Diedrich Coffee: four generations, three brands.

Diedrich Coffee Company, headquartered in Irvine, California, may be poised to leap into a firm runner-up position in the coffeehouse world, according to c.e.o. Rocky Laverty. "I intend to make Diedrich a credible Number Two behind Starbucks. We want to be Pepsi to their Coke, Avis to their Hertz." Certainly the potential is there. Laverty oversees three brands--Diedrich, Gloria Jean's, and Coffee People--with 375 retail stores worldwide. "Our total annual sales are in the $250 million range," Laverty says. With Starbucks topping $4 billion annually, it seems that Diedrich might never catch the leader. "But we have the opportunity to take the education of consumers about the attributes of great coffee to another level."

Time will tell. By his own admission, Laverty knew little about coffee until he came on board in 2003. And we have heard similar expansive plans before from past Diedrich executives. But Laverty is a quick study, and his experience as the former chief executive of Smart and Final--a kind of mini-Costco food store chain in seven states--gives him a broad managerial perspective.

Employees at the company seem confident, but they are also holding their collective breath. Laverty is the seventh c.e.o. to take the helm since the company went public in 1996. Founder Martin Diedrich, who does not relish management and calls himself the chief coffee officer, taught Laverty about coffee in the company's Coffee University. "Rocky is working out wonderfully," he says. "He understands that coffee quality is paramount, and he has gotten the senior management team to coalesce."

The modern Diedrich saga is a case study in the perils of over-expansion, franchise problems, shifting markets, and brand mixing, as well as the virtues of retrenchment and turnaround artistry. But before we review those more recent events and learn of Laverty's plans for the future, let us go back to 1916, when a German soldier was killed during World War I, eventually leading up, through an extraordinary chain of events, to Diedrich Coffee.

An Old-World Family Heritage

The dead soldier owned a small coffee farm in Costa Rica. His niece, an adventurous young woman named Charlotte Schmelinsky, inherited it, and after the war ended, she went to see the farm. It took three weeks by steamer, banana boat, train, and horseback. She found that the managers were doing a good job and, although she fell in love with the land and its climate, her young son Carl (her husband had been killed in World War I) was back in Berlin, and she returned to Germany. Over the years, she visited the farm a few more times, but then another war intervened. Five days before World War II ended, Costa Rica declared war against Germany and confiscated the property of German citizens.

In 1946, Carl left Germany for Naples, Italy, where he learned to roast coffee with an elderly coffee merchant. Then he rejoined the Ford Motor Company, for which he had worked as an engineer before the war, and helped build plants throughout the Middle East, until he was transferred to Vancouver, Canada. On a visit back to Germany, he met and married Inga Zietz, whose family had been long-time tea, coffee, and cocoa merchants in Breslau until the bombs destroyed the business.

In 1959, Diedrich moved to southern California to work for the U.S. Navy as a self-taught wildlife biologist. There, he and Inga were raising a family when his mother came to live with them in 1962. Then in 1966, recalls Martin Diedrich, who was eight at the time: "My grandmother suggested that maybe they could go to Costa Rica and reclaim the farm. My father got really excited about it." The mother and her son ventured to Costa Rica and, though they failed in their mission, Carl Diedrich was enchanted with Latin America. He ended up going into partnership with another German coffee-grower in Antigua, Guatemala. In 1967, the family moved there part-time, then full-time in 1970.

"My father wanted to perfect the coffee experience," Martin Diedrich recalls, "so he built his own coffee roaster and started roasting at relatively low temperatures, for a longer time, to really bring out the flavor and character. At the time, this was heresy. But he insisted that these high-grown, dense beans needed proper heat penetration. Nowadays, his premise is widely accepted among specialty roasters."

Accidentally Starting a Coffeehouse

In 1972, the Diedrichs moved back to southern California after a death in the family. "My father brought his little roaster and set it up in Costa Mesa in a one-car garage he rented, attached to a condemned home." Importing beans from his own farm and other coffee farmers he knew personally, Carl Diedrich began to roast and attempt to sell to retailers and wholesalers, but without much success. Part of the problem was that no one wanted small lots in those days. Also, he called the company simply Diedrich. "I told him he should call it Diedrich Coffee, so people would know what business he was in," his son says, "but he was very old world, and Diedrich by itself was supposed to be his personal guarantee of quality."

"Local people followed the scent trail into the garage," he recalls, "wanting to know what it was all about. Dad would sit them down on big sacks of coffee and pull an espresso for them on his old Pavoni. People would then drag their friends in to talk to this crazy old German guy and listen to his stories."

They also drank his coffee. At first, he refused to take any money, but eventually he was giving so much away that he had to charge. Over the years, that became his primary income.

