Is the Starbucks formula the ticket for restaurant chains to take their brands national?

It's a trend worth watching as more than one startup in the food industry models itself on the heels of the successful, if recently bruised, coffee group.

Chicago-based Potbelly Sandwich Works for one is applying many of the original principles that made Starbucks Coffee Co. the dominant competitor in its space: a popular product served up in spaces where people would actually want to hang out. Potbelly began in a Chicago antique shop turned makeshift deli. Chief Executive Bryant Keil bought out the original owners in 1996, and the dark wooden floors, old photographs and blackboard signs found at many of Potbelly locations strongly evoke the feel of the first store.

Customers are often treated to live music as they wait in line for sandwiches served in baskets. Despite the hectic lunchtime pace, the staff appears to be having fun. If it doesn't sound much like the fast food culture we've grown accustomed to, that's the point.

You're greeted by somebody friendly, says the boyish-looking Keil, 44, in an interview at the company's downtown Chicago offices. It's a cool environment.

The atmosphere helps Potbelly stand out in the highly-commoditized world of deli sandwiches where national brands such as Subway and Quiznos dominate.

High volume target

A quick comparison in the Chicago area shows prices at Potbelly in line with deli competitors.

Keil maintains volumes are nearly three times that of the chain's closest rivals. He won't discuss gross margins, but says the stores, which now number around 200, have strong unit economics, with established ones averaging about $1.2 million in yearly sales. The chain booked $176.9 million in 2007 revenue, up 34.5 percent increase from the year earlier.

We have a very high quality product and very little waste, says Keil, who funded Potbelly slow but steady regional growth out of his own pocket until 2001, when the chain began raising outside capital.

Starbucks influence

The Starbucks analogy is close to home for Potbelly. Howard Schultz, Starbuck's founder and chairman, has been an active presence on Potbelly's board since 2001. He was reinstalled as CEO earlier this month following progressively weaker results and concern that the Starbucks experience had been cheapened.

Maveron, Schultz's private equity firm, is Potbelly's largest investor, helping to raise capital that has fueled the chain's growth spurt. Adding stores at the rate of about one a week, Potbelly is now in 10 states (Illinois, Wisconsin, Minneapolis, Indiana, Ohio, Michigan, Texas, Pennsylvania, Maryland, Virginia) and Washington, D.C. It is planning to enter at least one new market in 2008.

Through five rounds of financing, Potbelly has raised roughly $100 million, allowing the chain to follow Starbucks' model of owning all its stores. A store costs about $575,000 to launch. Keil has not ruled out the franchise model at some time down the road; he says he gets around 150 inquiries a week.

The CEO has drawn from Starbucks former management ranks to help staff his corporate team, which now numbers about 150, turning to the chain's methods for market analysis and development.

I have tremendous respect for what they do. That's kind of the path that we're trying to take, he says.

Unlike Starbucks, however, he has no designs on going public for now. Running a publicly-traded company is probably not what I'm best at, he says.

Also in contrast to Starbucks, Potbelly faces a crowded market full of so-called fast casual players, such as national chains Chipotle Mexican Grill and Panera Bread Co., as well as a host of independents. Of course, anyone who offers lunch is a threat.

They have a simple menu where it's not too complex to execute it on a consistent basis, to keep up high quality, and to present fresh food, says Thomas Weisel Partner restaurant analyst Matthew DiFrisco. The brand looks like it should travel.

Potbelly appears on track for now. Largely unadvertised, it can see lunchtime queues snaking out the door during the summer. Maveron co-founder, former investment banker Dan Levitan, says the investment firm remains enamored with the concept.

The company has done a great job, in my mind, of having the brand integrate into people's lives, he says.

Maintaining the small-company culture as expansion amps up is the next challenge for the chain. Keil, who early in the chain's history halted growth for a year to iron out staffing issues, says he's not afraid to put on the brakes when problems arise.

What it means is recognizing that you're going into a curve and adjusting, he says. We're trying to build Potbelly to be a big company but we want to continue an entrepreneurial, small company feel.

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