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Industry Surveys
Industry Surveys
Restaurants
Restaurants
Erik B. Kolb, Restaurants Analyst
Erik B. Kolb, Restaurants Analyst
March 3, 2011
Topics Covered by Industry Surveys
Topics Covered by Industry Surveys
Aerospace & Defense Aerospace & Defense Airlines
Airlines
Alcoholic Beverages & Tobacco Alcoholic Beverages & Tobacco Apparel & Footwear:
Apparel & Footwear: Retailers & Brands Retailers & Brands Autos & Auto Parts Autos & Auto Parts Banking
Banking Biotechnology Biotechnology
Broadcasting, Cable & Satellite Broadcasting, Cable & Satellite Chemicals
Chemicals Communication
Communications s Equipment Equipment Computers: Commercial Services Computers: Commercial Services Computers: Consumer Services & Computers: Consumer Services &
the Internet the Internet Computers: Hardware Computers: Hardware Computers: Software Computers: Software Computers: Storage &
Computers: Storage & PeripheralsPeripherals Electric Utilities
Electric Utilities
Environmental & Waste Management Environmental & Waste Management Financial Services:
Financial Services: Diversified Diversified Foods &
Foods & Nonalcoholic BeveragesNonalcoholic Beverages Healthcare: Facilities
Healthcare: Facilities Healthcare: Managed Care Healthcare: Managed Care Healthcare: Products & Supplies Healthcare: Products & Supplies Heavy Equipment & Trucks Heavy Equipment & Trucks Homebuilding Homebuilding Household Durables Household Durables Household Nondurables Household Nondurables Industrial Machinery Industrial Machinery Insurance: Life & Health Insurance: Life & Health Insurance:
Insurance: Property-CasuaProperty-Casualtylty Investment Services
Investment Services Lodging & Gaming Lodging & Gaming Metals: Industrial Metals: Industrial Movies & Entertainment Movies & Entertainment
Natural Gas Distribution Natural Gas Distribution
Oil & Gas: Equipment & Services Oil & Gas: Equipment & Services Oil & Gas: Production &
Oil & Gas: Production & Marketing Marketing Paper & Forest Products
Paper & Forest Products Pharmaceuticals
Pharmaceuticals
Publishing & Advertising Publishing & Advertising Real Estate Investment Trusts Real Estate Investment Trusts Restaurants Restaurants Retailing: General Retailing: General Retailing: Specialty Retailing: Specialty Savings & Loans Savings & Loans
Semiconductor Equipment Semiconductor Equipment Semiconductors
Semiconductors
Supermarkets & Drugstores Supermarkets & Drugstores Telecommunicat
Telecommunications: ions: WirelessWireless Telecommunicati
Telecommunications: ons: WirelineWireline Transportation: Commercial Transportation: Commercial
Global Industry Surveys
Global Industry Surveys
Airlines Airlines
Autos & Auto Parts Autos & Auto Parts Banking
Banking
Food Retail Food Retail Foods & Beverages Foods & Beverages Media
Media Oil & Gas Oil & Gas
Pharmaceuticals Pharmaceuticals Telecommunications Telecommunications Tobacco Tobacco
Topics Covered by Industry Surveys
Topics Covered by Industry Surveys
Aerospace & Defense Aerospace & Defense Airlines
Airlines
Alcoholic Beverages & Tobacco Alcoholic Beverages & Tobacco Apparel & Footwear:
Apparel & Footwear: Retailers & Brands Retailers & Brands Autos & Auto Parts Autos & Auto Parts Banking
Banking Biotechnology Biotechnology
Broadcasting, Cable & Satellite Broadcasting, Cable & Satellite Chemicals
Chemicals Communication
Communications s Equipment Equipment Computers: Commercial Services Computers: Commercial Services Computers: Consumer Services & Computers: Consumer Services &
the Internet the Internet Computers: Hardware Computers: Hardware Computers: Software Computers: Software Computers: Storage &
Computers: Storage & PeripheralsPeripherals Electric Utilities
Electric Utilities
Environmental & Waste Management Environmental & Waste Management Financial Services:
Financial Services: Diversified Diversified Foods &
Foods & Nonalcoholic BeveragesNonalcoholic Beverages Healthcare: Facilities