In 1982, due to the unrest in Guatemala, Carl Diedrich relinquished ownership in his farm. "That was going to be his nest egg," son Martin recalls. "Here he was approaching old age, and I was traipsing around Guatemalan jungles being Indiana Jones." The younger Diedrich, an anthropologist and archeologist, was leading tours to Mayan ruins. "I came home in August 1983 to help my father. I was 24. I got room and board and $25 a week. For three years I slept in a sleeping bag on my parents' threadbare living room carpet."

From the outset, Martin Diedrich and his father argued about everything. In response to customer demand, Martin wanted to brew coffee and sell croissants and scones. He finally got his way, and built a prototype coffeehouse in the food court of a local Costa Mesa wine store. Meanwhile, Martin's younger brother Stephan had started a separate business, building innovative Diedrich coffee roasters--another legacy from their industrious father. "My brother built me a great new coffee roaster," Martin says.

In 1986, Martin Diedrich built his first full-blown coffeehouse in nearby Tustin, California. It was an immediate hit, with lines running out the door. He soon moved the Costa Mesa store to its own location as well, then added a third store in Newport Beach, California, in 1989, followed by a fourth six months later. "I was stretched very thin financially," recalls Diedrich. "I had no credit line, and every time I opened a new store, I risked my all. But I realized I had a tiger by the tail and wanted to know how far I could take it."

The Tiger's Tail is Hard to Hold

In 1992, to secure better financing, Diedrich sold 45% of the business to investor Paul Heeschen in return for a $1 million cash infusion, and other venture capitalists followed. In 1996, the company went public, with shares selling just over $9.00 "Our investors felt it was the right strategy to get more capital to grow the company," Diedrich recalls. Starbucks had gone public in 1992 and was doing very well indeed With the cash infusion, the company aimed for instant critical mass in Denver by purchasing 14 ailing Brothers Coffee outlets in Denver, along with seven Java City stores, plus three more Brothers stores in Houston. They changed all the store names to Diedrich.

"At that point, I relinquished the c.e.o. position," Martin Diedrich says. "My forte is coffee, not executive leadership of a multi-unit corporation." Steve Luppinaci, a retired accountant and friend of Paul Heeschen, took over briefly. Then board member Larry Goelman served as an interim c.e.o. Within a year and a half, the company had to close down over half of the stores it had acquired. "We simply didn't have the management depth or ability to make such a big geographical leap out of our core market," Diedrich says.

But that didn't dampen enthusiasm for expansion. In 1998, John Martin and Tim Ryan, both veteran Taco Bell executives, were hired as board chairman and c.e.o., respectively. In 1999, they purchased Portland-based Coffee People, which also owned Coffee Plantation in Phoenix and the extensive Gloria Jean's franchise chain. They changed the name of Coffee People and Coffee Plantation to Diedrich Coffee but left the well-entrenched Gloria Jean's name alone. The mall-based chain was started in 1979 by Ed Kvetko, a rough-edged Chicago contractor who named it after his wife. With a suburban, middle-class image, Gloria Jean's sold a wide variety of coffee drinks and flavors, along with an assortment of gift items.

Also in 1999, the new management team announced plans to open 1,500 Diedrich franchises nationwide in the next seven years. Martin and Ryan signed development agreements with experienced, multiunit franchise operators who already ran such stores as Taco Bell, Kentucky Fried Chicken, and McDonald's. Meanwhile, they moved the company's roasting facility to Castroville, California, taking over the Probat roasters used by Coffee People, and hired veteran coffee expert Steve Leach from Royal Coffee. With such ambitious, experienced managers, things looked good. On January 27, 2000, a Diedrich press release trumpeted "Strong Second Quarter Results," quoting c.e.o Tim Ryan as saying that the company was "profitable and poised for growth."

Then all hell broke loose. The first public sign of trouble came with an April 20, 2000, press release announcing that 39 Gloria Jean's stores had closed and that the company expected to record a "substantial loss," With an ailing stock market and poor financial climate, the franchise deals fell apart. The company posted a net loss of $22.4 million for the fiscal year ended June 28, 2000. John Martin and Tim Ryan quietly departed, and Mike Jenkins was hired as the new c.e.o, in September 2000.

Jenkins, who began his career as a waiter at Steak & Ale, had already served as c.e.o, of six food corporations, including Boston Chicken, which he reorganized and sold to McDonald's. At Diedrich Coffee, he set about closing unprofitable Diedrich and Gloria Jean's stores and restructuring company debt, executing a huge reverse stock split to bring the price above $1.00 to keep NASDAQ from de*listing it. In Portland, he changed the stores name back to the locally familiar Coffee People. Everyone at Diedrich loved Mike Jenkins. He saved the company. Then, at the age of 56, Jenkins tragically died of cancer in May 2002.

