Can Menu Innovation Lead to a Chipotle Turnaround?

Even prior to Chipotle Mexican Grill's (NYSE: CMG) well-publicized food safety incidents of 2015, some analysts were worried that Chipotle's restaurant volumes were peaking. One of the reasons behind the concern was "menu fatigue." Since Chipotle had basically the same menu since its founding, analysts were worried if its fresh, customizable Mexican cuisine was getting old with customers. Still, Chipotle's management remained mostly steadfast in sticking with its mantra of offering a smaller, but great tasting, menu. Certainly, Chipotle's highly profitable business model had been predicated largely on the cost efficiencies associated with a lean menu.

However, the recent unveiling of Chipotle's NEXT Kitchen  and new potential food items suggests Chipotle is changing its ways. Is this a smart strategy, or a sign of "desperation," as one analyst recently put it? Whatever the reason, one thing is clear: In light of new food safety incidents in Virginia last week, the company will need all the help it can get.

NEXT Kitchen

Recently, ran an article on Chipotle's NEXT Kitchen on 6th avenue and 13th street in New York City. Chipotle will test new menu innovations at the Greenwich Village kitchen, and the article described several menu items: Queso dip, a new salad dressing, frozen margaritas from an automatic margarita machine, and Banuelos, a flaky fried dough dessert, complete with chocolate dipping sauce. These innovations come on the heels of last fall's introduction of chorizo and the March announcement of GMO-free tortillas, which was backed up with the company's first national TV campaign, "As Real as it Gets."

Obviously, the last two years in Chipotle history have been very different from the previous 20-plus, and last summer, activist investor Bill Ackman's Pershing Square took a 9.9% stake in the company. Months later, longtime co-CEO Monty Moran resigned, and Pershing Square replaced four long-tenured board members with four of its own. One wonders if the new innovations were the ideas of founder and CEO Steve Ells, or if they were suggested -- perhaps forcefully -- by Pershing.

Upside case for innovation

While menu innovation is somewhat new for Chipotle, it's actually par for the course in the restaurant industry, from all-day breakfast at McDonald's, to Doritos Locos tacos at Taco Bell, to the Unicorn Frappuccinos at Starbucks.

The particular menu innovations Chipotle is testing could prove to be very lucrative. Queso had been the most requested item at Chipotle, and the company had long resisted due to the difficulty of making queso with all-natural ingredients. Chipotle seems to have finally cracked the code though. Its queso dip is reported to have a different texture than traditional queso (though still quite tasty, according to reports).

Chipotle was basically the only U.S. Mexican restaurant chain not to have the sought-after cheese dip, so one could say it was long overdue. It also seems reasonably priced enough to become a high-volume impulse buy. And with recent avocado price spikes, it's likely higher-margin (at least at present) than guacamole.

Bunuelos also look as though they might make either a great dessert or addictive mid-afternoon snack (when traffic is slower). Speaking of off-hours, the new frozen margaritas could make Chipotle an affordable happy-hour destination, as no tip would be required.

... And the downside

The downside to all this is that the new menu additions could add complication to restaurants where workers are already working at high capacity, as anyone who's ever been to a Chipotle at peak times can attest. The company has been the target of several worker lawsuits in the past couple of years, and it's hard to believe these new initiatives won't require extra effort. More menu items mean more complication, which increases the possibility of mistakes, or poor customer service. As last week's norovirus incident in northern Virginia shows, the company has very little margin for error on that front.

Moreover, the company had traditionally achieved such amazing unit economics and return on invested capital because its processes were streamlined, so a small crew could serve a huge amount of customers in a short amount of time -- known as "throughput." So while menu innovations can be exciting, if they prove unsuccessful in driving additional sales, Chipotle will have to deal with extra items, and potentially higher labor costs, without a sustained revenue increase. That could potentially hurt the bottom line, and if the company removes an item due to poor performance, it would make for yet another poor headline.

The takeaway

Chipotle is changing its long-standing strategy on menu innovation. Will such a departure precipitate an elusive turnaround, or lead to even more headaches? The next year should be quite interesting to watch.

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Billy Duberstein owns shares of Chipotle Mexican Grill and Starbucks. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool has a disclosure policy.