Healthcare: Facilities Healthcare: Managed Care Healthcare: Managed Care Healthcare: Products & Supplies Healthcare: Products & Supplies Heavy Equipment & Trucks Heavy Equipment & Trucks Homebuilding Homebuilding Household Durables Household Durables Household Nondurables Household Nondurables Industrial Machinery Industrial Machinery Insurance: Life & Health Insurance: Life & Health Insurance:
Insurance: Property-CasuaProperty-Casualtylty Investment Services
Investment Services Lodging & Gaming Lodging & Gaming Metals: Industrial Metals: Industrial Movies & Entertainment Movies & Entertainment
Natural Gas Distribution Natural Gas Distribution
Oil & Gas: Equipment & Services Oil & Gas: Equipment & Services Oil & Gas: Production &
Oil & Gas: Production & Marketing Marketing Paper & Forest Products
Paper & Forest Products Pharmaceuticals
Pharmaceuticals
Publishing & Advertising Publishing & Advertising Real Estate Investment Trusts Real Estate Investment Trusts Restaurants Restaurants Retailing: General Retailing: General Retailing: Specialty Retailing: Specialty Savings & Loans Savings & Loans
Semiconductor Equipment Semiconductor Equipment Semiconductors
Semiconductors
Supermarkets & Drugstores Supermarkets & Drugstores Telecommunicat
Telecommunications: ions: WirelessWireless Telecommunicati
Telecommunications: ons: WirelineWireline Transportation: Commercial Transportation: Commercial
Global Industry Surveys
Global Industry Surveys
Airlines Airlines
Autos & Auto Parts Autos & Auto Parts Banking
Banking
Food Retail Food Retail Foods & Beverages Foods & Beverages Media
Media Oil & Gas Oil & Gas
Pharmaceuticals Pharmaceuticals Telecommunications Telecommunications Tobacco Tobacco
CURRENT ENVIRONMENT
CURRENT ENVIRONMENT
Outlook 2011: will the
Outlook 2011: will the positive momentum continu
positive momentum continue?
e?
In our outlook at the start of 2010, we questioned if 2010 would bring “blue skies” to the restaurant In our outlook at the start of 2010, we questioned if 2010 would bring “blue skies” to the restaurant industry, or if it would just be the “eye of the storm,” as we were somewhat suspicious of a meaningful industry, or if it would just be the “eye of the storm,” as we were somewhat suspicious of a meaningful recovery for the industry in 2010. Even though 2010 first-half sales were up only modestly (despite easy recovery for the industry in 2010. Even though 2010 first-half sales were up only modestly (despite easy comparisons with the first half of 2009), it now appears that the industry has generally stabilized, and some comparisons with the first half of 2009), it now appears that the industry has generally stabilized, and some restaurant companies are even growing.
restaurant companies are even growing.
In the second and third quarters of 2010, there was serious concern over a double-dip recession, and a In the second and third quarters of 2010, there was serious concern over a double-dip recession, and a pronounced stock market correction. Since September 2010, however, both the economic outlook and the pronounced stock market correction. Since September 2010, however, both the economic outlook and the stock market have improved. Home prices also seem to have stabilized, though the bottom nationwide may stock market have improved. Home prices also seem to have stabilized, though the bottom nationwide may not be fully reached until spring 2011. We single out home prices and the stock market, as they are the not be fully reached until spring 2011. We single out home prices and the stock market, as they are the primary stores of household wealth. The recent improvements in both have resulted in a notable uptick in primary stores of household wealth. The recent improvements in both have resulted in a notable uptick in consumer confidence. Indeed, the University of Michigan’s Index of Consumer Sentiment increased to 74.5 consumer confidence. Indeed, the University of Michigan’s Index of Consumer Sentiment increased to 74.5 in December 2010, up 4.1% from November’s 71.6 and 10.0% from October’s 67.7. The January 2011 in December 2010, up 4.1% from November’s 71.6 and 10.0% from October’s 67.7. The January 2011 figure was about flat with December, at
figure was about flat with December, at 74.2.74.2.
