How a Shareholder Coup at Olive Garden’s Owner Sparked a Turnaround

One of the biggest tests of activist investing focused a lot on breadsticks.

Investment firm Starboard Value LP, seeking to throw out the board of Darden Restaurants Inc., argued that waitstaff at the company’s Olive Garden chain gave away too many, which left the appetizers cold, hard and uneaten on customer tables.

After a rare shareholder coup 18 months ago, Starboard nominees took control of the Darden board and pushed for changes—streamlining kitchen operations, selling more alcohol and serving better-tasting breadsticks—that accelerated a rapid company turnaround.

Since Starboard’s move, the previously struggling stock has risen 47%, versus 6% for the S&P 500; much of its real estate has been spun off, giving shareholders a second stock; and year-over-year sales at existing locations of the Olive Garden chain have increased for six straight quarters.

Activism is turning into a powerful force in American corporations, with shareholders taking stakes and agitating for change. Rarely, though, have such investors replaced an entire U.S. board. Darden, then valued at roughly $6 billion, was the largest takeover of its kind. Bankers at the time joked the dog had finally caught the car, making Darden a highly visible test of whether activist investors can run a company better than its own managers.

Credit for the success is shared. People who worked at Darden before Starboard’s arrival say the investment firm helped propel cost cuts, spurred creativity and steered the chain closer to its core business of serving customers looking for a good deal on Italian food.

Some changes, however, mirrored ideas that Olive Garden management had already started, such as improving the breadsticks. And not all of Starboard’s ideas worked out—for example, adding salt to the pasta water, a traditional cooking method.

Executives said that adding salt to the boiling water could jeopardize warranties on its expensive pots. While the company tested salting the water for the new board, it decided that the sauces delivered enough flavor, and Starboard came around, one person familiar with the matter said.

Starboard CEO Jeffrey Smith stepped down this week as Darden chairman, saying the board and management put the restaurant company, which also owns the chains LongHorn Steakhouse and The Capital Grille, on a good path. His firm, which has pared its position to 5.2% from 8.8% this year, is now looking at profits, both realized and paper, of more than $540 million, according to filings.

“Our job is to significantly improve the direction of the operational execution and significantly improve the oversight of the board, to change the direction of the company,“ Mr. Smith said in an interview. “My involvement is no longer as necessary.”

Starboard’s next challenge is likely to prove tougher. The New York investment firm is seeking to unseat the board at Yahoo Inc., a company with a $35 billion market capitalization and more intractable problems.

Inside and out

Two men, one from outside the company—Starboard’s Mr. Smith, age 43—and one from inside—Olive Garden President Dave George —played leading roles in the transformation, starting with Olive Garden, Darden’s biggest and weakest chain.

A former investment banker, Mr. Smith had helped turn around and sell his father’s juice company, The Fresh Juice Co., but he rarely targeted food companies. His firm has run activist campaigns at 102 companies, with 61 proxy fights, 20 seeking to overthrow a majority of the board, according to research firm FactSet.

Mr. George, 60 years old, has worked in restaurants his whole adult life. He started washing dishes over the summer during college at the Grand Hotel on Michigan’s Mackinac Island. He later became a grill cook and a sauté breakfast cook making omelets. He earned a degree in hospitality and after college became a manager at Houlihan’s Restaurant and Bar, and then a regional director. In 1996, he joined LongHorn Steakhouse and eventually became president. He ran the company after it was acquired by Darden in 2007.

When Mr. George was selected in January 2013 by Darden’s then-chief executive, Clarence Otis, to turn around the struggling Olive Garden chain, he decided to see firsthand what was going wrong.

For 12 weekends in a row, he and members of his senior management team flew to different Olive Garden restaurants around the U.S. to work alongside busboys, dishwashers and cooks.

“We asked everyone one question: ‘What stands in the way of you delivering ‘hospitaliano?’” Mr. George said, referring to Olive Garden’s faux-Italian word for hospitality.

He got an earful. Busboys said they cleared tables and set them with napkins, cutlery and glasses for a full party. If a hostess seated two people at a table for four, she would remove the extra settings, undoing their work. Cooks said they spent too much time filling cups of precisely measured basil for garnish—a regimen created to save waste. They also complained of having to weigh servings of uncooked pasta to fill 8-ounce bags.

