Chipotle's growth machine

September 12, 2011: 5:00 AM ET

Founder Steve Ells has built a multibillion-dollar Mexican food chain by providing fresh meals fast. Can he do it again, this time with Asian cuisine? Or is he a one-hit wonder?

By David A. Kaplan, contributor

"Chipotle succeeds not because of the burritos," says Ells. "It works because of our system."

FORTUNE -- It's fast food, but it still may be the most anticipated restaurant launch in town. In a modest unmarked storefront near Dupont Circle in downtown D.C., ShopHouse Southeast Asian Kitchen is finalizing the menu and training the staff. Scheduled to open within days, the innovative restaurant has tantalized both eaters and investors. The food will feature a mix of meats and fresh vegetables served in a bowl with spicy sauces and aromatic herbs. The flavors will be a blend of Thai, Vietnamese, and Malaysian. The style will be "fast casual": Customers move along a cafeteria-style line, with servers behind the counter customizing each meal. You can sit down and eat -- there's room for roughly 40 -- or take out your meal. The intriguing thing about ShopHouse, though, is it's not the startup of a fledgling, but the wholly owned experiment of Chipotle Mexican Grill Inc., already a national leader in fast-casual cuisine and No. 54 on Fortune's 2011 list of the 100 Fastest-Growing Companies. If the ShopHouse concept works, it represents an opportunity for the company to expand even beyond its current torrid pace. Bob Derrington, a managing director at Morgan Keegan, says some of his clients are asking, "Is this the birth of a billion-dollar baby?"

Fastest-Growing Companies: The full list

Chipotle's (CMG) growth has been remarkable. Revenue for the 12 months ending June 30 was more than $2 billion, up 23.5% from the prior year. Since 2006, revenue has nearly tripled; in the same period the number of restaurants in the chain doubled. In restaurants open at least a year, sales were up 11% in the first half of 2011. Profit margins in Chipotle restaurants have been in the 25% to 26% range -- among the highest in the fast-food industry. That's all the more notable since Chipotle says it spends more on food and more time preparing it.

The high margins can be explained by other efficiencies, like that its top-performing locations can move 300 customers an hour; that rate of service -- "throughput" -- is a Chipotle obsession. "Slow food, fast," the company boasts. It doesn't hurt that the average tab runs upwards of $9 -- more than a Big Mac and fries. Chipotle's margins, along with its rate of growth and its decision not to franchise, accounts for its generous market capitalization relative to other fast-food chains. McDonald's (MCD) market cap of about $90 billion, for example, is roughly nine times that of Chipotle's, but McDonald's has about 30 times the number of restaurants. Thus, Chipotle's relative value per restaurant -- $9 million or so -- is more than triple that of McDonald's. Chipotle's stock price, at about $275 as of late August, has almost doubled in the past year.

Chipotle is a niche in a huge market. American fast food is dominated by burger joints. Fast casual emerged in the 1990s as a refinement of conventional fast food. Instead of frozen fare processed elsewhere, dishes are made from scratch. Instead of products from agribusiness, ingredients are local and raw. The fast-casual segment remains a small part -- 3% -- of the overall restaurant market, according to the NPD Group, but has doubled its share over the past decade. Panera Bread (PNRA) does soup and sandwiches; Five Guys, burgers and fries; Boston Market, chicken. And there's Chipotle Mexican, which has 1,150 company-owned restaurants in 38 states in the U.S., serving almost 800,000 people a day.

While Pan-Asian isn't a wholly new idea in fast casual -- Pei Wei Asian Diner, owned by P.F. Chang's China Bistro (PFCB), has about 170 outlets, and Panda Express has more than 1,300 "quick service" locations -- the fact that ShopHouse comes from one of the big entrepreneurial players in the industry has raised hopes among investors.

Steve Ells, Chipotle's intense 46-year-old founder and co-CEO, sees ShopHouse as a chance to validate his business model, which is based on operational proficiency and social responsibility. "Chipotle succeeds not because of the burritos," he told me one afternoon in a ShopHouse tasting kitchen in Manhattan. "It works because of our system: fresh, local, sustainable ingredients, cooked with classic methods in an open kitchen where the customer can see everything, and served in a pleasing environment." On billboards, on its website, in the shops, in conversations with executives -- everywhere -- the company calls it "Food with integrity." (Alas, with calories too. You can get to 1,100 calories pretty fast with a nicely loaded tortilla.) Although you won't find linen tablecloths at Chipotle, you also won't confuse it with Taco Bell; the minimalist contemporary décor of stainless steel, plywood, and exposed ductwork suggests somebody cared about aesthetics.

