Stroll into any Panera in the country — whether it is in Portland, Ore.,or Portland, Maine, St. Louis, Mo. or St. Augustine, Fla. — and the setting is the same: a wide-open airy space with stylish light fixtures, walls painted in rich red and yellow hues, an assortment of cushy, upholstered seats and perhaps a gas fireplace. The scent of fresh bread baking wafts through the café. Panera’s menu offers hearty $7 sandwiches made on artisan breads, as well as soups, salads and baked goods. It serves its meals on real dishware rather than on plastic plates, and invites customers to sit on elegant wooden chairs rather than in Formica booths.

What Is Panera?

It is not your average fast food joint. Today, Panera attracts both everyday customers and Wall Street investors; it is one of the fastest-growing chains in the U.S., with 1,420 stores, and a roughly $3 billion market capitalization. During the depths of the downturn, when most companies contracted, Panera’s management invested in its product line and increased the number of stores. The strategy worked: In 2009, the company posted revenues of $1.4 billion, up from $640 million in 2005.

The reason for Panera’s success is simple: The chain has pursued a niche strategy, differentiating itself as a fast food restaurant that serves healthy, tasty, affordable food, according to Lawrence Hrebiniak, a Wharton management professor. And at a time when two-thirds of adults in the U.S. are classified as obese and many Americans are paying more attention to the food they eat, Panera offers a wholesome alternative to purveyors of fatty burgers and burritos. Equally important, Hrebiniak says, it provides an appealing customer experience.

“Panera has become a symbol of warmth,” he adds. “In advertisements, they position themselves as a warm, welcoming place. They want you to bring your friends and family. They want you to come to Panera to have lunch with a good old friend…. When times are tough, people go back to the basics. You can’t go out to dinner and drop $250, but you can go to Panera with a friend and have a tasty bowl of soup and smell the bread baking.”

As the economy improves, however, there are challenges ahead. Panera’s management must stay close to the market, paying particular attention to whether customers’ needs or demands are changing, and adjusting their products accordingly. The company must also maintain solid entry barriers for potential competitors, which will ensure that customers perceive they are getting a good value. “This is a challenging and difficult task,” Hrebiniak notes.

‘Self-service Gas for the Human Body’

Panera started out as the St. Louis Bread Co., a modest chain that ran 19 bakery-cafes in urban Missouri. In 1993, Ron Shaich, who at the time was head of the similarly-minded chain Au Bon Pain, bought the company for $23 million and renamed it Panera, Latin for “time of bread.” By 1999, Shaich sold off Au Bon Pain to concentrate on the Panera division. “At the highest level — and I’ve been doing this for 30 years — what I am trying to do is bring real food to people in environments that engage them,” says Shaich in an interview with Knowledge at Wharton.

According to Shaich, who stepped down as CEO last year but remains chairman, Panera’s growth is due to a larger trend driven by American consumers’ rejection of commodities. “After World War II, McDonald’s and Burger King were special, but by 1993-1994, they had become self-service gasoline stations for the human body,” he notes. “There was a reaction to that; people wanted specialness, and an end of commoditization. We saw it happening in specialty soft drinks, ice cream, beer and coffee. It was also happening in the food industry. This was a trend that I understood would play out over decades, not quarters. My vision for how Panera would compete was rooted in specialty artisan bread, made with no chemicals and no preservatives.”

And compete it has. By the beginning of the financial downturn, Panera was one of the best performing restaurant stocks. Between 2007 and 2009, its earnings per share grew by more than 50%. Panera, which appears in the Quick-Serve and Quick-Casual market grouping, consistently ranks third in financial performance, trailing only McDonald’s and Chipotle.

“As we began the recession, we made a decision to increase our investment,” says Shaich. “At a time when almost every other restaurant was driven to cost cutting, and pulling back, we invested in the quality of the product, in growth and in marketing.”

During the recession, Panera introduced a range of low-fat fruit smoothies and brought out new dishware for its dine-in customers. It retooled its salad line, introducing new dressings, and new signature dishes. The company also moved toward growing its own lettuces. “These details actually matter Shaich states. “In the middle of a recession our salad business was up 30%.”

The company increased its labor force, paid bonuses and gave raises. It made significant investments in the quality of its stores and built new ones, taking advantage of the fact that construction costs were down 20%. In addition, Panera rolled out a loyalty program during the recession, giving its most devoted customers opportunities to earn free pastries and coffees, and offering invitations to cooking demonstrations.

Shaich says that Panera had gained credibility with investors before the recession, which gave management more room to maneuver when the economy worsened. “We had a highly supportive board, highly supportive investors, and we had a pristine balance sheet,” he notes. “We stayed the course, and we became an even better competitive alternative.

“We’re not doing anything new and different; we’re trying to get closer to our vision,” he adds. “I believe the biggest detriment to other companies is intense overreaction. There is intense pressure for short-term results. I compete for two, five, 10 years out, but if you’re competing for the next two quarters I have a lot more options than you do.”

The Panera Customer Experience

The success of Panera’s brand is mainly because the company clearly has a deep understanding of what drives its customers, according to Yoram “Jerry” Wind, professor of marketing at Wharton. In a down economy, one of the main drivers is price. “Right now, we’re in an environment where 17% of people are either unemployed or underemployed. That’s a huge part of the population, and it has made customers very price conscious,” says Wind. “The value equation must be strong in a bad economy. This is part of why Panera, which has affordable food, is winning.”

Panera also recognizes its customers’ patterns and preferences, and pays attention to the seemingly small details that comprise the customer experience, notes Wind.”Starbucks created this idea of ‘the third-place’: You have home, you have work and you have Starbucks. You see people sitting at Starbucks all day long drinking coffee, talking, reading the newspaper, on their computers,” he says, noting that this is also true of Panera.

