Diedrich Signs Pact to Open 50 Cafes in San Diego Area

Pressing forward with an aggressive expansion plan, Diedrich Coffee Inc. said Monday it has signed a franchise agreement with Taco Bell restaurant operators to open 50 coffeehouses in the San Diego area over the next five years.

It was the second such announcement by the Irvine-based coffee retailer in as many months.

Under the agreement, an undisclosed number of Diedrich coffee carts and kiosks also will be opened in the San Diego, Palm Springs and Temecula areas. The parties also have a one-year option to develop 45 coffeehouses in Arizona.

Diedrich previously said it plans to open 1,500 coffeehouses nationwide over the next five years by turning to large franchise organizations that would install the outlets in specific geographic areas.

The strategy is aimed at enabling Diedrich to gain ground on its major competitor, Seattle-based Starbucks Inc., which has more than 1,700 stores in the continental United States.

“For us to catch up with Starbucks, we can really only do it by franchising,” said Catherine Saar, Diedrich’s vice president of marketing and wholesale.

While franchise operators can provide crucial financial muscle to help Diedrich grow, it can be tricky hooking up franchisers who are focused on shoveling out fast food for the masses with a business that caters to highbrow coffee connoisseurs, some industry observers say.

Indeed, the two enterprises have markedly different “corporate cultures,” said Randall Hiatt, president of Fessel International restaurant consultants.

“When you walk into a Diedrich’s, you feel like the people can tell you about coffee,” he said. “That’s a culture you don’t get at Taco Bell. So that’s a cultural transplant that is going to be, I would think, a major hurdle.”

On the other hand, analysts say there are many advantages to using established franchisees, who know the marketplace, to expand into new geographic locations.

“This allows them to start building out the entire country all at once, and the franchisees are using their capital as opposed to Diedrich’s having to spend its capital,” said analyst Eric Wold with Van Kasper & Co. “I think this is a superior way for them to grow the business.”

The coffeehouses would be independent operations, not attached to Taco Bell eateries.

Analysts questioned whether Diedrich will ever catch up with Starbucks, which is sprinting ahead into European and Asian markets. But even being second best in such a market would be an enviable position, they said.

“Nobody is really close to Starbucks, so it wouldn’t be a bad deal to be Avis in that market.” Hiatt said.

Diedrich’s first two franchising agreements, which would effectively triple the number of Diedrich coffeehouses nationwide, were both struck with Taco Bell operators. Diedrich Chairman John Martin and Chief Executive Tim Ryan are former Taco Bell executives.

Their connections with the fast-food chain have helped jump-start Diedrich’s expansion plans, which had stalled last year after some disappointing financial results.

When Diedrich announced plans in September to open 44 coffeehouses in North Carolina over the next five years, the company’s stock jumped 17.6%. On Nov. 3, the company’s shares rose 20% after an Internet rumor that Diedrich was set to announce a second franchise agreement.

But Monday’s announcement caused barely a ripple on Wall Street. Diedrich’s shares closed at $5.50, down 6 cents in Nasdaq trading.

The latest franchise agreement was struck with Karl James and Victor Silva, who operate 50 Taco Bell restaurants in the San Diego area.

Following the same game plan employed in the earlier agreement, James and Silva will form a new company, Rocket Enterprises Inc., to run the coffeehouses. The first outlets should open in the first quarter of 1999, and two more coffeehouses should be complete by the end of the year, Saar said.

The franchise ventures are being financed by Los Angeles-based Franchise Mortgage Acceptance Co. Martin sits on that company’s board of directors.

Diedrich operates 36 coffeehouses in California, Colorado and Texas and seven cart operations in California.

The company said it is in discussions with several other franchise organizations.