Oh, Sweet Revenge

It's just after 4 on an early summer morning, and two uniformed men work the counter at Dunkin' Donuts in Framingham, Mass. As they serve takeout coffee to early risers, the workers seem blithely ignorant of the enemy that's gathering nearby. There are no lanterns visible from the Old North Church to shine a warning. But a half hour to the east, just across the Charles River in Medford, dozens of workers push trays of doughnuts around a new Krispy Kreme store as more than 100 customers line up outside. When the doors swing open at 5:30, they mark Krispy Kreme's entry into Dunkin' Donuts' home market--and the opening volley in the Boston-area Doughnut War. Krispy Kreme has a great first day, selling $73,813 worth of gooey treats. But back in Framingham, business holds steady: customers stream through the door all day long.

These should be dark days for Dunkin' Donuts, the fast-food breakfast chain that seems as if it's being overtaken by hotter, fresher competitors. When it comes to doughnuts, the country is gripped in a torrid relationship with fast-growing Krispy Kreme, which Fortune magazine recently crowned "America's Hottest Brand." In the land of coffee, Starbucks continues to dominate; this year it achieved the cultural two-fer of making its debut in the Fortune 500 and having its employees (the "Women of Starbucks") grace the pages of Playboy. Yet even as those rivals post double-digit sales growth, Dunkin' Donuts, a subsidiary of the British liquor giant Allied Domecq, is still quietly thriving: sales grew 9 percent last year to $3 billion.

The chain's success illustrates a little-advertised truth of business. Too often the financial pages read like the sports section, filled with winners and losers. Reality is more complex. In many markets, business is not a zero-sum game, and competitors create opportunities. "If I were Dunkin' Donuts, I wouldn't be too upset about the buzz surrounding Krispy Kreme and Starbucks," says Nancy Koehn, a professor at the Harvard Business School. "There's nothing wrong with flying profitably below the radar." Jon Luther, who signed on as Dunkin' Donuts' chief in January, says the rivalry has helped his company: "[It's] created an awareness for the category, and we're benefiting." As it faces these aggressive newcomers, Dunkin' is playing tough business defense--one that offers lessons for any company.

LESSON ONE: Competition Can Be Good

In 1994, when Will Kussell arrived as Dunkin' Donuts' senior VP of marketing, he found a vastly different atmosphere from his previous employer. "At Reebok, there wasn't a minute you weren't face-to-face, eyeball-to-eyeball with Nike," he says. At Dunkin', by contrast, there was no obvious rival, which he says had led to complacency. The average franchisee considered his prime competition to be the next Dunkin' location just down the road. Stores were dingy. The menu hadn't changed in years. Dunkin' Donuts, Kussell says, "was a great brand that had lost its way." But during the 1990s, driven partly by an influx of new managers and partly by the expansion of Starbucks, Dunkin' Donuts transformed itself.

This cycle routinely plays out in other industries. That's not to say an established company enjoys facing new competition, but doing so can be a spark. Consider General Motors circa 1980: bloated, bureaucratic and building lousy cars. After Toyota's and Honda's arrival, it took years for GM to regain its competitive footing. But there's little doubt it's a better company today.

LESSON TWO: Innovation Is Overrated

By the mid-'90s, after years of airing those "Time to Make the Donuts" commercials, Dunkin' had become too focused on the high-calorie pastries. But as managers searched for products to broaden the menu and appeal to health-conscious families, they didn't look only at ideas cooked up in their own R&D labs. Instead of trying to reinvent breakfast, they began pushing basic products--like bagels, low-fat muffins and breakfast sandwiches--that customers already ate elsewhere. Taking a cue from Starbucks, which had morphed coffee into a cold, creamy drink called the Frappuccino, Dunkin' fired back with the Coolatta, and added flavored coffees to its lineup. These days, beverages account for more than half of revenues in some markets.

So maybe Dunkin's managers didn't score points for originality. But today, bagels, breakfast sandwiches and Coolattas each sell more than $200 million annually, and some observers see Dunkin's better-developed menu as an advantage over rivals. "There's no confusion in customers' minds when they walk into Dunkin' Donuts what food products will be available," says Ted Lingle, executive director of the Specialty Coffee Association of America. "I don't think Starbucks has that same clarity."