The Chipotle rules can be very specific. For example, the menu is limited to four core basics, but it offers a range of garnishes like salsa and cheese and guacamole that can produce scores of combinations. Ells serves neither dessert nor coffee. (Too complicated.) There's no dollar menu or "limited-time offers." (Too gimmicky.) And while the Dulles Airport restaurant serves scrambled eggs for breakfast, Ells has declined to begin breakfast operations elsewhere. By any other name, he is a control freak. "Steve is hypersensitive to his visual and tactile surroundings -- from the temperature in a room to the cushiness of a chair to the feel of a pen," says co-CEO Monty Moran, who has known Ells since college.

Yet despite a rigid focus, Ells's system also offers employees the chance to advance quickly. His best store managers -- who often begin in the service line and are paid near minimum wage -- can become "restaurateurs," which often means annual compensation above $100,000, including performance bonuses and stock options. (His youngest restaurateur is 23.)

Bucking conventional fast-food wisdom

Ells frets that all the talk about ShopHouse could become distracting. He says his chief leadership focus remains the 18-year-old Chipotle chain. And with 135 to 145 restaurants opening this year -- including a second European location next month, in Paris -- he has plenty on his plate. Even so, ShopHouse holds unmistakable promise. The tap dance is to make sure Chipotle's fortunes do not rise or fall based on ShopHouse -- unless of course it's a culinary and commercial triumph.

Multibillion-dollar baby: One of the Chipotles in Manhattan

The challenge of balancing expectations has fallen to Chipotle's CFO, Jack Hartung. "ShopHouse isn't yet a growth strategy," he says. "But it is a growth opportunity." The "big question," says analyst Derrington, "is whether Ells can make the same magic twice: Can Asian be as broadly appealing as Mexican?"

Ells doesn't have the typical CEO biography. He's loved to cook since third grade. His mother remembers him playing with scrambled eggs relentlessly in the kitchen. Nonetheless, Chipotle (pronounced, like its smoke-dried jalapeño namesake, chi-POAT-lay) was pretty much an accident. After majoring in art history at the University of Colorado at Boulder, Ells attended the Culinary Institute of America. In 1990 he landed a job as a $12-an-hour line cook at Stars, the erstwhile San Francisco landmark whose Jeremiah Tower was an early celebrity chef. Ells wanted his own fancy place but had no capital. He figured he'd create a fast-food joint to generate cash flow with which to move up the food chain. Ells loved the little taquerías in the Mission District and decided to open one back in Colorado, where he'd grown up. With an initial $85,000 investment from his father, a former pharmaceuticals executive, he converted a Dolly Madison ice cream store near the University of Denver campus into a burrito shop called Chipotle, opening in 1993. He was 28 and had never studied business in his life.

His overstuffed, individualized burritos were an instant hit, and Ells was quickly able to stop chasing skeptical prospective customers down the street. ("Come back!" he'd plead.) In two years he opened more shops in Denver, which even today has the most Chipotles per capita. Along the way, Ells started bucking conventional fast-food wisdom. Horrified by the confinement conditions at factory farms, he started to use naturally raised livestock. He bought organic when he could and vowed to avoid products with hormones. Ells did so not because he necessarily thought customers appreciated it, but because it struck him as ethical. He's nothing if not resolute in his convictions. "If you go to dinner at Steve's house," co-CEO Moran says, "he couldn't care less what you want to eat. He'll tell you what you want, and you'll like it -- and he'll be right."

Ells eventually abandoned his dream of starting his own high-end restaurant. Instead he settled into a life of empire building. The financial challenge was to expand outside Colorado, so he began to search for investors. In 1998 he sent a business plan to McDonald's executives, who apparently liked what they read: Within three years McDonald's owned a majority stake in Chipotle. Meanwhile Ells, with $360 million from McDonald's at his disposal, expanded to over 500 outlets. Eventually Ells wanted out of the marriage. (Among other things, McDonald's favored going global too quickly for Ells' taste.) A deal was struck. In 2006, Chipotle went public; the stock price doubled its first day of trading on the New York Stock Exchange. In the end McDonald's walked away with a profit of more than $650 million, and Ells was a rich man and free to run the company his own way.