Although most economists feel that the US has definitively emerged from recession, Standard & Poor’s Although most economists feel that the US has definitively emerged from recession, Standard & Poor’s Equity Research thinks that some uncertainty still exists about the strength of the economy in 2011, Equity Research thinks that some uncertainty still exists about the strength of the economy in 2011,
particularly as it pertains to consumer spending in general and to spending in restaurants in particular. The particularly as it pertains to consumer spending in general and to spending in restaurants in particular. The withdrawal of monetary and fiscal stimulus at the federal
withdrawal of monetary and fiscal stimulus at the federal level and austerity measures being taken by level and austerity measures being taken by statestate and municipal governments are all black clouds on the economic horizon.
and municipal governments are all black clouds on the economic horizon. We believe that home prices, while not
We believe that home prices, while not a direct causative factor in a direct causative factor in restaurant sales, are still an restaurant sales, are still an importantimportant influence for several reasons. First, homes had become a source of capital against which many people influence for several reasons. First, homes had become a source of capital against which many people
borrowed in order to maintain their lifestyles. Obviously, since the collapse in home values, this is no longer borrowed in order to maintain their lifestyles. Obviously, since the collapse in home values, this is no longer true; furthermore, those conditions are unlikely to come back anytime soon. Second, rising home values true; furthermore, those conditions are unlikely to come back anytime soon. Second, rising home values contribute to positive consumer sentiment, but with the outlook still uncertain, consumers aren’t likely to contribute to positive consumer sentiment, but with the outlook still uncertain, consumers aren’t likely to alter their
restaurant industry, in our view. Not only did it reshape the industry, but it also is likely to remain an restaurant industry, in our view. Not only did it reshape the industry, but it also is likely to remain an influence on the industry’s fundamental vigor for years to come.
influence on the industry’s fundamental vigor for years to come. SALES IMPROVE AS AMERICANS DINE OUT ONCE AGAIN SALES IMPROVE AS AMERICANS DINE OUT ONCE AGAIN
As background information for our industry forecast for 2011, we note that 2010 sales, according to the As background information for our industry forecast for 2011, we note that 2010 sales, according to the National Restaurant Association’s
National Restaurant Association’s 2010 Restaurant Industry Forecast 2010 Restaurant Industry Forecast , were estimated to reach $580 billion,, were estimated to reach $580 billion, a 2.5% increase (in current dollars) from the 2009 figure. After adjusting for inflation, however, sales in a 2.5% increase (in current dollars) from the 2009 figure. After adjusting for inflation, however, sales in 2010 would be virtually flat with the previous year. Still, this is an improvement over the 1.2% and 2.9% 2010 would be virtually flat with the previous year. Still, this is an improvement over the 1.2% and 2.9% declines in real (inflation-adjusted) sales experienced in 2008 and 2009, respectively. Standard & Poor’s declines in real (inflation-adjusted) sales experienced in 2008 and 2009, respectively. Standard & Poor’s estimates similar low-single
estimates similar low-single-digit increases in traffic and mix -digit increases in traffic and mix changes (changes (i.e.i.e., how often consumers visit a, how often consumers visit a restaurant, and the effect of their menu choices on the average ticket) for 2010.
restaurant, and the effect of their menu choices on the average ticket) for 2010.
In 2009, sales totaled $566 billion and marked the first annual sales decline (in current dollars) experienced In 2009, sales totaled $566 billion and marked the first annual sales decline (in current dollars) experienced by the domestic restaurant industry in the four decades that the National Restaurant Association has been by the domestic restaurant industry in the four decades that the National Restaurant Association has been tracking this measure. This unprecedented decline followed a 3.2% increase in 2008 to $570 billion (as tracking this measure. This unprecedented decline followed a 3.2% increase in 2008 to $570 billion (as revised), which previously had been the industry’s worst annual sales performance. Only once before in the revised), which previously had been the industry’s worst annual sales performance. Only once before in the association’s tracking historyin 1991, another recession yeardid nominal sales increase less than 4% a association’s tracking historyin 1991, another recession yeardid nominal sales increase less than 4% a year. On an inflation-adjusted basis, the decline in industry sales in 2009 was 2.9%, almost spot on with year. On an inflation-adjusted basis, the decline in industry sales in 2009 was 2.9%, almost spot on with our projection of a 3.0% decline.
our projection of a 3.0% decline.