Dunkin's successful appropriation of competitors' products shows how exaggerated the concept of being the pioneer--or in Internet parlance, the first mover--can be. From Atari's videogames (which created a market now dominated by others) to Apple's failed Newton (which paved the way for Palm), business is filled with examples in which profits accrue to companies that copy, rather than invent, products. Indeed, Dunkin' loyalists are quick to point out that despite the perception that Starbucks invented the concept of selling high-quality coffee for a premium, the idea was pioneered by Dunkin' Donuts' founder, Bill Rosenberg, when he started the chain in 1950. "He charged more for coffee than anybody in his day, and people thought he was crazy," says Jessica Brilliant Keener, co-author of Rosenberg's memoir, "Time to Make the Donuts." That illustrates the point nicely: after a few decades of many players profiting, nobody much remembers who invented a good idea anyway.

LESSON THREE: Markets Have More Niches Than You Think

Part of the benefit of competition is it forces companies to think more carefully about what exactly they're offering customers. The differences between rivals may be greater than they look on the surface. Dunkin' Donuts, Starbucks and Krispy Kreme all sell pastries and caffeinated beverages, so they're obvious competitors. But beneath that similarity, they're serving different markets. Krispy Kreme's customers visit only occasionally but buy dozens of donuts; that chain is peddling a dietary splurge, not daily sustenance. "This is a destination experience, one that's more of a treat," says Krispy Kreme marketing chief Stan Parker. Starbucks, like Dunkin', tries to infiltrate customers' daily routines, but Starbucks chief Howard Schultz has always seen his stores as neighborhood hangouts, a sort of nonalcoholic "Cheers" setting with comfy chairs, porcelain cups and, increasingly, wireless Internet access. Dunkin' Donuts, in contrast, is increasingly built on speed. Most of its new stores feature drive-throughs, and the chain bills itself as a pit stop for harried commuters. (One recent TV ad features a cops-and-robbers chase in which everyone stops for coffee before resuming the pursuit.) As Starbucks goes after Dunkin' strongholds, Dunkin' managers think endlessly about how to get even faster. "We've had these raging debates about self-service condiment bars," says Kussell, referring to those setups in rivals' stores where customers add milk or sugar to their own coffee. No question: Dunkin's tradition of having workers customize drinks behind the counter adds to service times. But so far the chain has decided to keep this small luxury.

LESSON FOUR: Grow at Your Own Speed

If Starbucks seems ubiquitous, that's because national expansion was part of Schultz's game plan when he began reinventing the coffeehouse in the mid-1980s. But that fast-growth strategy caused growing pains early on. Dunkin' Donuts, by contrast, is still concentrated on the East Coast; it has just a few dozen locations west of the Mississippi. Instead of conquering new lands, Dunkin's managers have spent much of their energy exploring how deeply the brand could penetrate existing markets. The result: in Massachusetts, where the quickest way to get someone lost is to give directions that include the phrase "Turn left at Dunkin' Donuts," there's one store for every 7,389 residents, compared with one Starbucks for every 15,383 in its home state of Washington. When Luther joined Dunkin', he realized that its expansion had been too slow. "It became obvious right off the bat," he says. "Why aren't we national?"

But slow-mo growth is hardly fatal. Remember that Wal-Mart remained largely a Southern retailer until a decade ago. Home Depot went national long before Lowe's, but today analysts are more bullish on Lowe's, in part because with just 875 locations compared with Home Depot's more than 1,500, Lowe's has more room to expand.

Luther points to five cities--Tampa, Fla.; Charlotte, N.C.; Cleveland; Atlanta, and Detroit--where he hopes to build more stores in the next two years. Eventually he hopes to lead the brand toward the West Coast. To increase sales at existing stores, his R&D team is toying with menu items to turn the chain into a lunch spot. And it's starting to integrate Dunkin' stores with their corporate sibling Baskin-Robbins to woo afternoon customers with coffee-and-cone pairings.

How do Dunkin's prospects look? Koehn, the Harvard professor--who admits to her own heavy Starbucks habit--argues the Seattle chain is still the better bet. The reason: in a stressed-out world, it's selling a luxurious escape. "Life is moving too fast for consumers... [and] a lot of people I know are trying to pause," says Koehn, who studied Starbucks extensively while writing the book "Brand New." Koehn says Starbucks sells that ideal.

Maybe. But for many people, those leisurely moments are harder to come by. Consider how many book-club meetings fold because no one had time to read the book. Or how many people sign up for spinning classes but are too busy to attend. Amid layoffs and long commutes, Dunkin' Donuts is a bet on convenience--and a bet against Americans' finding time for a time out. In a 24/7 to-go world, that's a strategy that's bound to eventually find a place in the spotlight.