Fast-casual face-off: Chipotle and rivals

Today, with executive offices in Denver and Manhattan, the company employs 27,000, about 60% full-time. Others compete in the $5 billion category of fast-casual Mexican -- like Qdoba, Moe's Southwest Grill, and Baja Fresh -- but Chipotle is the top taco. Its expansion has been accompanied by some labor pains: The federal government continues a criminal investigation of Chipotle's employment of immigrants, including in places like D.C.; the company fired 450 workers in Minnesota last year -- about a third of its workforce there -- after an audit showed they had improper documentation. (Chipotle says it is cooperating with federal inquiries.)

That kind of controversy has been rare. Instead the company has typically been lauded for its efforts to be a responsible corporate citizen, knowledgeable about the communities it serves. On a recent afternoon, in navy-blue shorts and urban sneakers, Ells took me along to visit a small nonprofit bakery in Manhattan's East Harlem, under the rumble of the elevated Metro-North commuter tracks. Hot Bread Kitchen employs immigrant women, who both make ethnic breads and incubate their own businesses. The three-year-old bakery, which has annual revenue of $1 million or so, sells to the public through local groceries and farmers' markets. Ells wanted to see if their delicious premium tortillas might be good enough to supply all the Chipotles in New York City.

Within minutes, Ells decided he loved the product -- it was tasty, chewy, and had nonpareil texture. "How many could you make?" he asked Jessamyn W. Rodriguez, 35, the bakery's founder and CEO. "This could be a game-changer for us!" she replied, aware that Ells had just given her social-enterprise organization the chance of a lifetime. Rodriguez said she could get production up to 42,000 a day. If Hot Bread Kitchen's health standards and production capabilities check out, Chipotle will start buying its tortillas this month. Ells has similarly transformed other farmers and suppliers around the country.

No one-hit wonder

These days Ells is paying particular attention to the details of ShopHouse. He has been involved in all phases of its construction, menu, and marketing. The two-story building in Washington evokes the classic urban shophouses of Southeast Asia, in which families run markets on the first floor and live upstairs. The imminent rollout will be curious. There will be no advertising, no official opening date. Signage will make no mention of the Chipotle connection. The registered website, shophousekitchen.com, is virtually dark. The "soft" opening is of a piece with Chipotle's preference not to make ShopHouse too big a deal. "We don't even have a plan where we might open a second location," Ells says.

Ells at a Chipotle in New York City with über-chef Nate Appleman: "Food with integrity."

Don't underestimate the stakes for him, however. Ells doesn't need more wealth, and the company hardly needs expansion opportunities, with Europe and more U.S. spots beckoning. But intellectually and emotionally he wants to prove that Chipotle is not a one-hit wonder -- that ShopHouse could stand on its own culinary feet. "Steve really wanted to prevent ShopHouse from being part of the Chipotle machine," says Mark Crumpacker, the chief marketing officer of Chipotle, who went to high school with Ells.

The menu at ShopHouse obviously is key to the restaurant's prospects. Egg rolls it's not. In the past year Ells hired two famous foodies to help him, as well as to map Chipotle food strategy: Nate Appleman, 32, a Rising Star Chef from the James Beard Foundation; and Kyle Connaughton, 35, former head development chef at the Fat Duck Experimental Kitchen outside London. The three of them gave Fortune a preview of the ShopHouse menu as it was being finalized last month. The dishes: grilled steak with chili-jam marmalade, roast corn with scallions, Chinese broccoli, pickled vegetables -- all served over brown rice, plus green papaya salad on the side. You could recognize the coriander, garlic, turmeric, and lemongrass. The carrots were stunningly bright (something about the pickling process), and the salad was an appealing mix of sweet, salty, spicy, and sour.

"Nice heat!" Ells proclaimed about the steak. I surely agreed -- as I downed my third bottle of water. If the customers agree too, Ells will have planted a new seed of growth. Just as important, he'll have demonstrated that he didn't just hit it big because of Mexican food -- that his corporate principles apply as much to rice bowls as tortillas. Showing up the skeptics is just as rewarding as a quarterly earnings report. Because for Steve Ells, it's personal.

This article is from the September 26, 2011 issue of Fortune.


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