Standard & Poor’s Equity Research forecasts that US foodservice industry revenues will increase 2.2% in Standard & Poor’s Equity Research forecasts that US foodservice industry revenues will increase 2.2% in 2011 to $582 billion. We expect menu price inflation of 1.0%, which we base in part on reports from 2011 to $582 billion. We expect menu price inflation of 1.0%, which we base in part on reports from
numerous restaurant chains of their inability to raise prices, offset by our expectation for higher commodity numerous restaurant chains of their inability to raise prices, offset by our expectation for higher commodity
costs. costs.
In other words, there appears In other words, there appears to be little, if
to be little, if any, pricingany, pricing power at
power at restaurants followingrestaurants following 2009’s price increase of 2.2%. 2009’s price increase of 2.2%. In addition, we track the In addition, we track the consumer price index for consumer price index for “food away from home,” as “food away from home,” as
Table B01: Projected
Table B01: Projected
Foodservice Industry
Foodservice Industry
Sales
Sales
PROJECTED US FOODSERVICE INDUSTRY SALES PROJECTED US FOODSERVICE INDUSTRY SALES (In billions of dollars)
(In billions of dollars)
% CHANGE % CHANGE --20 200909- - F2F201010- 0-2 200009 9 FF2200110 0 FF2200111 1 FF2200110 0 FF22001111 Commercial foodservice, total
Commercial foodservice, total 517.3517.3 520.4520.4 531.8531.8 0.60.6 2.22.2 Commercial eating & drinking places
Commercial eating & drinking places 11 399.0399.0 399.6399.6 408.6408.6 0.20.2 2.22.2 F
We expect traffic to be up 0.5%–1.0% in 2011, which reflects company commentary in second-half 2010 and early 2011 on traffic, as well as our overall economic view that employment gains will be relatively modest through the rest of the year. We still expect diners to watch their consumption of appetizers,
desserts, and higher-priced beverages; we think this should result in a 1.0% negative mix as part of the sales equation in 2011.
The end of federal stimulus clouds industry outlook for 2011
It is quite probable that the economic recovery since the third quarter of 2009 has been due largely to a boost to consumers and businesses from the American Recovery and Reinvestment Act of 2009 (ARRA), otherwise known as Stimulus II. In late February 2009, Congress passed the ARRA with a total size of $787 billion, of which about two-thirds was scheduled to be spent within 24 months.
It is likely that the ARRA’s effect on consumer spending has been somewhat larger than that of Stimulus I in 2008. Stimulus I had consisted of more than $100 billion in tax rebate checks for most Americans, which were sent out mostly in the second quarter of 2008. We think the positive (if temporary) effect that stimulus checks had on restaurant sales was seen in the US Census Bureau’s tally of monthly retail sales at food and drinking establishments. Restaurant sales growth held up generally well in 2008 until November, when sales growth slowed dramatically to 0.5% from a year earlier, and December, when sales were flat. This notable slowdown corresponded closely with the commencement of the sharp rise in joblessness, in our view.
Sales generally trended lower in the first half of 2009 as unemployment rose further, until the effects of ARRA began to be felt in the second quarter. Because ARRA’s stimulus worked through a reduction in monthly payroll taxes, rather than a one-time rebate check, its effects have likely been more diffuse as well. One can argue that the hundreds of billions in tax cuts, state aid, and infrastructure spending did have a positive material effect on employment in 2009, albeit by making the unemployment rate “less worse” than it otherwise would have been. On the other hand, one can make a case that most businesses still have substantial excess capacity and will more likely than not keep staffing at current levels, or seek to augment permanent staffing with temporary workers only where needed.
Additionally, states and localities that received aid did not actually increase payrolls and spending as much as envisioned. After using the aid to plug existing gaps in budgets, many states and municipalities are facing new holes in their fiscal plans, and are likely to enact more budget cuts for fiscal 2011. Cuts in government payrolls and the tax increases needed to balance state and local budgets could significantly offset the
necessary. Although readings of the S&P/Case-Shiller Home Price Index improved throughout most of 2009 and 2010, the pace of improvements has slowed decidedly since May 2010, and even turned negative in October and November. Indeed, in November 2010 (latest available data), the 20-city index was still 28.6% below its peak in the spring of 2006, according to Standard & Poor’s. One theory for the modest weakening in prices blames the expiration (on April 30, 2010) of the $8,000 first-time homebuyers’ tax credit, which had been expanded to most homebuyers.
