the United States but also India, South Korea, Thailand, Taiwan and Kuwait—one of the few companies with a global presence.

It’s also a private company, which makes it different from most of its leading competitors. Company-owned stores are concentrated primarily in the Boston, Philadelphia, New York, Chicago and Washington, D.C. markets with franchisees operating the others throughout the country. IBISWorld estimates that Au Bon Pain has achieved 5 percent market share in the bakery cafe sector of fast-casual. It does not release financials because it is a private company, but IBISWorld estimates that 2013 sales for U.S.-based cafes were $349 million.

Corner Bakery Cafe

Perhaps sensing some vulnerability in the Panera franchise program, Corner Bakery Cafe has been coming on strong, expanding to new markets throughout the U.S. The company signed 12 new area development agreements in 2013, which put more than 120 new cafes on the drawing board and added to a total of more than 300 restaurants under development. Corner Bakery Cafe plans to double its footprint in the next three years.

President Gary Price declared 2013 “one of our most successful years in the company’s history.” Like Panera, Corner Bakery Cafe is focusing on new technologies to improve ordering and food delivery, including a revamped website with “to go” online ordering and a reformatted section to make information easily accessible to potential franchisees.

As the name implies, Corner Bakery Cafe differentiates itself from competitors by presenting the image of a “neighborhood” bakery that serves everything from hot breakfast scramblers, and signature panini to pastas and sweets.

Established in 1991, Corner Bakery Cafe restaurants are owned and operated by CBC Restaurant Corp, an affiliate of Il Fornaio (America) Corporation. In 2011, Roark Capital Group, an Atlanta-based private equity firm, acquired Il Fornaio.

Bruegger’s Bagels

Begun in 1983 by Nord Brue and Mike Dressell in Troy, N.Y. (and today headquartered in Burlington, Vt.), Bruegger’s is credited with bringing New York-style bagels to the masses when they were not as popular with consumers as they are today. The company has a chain of more than 300 bagel stores throughout the United States and Canada and IBISWorld estimates its market share at 3.1 percent. The company’s franchise program has helped spread the brand to 26 states.

It differentiates itself by stressing authenticity and traditional preparation of its New York-style bagels. It also promotes the fact that its menu is created by an executive chef, Phillip Smith. Besides bagels, the chain’s menu includes breakfast and lunch sandwiches, signature soups, salads and desserts.

Owned by Groupe Le Duff, SA, Bruegger’s also embarked on a major renovation project for its units earlier this year with a new prototype featuring an open kitchen so customers can see bagels being made, as well as communal seating. The renovation project began with a flagship bakery in St. Paul, Minn., that opened in January with an artist challenge to create artwork for the new location. It will continue to roll out the new design in other locations.

Bruegger’s is also known for its many philanthropic activities, raising money for various charities.

Future

Whether investors are considering an area development agreement for a Panera franchise or a one-unit deal with one of its competitors, industry forecasts for the sector look promising for the near future. “The industry is expected to continue on a growth trajectory over the next five years as many of the same trends that have influenced the industry continue,” the IBISWorld report concludes.