Newly appointed c.e.o. Phil Hirsch resigned after a year, then board members Paul Heeschen and Dick Spencer served as interim co-c.e.o.s during yet another exhaustive search. Finally, in April 2003, Rocky Laverty took the helm.

A New Dawn

In considering whether to take the job, Laverty visited many of the 30 Diedrich stores in southern California. "The coffeehouses looked a little shabby, but when you talked to people, they said, 'Oh, Diedrich has the best coffee in town,' SG here you had a fantastically loyal customer base despite financial mismanagement that might have driven them away."

The new c.e.o. credits the late Mike Jenkins with turning the company around and laying a foundation for future growth. Laverty has sold the Phoenix-based Coffee Plantation chain and says that the remaining Gloria Jean franchises--down to about 150 in the U.S.--are lean and mean. He has put money into remodeling all of the Diedrich stores, and emphasizes new merchandizing techniques, building on the reputation of the coffee. From Gloria Jean's, he has taken more cold coffee-flavored drinks to attract day-time consumers. Store managers now have incentives for reaching set monthly goals and objectives, so that they can earn up to 100% of their salary as a bonus.

"My management style is to get my butt out of my office chair and to get into the stores frequently and talk about what's going on," Laverty says. He plans to open four or five new Diedrich stores this year, starting in Orange County. "One of the mistakes they made before was to attempt national expansion before expanding in their core market sufficiently. Multi-state expansion is tough. Southern California has 20 million people, as big as Australia. There's a lot of room to grow right here."

Speaking of Australia, the thriving Gloria Jean's franchise there has inspired Laverty. With some 200 stores, the two partners, Nabi Saleh and Peter Irvine, are outselling Starbucks in Australia. "I went there," Laverty says, "and when I talked to people in Sydney, they said, 'Ah, my favorite place to hang out is GJ's."

That's how Laverty would like people to think about Gloria Jean's in the U.S., as well as the franchised stores in Guam, Indonesia, Ireland, Japan, Malaysia, Mexico, New Zealand, the Philippines, South Korea, Thailand, Turkey, and the United Arab Emirates. In America, however, Gloria Jean's does not have an upscale image, "We're working on that," Laverty says. He has asked Steve Leach to purchase topnotch Cup of Excellence Brazilian beans and sell them in Gloria Jean's, where they are doing quite well. "We plan to franchise 25 new mall stores this year, We are also planning prototype street locations in Chicago and Boston for new stores," Laverty says. He also envisions a new company-owned Gloria Jean's in Orange County.

He also admits, "we have three different concepts, which are too hard to manage. I see an opportunity to move the concepts together." Thus he may put "GJ" on Gloria Jean's products as part of a shift in that direction. Laverty says that at the 25 Coffee People stores, "it is still more about a hip attitude than about coffee."

The c.e.o.'s goal is to make the company's coffee reputation and quality the overriding image of all three brands, With Martin Diedrich overseeing the coffee operation and Coffee University, and Steve Leach cupping and roaming the world in search of the best beans, he has a good start. Roastmaster John Cozbekian, a veteran of George Howell's Coffee Connection chain, brings his experience to the process at the 57,000 sq. ft. Castroville plant, The Probat machines--the four-bag-at-a-time R1500 and three-bag R1000--are computer-programmed with Gozbekian's profile for each origin, as well. A small Diedrich IR 24, which came from one of the stores, stands ready to roast smaller batches.

According to Carl Mount, vice-president of manufacturing and purchasing, three Fres-co GL 18s are the workhorse form-fill-seal machines that spit out bulk five pound one-way valve bags of freshly roasted beans for distribution to all of the company's stores, not only in the U.S., but overseas. Though, the Australian and Mexican franchises have their own roasting facilities. A Fres-co GL 9 is used for smaller runs, while an ICA CVK 40-Paket machine produces 12 and 16 ounce nitrogen-flushed one-way valve bags for the retail stores. A Triangle S5 PDC and Bosch SVK 2500 make fractional packs for offices. Also serving that market are two Keurig k-cup production lines.

Diedrich Coffee appears on track, ready to expand once again. The company, which sources about 30% of its beans directly from farms, has just announced a partnership with Rainforest Alliance, which certifies socially responsible, sustainable coffee. The Diedrich share price hovers around $5.50, Maybe everyone can stop holding their breath--maybe.

Mark Pendergrast is the author of Uncommon Grounds and a contributor to Tea and Coffee Trade Journal. He can be reached at [e-mail].