Chipotle's Desperation Is Brilliance in Disguise

By Markets Fool.com

Image source: Chipotle.

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What doChipotle Mexican Grill(NYSE: CMG)and Ladies' Night have in common? They're both using free drinks to get people in the door.

Chipotle's latest promotion kicks in tomorrow, offering any high school or university student a free non-alcoholic beverage with an entree order. Flash a valid student ID and you can tack on a complimentary fountain drink or iced tea during the month of September.

It seems desperate at first. Soft drinks are the highest-margin product at any eatery, and it's an impulsive purchase for the younger set that would typically purchase sodas instead of asking for complimentary water cups. Prices may vary across regions, but it's effectively as much as a 22% discount for someone that would be pairing up a chicken burrito with a soda.

Chipotle is going to have to make that up in volume so it generates as much revenue as it would without the promotion, and it's going to have to more than make that up in volume if it wants to get to the same profit level given the lower margin on the foodstuffs. It's a big bet, but the more I think about it the more I like it.

Life after Chiptopia

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Chipotle's world was turned upside down when the first of the food-borne illness outbreaks made headlines. There hasn't been a verified outbreak in 2016, but consumers still haven't forgiven the chain. It has rattled off three straight quarters of double-digit percentage declines in comps, and the 2,124-unit operator has turned to promotions to coax customers back.

It was aggressive earlier in the year, offering BOGO entrees and free chips with guacamole. It then shifted to a temporary loyalty rewards program --Chiptopia-- last month. The three-month promotion is a card-based system where frequent diners get rewarded with free eats after every four visits in any given month.

Chiptopia's success has been mixed. The chain has signed up millions to the program -- it registered 3.6 million customers during the first three weeks of the program alone -- but comps were still down roughly 21% in that time. The one thing that Chiptopia has done is get its most frequent customers to come back more often. It's now time to woo the other 75% of its audience, and that's where this free drinks for students comes in handy.

It's the younger set that used to rave about Chipotle. It's teens and young adults that thought it was cool and trendy to post about eating at Chipotle. It's easy to see why students may have turned following the outbreaks, using the same viral media tools which they used to brag about trips to the burrito roller in the past.

Time is running out for Chipotle to get it right, at least with investors. If comps don't start turning positive by the fourth quarter -- when it's already pitted against last year's horrendous holiday quarter when things started to come undone -- it will be hard to justify the stock's still-lofty valuations. The combination of the final month of Chiptopia to woo regulars and the new free drink promo for students to woo the young masses gives Chipotle two ways to win in September. It will set the momentum for fourth quarter, a period that it can't afford to lose.

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Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.