However, not all “savings” are created equal. Because of the way that savings are counted, a reduction in debt is equivalent in most cases to “savings.” Thus, when debt is either paid back or forgiven, there is no true money set aside. This statistical phenomenon has led to something of a paradox in 2010: as consumers simultaneously both increased spending and reduced their debt outstanding by a record amount, the savings rate bounced around roughly between 5% and 6%.
How can a record reduction in debt occur even as consumer spending is rising? What this most likely means is that in the aggregate, consumers are once again spending freely (although they won’t admit it), even as record amounts of debt are being written off under government-sponsored mortgage debt restructuring programs, as well as by private lenders. Anecdotally, stories abound of those who have kept their credit lines current in order to maintain their lifestyle, even as they have voluntarily defaulted on their mortgages.
Travel influences restaurant spending
Another factor that has a pronounced effect on the restaurant industry, but does not receive as much attention as we think it should, is the current state of the travel industry. Travel has a significant impact on dollars spent on food consumed in restaurants. Smith Travel Research, an industry data source, predicts that the hotel occupancy rate had increased 5.3% in 2010, compared to a 9% decline in 2009. For 2011, the firm forecasts a further 1.6% increase in occupancy rates.
How important is hotel travel to restaurant sales? According to the National Restaurant Association’s 2007/2008 Operations Review, travelers and visitors in 2007 (latest available) accounted for a median of 15% of sales at quick-service restaurants, 20% at casual dining establishments, and 40% at fine dining restaurants. We believe the decline in travel-related restaurant meals over the last few years has been significant, due to less discretionary income available to consumers and business cutbacks on travel.
CIVETS: the next BRICs?
While the BRIC countries remain a key focus for many operators, especially those that were not part of the initial wave to invest in these nations, many restaurant companies are now pursuing efforts elsewhere. While we have seen a notable uptick in all geographic areas, specific targets now include a group of countries known as CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa) and the Middle East.
US-based restaurant companies seem drawn to the CIVETS countries for a number of the same reasons that previously brought them into the BRIC nations. First, and probably most important, economic prospects in these countries have been rapidly improving, with further growth and diversification likely to continue. Coupled with this growth is usually a motivated and sizable youth population that has growing disposable income and a desire to adopt the cuisine and other aspects of middle-class life. Finally, the CIVETS nations generally offer relative (or at least improving) political stability and capable financial systems that usually encourage foreign investments.
Colombia.Although its protracted battle against guerrillas demonstrates some of the risks associated
with moving into less-developed regions, Colombia’s improving political stability and 16% annualized GDP growth over the past six years also show the appeal of such opportunities. One drawback is its relatively low population growth. According to an October 2010 article in Nation’s Restaurant News, Colombia has about 53,000 restaurants.
Indonesia.Though demand for fast food is growing rapidly in Indonesia, the biggest challenge for US restaurants is to adapt their menus (and the related supply chains) to a predominately Muslim culture.
Vietnam.According to the above-mentioned NRN article, Vietnam has about 530,000 foodservice establishments, of which about 430,000 are street stalls. With coffee companies holding the number one and two chain spots, the country seems ripe for opportunity. Yum Brand’s KFC, which has been in the country for a decade, has nearly 100 units in Vietnam.
Egypt. In addition to quick-service prospects, Egypt also has shown high demand for casual dining establishments. Indeed, Chili’s Grill & Bar (a division of Brinker International Inc.) and T.G.I. Friday’s (owned by Carlson Companies) have long been players in the Egyptian market, especially in Cairo. However, January’s political upheaval in Egypt, including widespread and violent rioting, points out the potential risks of operating in less-stable countries.