“In other words, it’s not only the product; it’s customer experience you’re providing. Starbucks does this very well: They have just the right music, the right kind of furniture and the right ambience. Panera also appears to have created a customer experience that consumers respond to.”

Indeed, in many cities and towns, Panera has become a de facto community center. Customers go to Panera to socialize, work (the chain has one of the largest industrial strength wi-fi networks in the country), and participate in clubs and meetings. The price of admission is the food.

“We’re seeing the evolution of the common space and the community space, and Panera is a part of that,” according to John Ballantine, a senior lecturer who specializes in strategic management at Brandeis University International Business School. “Before, it was a good bakery with quality food at decent prices. But now it’s become a place where people gather. There is ample room, plenty of comfortable chairs. You often see the elderly gathered there for clubs, as well as young people and students hanging out, and others with their laptops using it as their virtual office. It’s welcoming, and it’s comfortable. It’s almost an extension of the café world of Europe.”

Riding the Health Food Trend

Panera’s popularity is helped by market forces that are working in the chain’s favor, namely concerns over eating habits. According to the Office of the U.S. Surgeon General, nearly one in three children is overweight or obese, and the U.S. spends $150 billion a year treating obesity-related illnesses. In addition to several federal government initiatives to combat the problem, there has been a significant increase in media attention to the importance of healthy eating.

Panera’s emphasis on artisan sandwiches made with wholesome ingredients and soups — menu items include a low-fat vegetarian black bean soup, a Mediterranean veggie sandwich, and a turkey and artichoke panini – fits neatly into the movement toward healthy eating. Panera is increasingly gaining a reputation in this area, too: A survey by Zagat, the restaurant guide, ranked it first for “best healthy option,” while Health magazine has rated the chain as one of the healthiest “quick serve” restaurants.

The restaurant has gained traction with health-minded customers, but more importantly, the chain is winning over the nutritionally apathetic because its menu has the appearance of offering foods that are good for you, according to Ambar Rao, professor emeritus of marketing at Washington University’s Olin School of Business. “Even with this health food craze, most people don’t really change their eating habits, unless their doctor tells them they need to,” he says. “But if they dine at a place like Panera, which doesn’t serve burgers or fries, and is big on salads, sandwiches and vegan soups, they at least have the illusion that they’re eating more healthy.”

It is not exactly diet food, however. Panera’s Fuji Apple Chicken Salad served on a bed of baby field greens — ostensibly a healthy-sounding dish — has 520 calories and 31 grams of fat. Add to that a dressing of Asian sesame vinaigrette and the meal weighs in at 680 calories and 44 grams of fat. For the record, a McDonald’s Big Mac has 540 calories and 29 grams of fat.

Even if it is merely an illusion, customers take solace in the fact that Panera is at least giving them the option to make healthier choices, notes Rao. While many foods on the chain’s menu appeal to health-conscious customers, there are also plenty of breads, bagels and baked goods for those unmoved by the trend toward healthier eating. “When you order a sandwich at Panera, you have a choice of either a small apple or roll or a bag of chips as an accompaniment,” he says. “This makes the customer feel like the restaurant is giving them the choice to be healthier.”

Panera Bread Strategy: Too Much of a Good Thing?

Panera has done well pursuing a strategy as a supplier of healthy, flavorsome, and affordable food. Many experts, including Brandeis’ Ballantine, predict that as long as Panera stays true to that market niche, the company will continue to be profitable. “The spacious, welcoming and convenient environment and the high quality, reasonably priced coffee, snack, or meal is something that many middle class customers want,” he points out. “Panera seems to have found that niche.”

But, he says, if the company veers from this strategy and attempts to move up the food chain, so to speak, there could be problems. “If Panera tries to create a more complicated menu with fancier, more involved dishes and then charge a higher price for the food, it could run into trouble.”

Over-saturating the market is another concern. “Clearly that’s what happened to Starbucks,” Ballantine notes. Over a five-year period from 2002 to 2007, Starbucks nearly tripled its number of stores worldwide, from 5,886 to 15,011. But by the start of the economic downturn, Starbucks’ revenues and profit tumbled. Customer traffic declined, and in 2008, the company closed 600 underperforming stores.

“I’d worry about over-expanding,” Ballantine states. “Panera’s management has to understand market dynamics in different parts of the country and understand the demographics. Every city and town has slightly different target clientele: Some cities have more elderly and retired, others young professionals and families, others are state university towns, and the needs and demands of each are slightly different. Panera needs to be mindful of that.”

The primary challenge for Panera will be to maintain its “special factor,” or else it risks becoming just another commodity, agrees Wharton’s Hrebiniak. “To maintain the basis of differentiation, you need to make the customer feel that you’re not like everybody else. You don’t want to be on every corner. You want to have some exclusivity.

“Frankly there aren’t that many competitors out there that are doing the same thing as Panera,” he notes. Subway, for instance, positions itself as offering healthy and cheap food, but not necessarily a cozy environment. The Olive Garden, meanwhile, is building its brand around family and friends, but it is not positioning itself as healthy. A Belgian chain, Le Pain Quotidien (French for “daily bread”) is more upscale and polished, and could perhaps one day become a rival but it’s early yet, Hrebiniak says. Le Pain Quotidien has a presence in 11 countries, including 42 cafes in the U.S., 20 of them in Manhattan.

Still, Hrebiniak adds, management must work hard to ensure that customers perceive that they are getting a good value. “As in any other company, management must keep a close eye on industry forces and competitors’ moves. They must stay close to the market, talking to customers and ascertaining any changes in their needs or demands. Success always breeds imitation, and management must maintain solid entry barriers and stay one step ahead of competitors to reinforce the company’s value proposition.

“When you’re on top what you do? It’s difficult to maintain that advantage,” he says.