“We were spending a lot of labor hours on preparation and production and it added no benefit to the guest,” said Mr. George, who ended those practices.

At the end of 2013, Starboard disclosed its stake in Darden. Its focus was first on corporate restructuring, not fine-tuning kitchen operations.

In May of 2014, Starboard launched a proxy fight to take over the entire board. The battle was precipitated by Darden’s decision to sell Red Lobster without seeking a shareholder vote requested by Starboard and others.

Mr. Otis said in July he would step down as CEO. “It didn’t make a difference who the board was,” Mr. George said. “If trends didn’t change at Olive Garden, I would be working somewhere else.”

An Olive Garden executive came up with an idea to focus on one menu item every quarter and retrain everyone from cooks to servers how to make and serve the best product possible. First up: breadsticks.

Olive Garden chefs in August 2014 attended a conference in Hollywood, Fla., where they trained directors of operations—who are responsible for more than one restaurant in the chain—how best to cook breadsticks with the perfect amount of butter and garlic salt, techniques shared with their staff.

The company also emphasized its policy of serving one breadstick for every person in the party, plus one. Managers were told to stick to the policy of delivering more breadsticks only on request. As the chain grew over the years to more than 800 restaurants with 90,000 employees, the policy wasn’t consistently followed, with some servers bringing out more without being asked.

By early September of 2014, Starboard had joined the discussion.

The quality of the breadsticks at Olive Garden, Starboard said, had declined, with the popular appetizers often cooling and hardening after sitting at the table for more than seven minutes. It argued the chain could save between $4 million and $5 million annually if it just followed its own policy on how many to serve.

The critique became the butt of jokes, including by comedian Stephen Colbert, who called them “carbohydrate rods.” Distracted by the attention, Mr. George told his managers to turn off their Google news alerts for a while.

The breadsticks were part of a 294-page plan presented by Starboard for cutting costs and improving sales at Olive Garden by upgrading food quality, eliminating non-Italian meals, reducing unnecessary food preparations, encouraging alcohol orders and introducing tabletop tablets to reduce wait times.

Overboard

In October of 2014, Darden shareholders voted to replace the board with Starboard nominees. Eugene “Gene” Lee, chief operating officer, became interim CEO. Afterward, Starboard’s Mr. Smith and other new directors worked a shift in one of Darden’s restaurants.

Mr. Smith, who became Darden chairman, spent a few days a week over several months at the company’s Orlando, Fla., headquarters. In early 2015, Mr. Smith stopped by to see Mr. George as he and his team worked on developing a five-year plan for Olive Garden.

“He came in and said, ‘What are you talking about?’ My team clammed up for a few minutes,” Mr. George said.

Mr. Smith spent the next four hours with the executives, challenging them to think about ways to breathe new life into the chain. That inspired the executives, Mr. George said. In some markets, for example, Olive Garden is now experimenting with setting aside space for children’s activities, allowing parents to linger over their meal.

Some of Starboard’s suggestions were already in progress. Others happened after the new board was elected, such as introducing tabletop tablets for customers to order and pay for meals. Starboard pushed the technology to reduce wait times. Mr. Lee said on Tuesday the tablets have allowed restaurants, on average, to close out checks seven minutes faster.

Starboard has also encouraged Olive Garden to boost alcohol sales. Last summer, the chain began offering guests waiting for a table a 50% discount on a glass of wine, encouraging some guests to order a second glass. Top-performing employees have been to Italy to learn to pair meals with wine.

“From the moment he walked into the boardroom, Jeff has been focused on helping Darden regain its leadership position in full service dining,” Mr. Lee said Tuesday.

Mr. Lee recently asked the Olive Garden team to create a prototype for how guests likely will interact with a casual dining restaurant in 7 to 10 years.

“Jeff said he didn’t want it to be a theoretical exercise, but for us to actually do it,” Mr. George said. The company is scouting locations to build an Olive Garden of the future. “That thinking is permeating all the stuff we’re doing,” he said.

After an Olive Garden chef noticed employees making sandwiches for themselves using breadsticks, the company decided to offer them as a menu item in May. The company promoted the new offering with a food truck tour around the U.S.

One of the food trucks stopped outside of Starboard’s New York headquarters in June, where Messrs. Smith and George handed out sandwiches.

Write to Julie Jargon at julie.jargon@wsj.com and David Benoit at david.benoit@wsj.com