The federal minimum wage underwent a three-step increase from 2007 to 2009 totaling $2.10 per hour, bringing the federal minimum wage to $7.25 an hour on July 24, 2009. Nevertheless, labor costs remained subdued in 2009 and 2010 due to the large available labor pool amid record unemployment for unskilled, mostly young workers. Since most restaurant chains compete with many other employers for the same
employees, the increases in the minimum wage have likely put upward pressure on wages even for employees making more than the minimum. Granted, the rise in unemployment greatly mitigated this pressure, but we believe labor costs are generally higher than they otherwise would have been.
We note that the increase in the minimum wage has affected some chains more than others. Some larger national chains, such as McDonald’s, already pay wages in excess of the mandated minimums to most of their employees. In addition, because numerous states already had a minimum wage that exceeded the new federal minimum, the impact of the increase was likely limited to those chains operating in states where the federal rate prevails. Chains like Texas Roadhouse Inc. that operate in regions where the average hourly wage is somewhat lower than the national average are likely to see labor costs rise more in line with the increase in the federal minimum wage.
Although the overall unemployment rate fell to 9.0% in January 2011, teenage joblessness remains
stubbornly high. Moreover, the unemployment rate for teenagers25.7% in January, up from 25.4% the previous monthcould remain at sharply elevated levels if the restaurant industry and other employers of large numbers of unskilled or inexperienced workers remain cautious in hiring. This caution is reflected in the change in hourly wages in the leisure and hospitality industry: from September 2009 to September 2010, wages rose 1.5%, according to the Bureau of Labor Statistics.
Food commodity cost outlook remains elevated
Most restaurants enacted only modest price increases in 2010 in an effort to preserve sales, regardless of the likely negative effect this might have had on profit margins. Unfortunately for most operators, the cost of most protein foods (i.e., meats, eggs, fish, and dairy) rose sharply during 2010, even as top-line growth returned for many companies. Because many publicly owned restaurant companies negotiate most of their
commodity purchases well in advance, however, the inflation in commodity costs may not have been entirely felt in 2010. The National Restaurant Association estimates
170 180
BEEF, PORK AND POULTRY PRICES (Index, 1982=100)
such as protectionist movements in various countries, or unpredictable weather conditions such drought or excessive precipitationcould alter global supply and demand balances.
Following are current outlooks for various commodities from the USDA. Keep in mind that many restaurants, particularly large restaurant chains, purchase commodities on a forward basis or enter into hedges, so the prices they pay may differ from spot prices. In general, when spot prices are rising, prices actually paid may be lower than spot prices; conversely, when spot prices are falling, prices actually paid may be higher.
Wheat. After reducing acreage for 2010 plantings in response to stabilization of wheat prices in 2009,
which in turn followed record highs in 2008, US wheat production for 2011 is expected to benefit from more ideal weather. Fortunately for US farmers, export demand has been stronger than expected due to lower yields in several key producing countries. Ending stocks are projected to be higher than earlier forecast as well. For the 2010/11 marketing year, farm prices are projected at $5.30–$5.70 per bushel, reflecting an increase from the previous estimate.
Corn.In recent years, farmers increased corn acreage: the use of corn to make ethanol for fuel raised
demand and put upward pressure on prices. Due to the increase in acreage, stabilization in the amount of corn used to produce fuel, and a record crop of 13.2 billion bushels, corn prices have moderated and the outlook is more stable. In 2010, greater demand for fuel production offset lower exports. Farm prices in the current year are forecast at $4.90–$5.70 a bushel, compared with the 2009/10 average of about $4.75.
Rice.Of much greater importance in many other countries than in the US, global rice production improved in 2009 due to better weather in several of the primary producing countries. A poor harvest in 2008 did not keep pace with consumption in many places around the world, which led to export restrictions in several countries and other artificial market controls. The sharp increase in rice prices spurred US farmers to plant substantially more acreage (primarily of long-grain rice) in recent years. This resulted in record US rice production in 2010. Used perhaps more extensively by restaurants serving Mexican or Asian cuisine than at other restaurants, rice was expected to cost somewhat less in 2010/11 for both long-grain and short-grain product, and the record production forecast is further pressuring prices. The USDA projects the
average farm price to fall to $10.50–$11.50 per hundredweight (cwt) for long-grain, from about $9.50 in 2009/10, and to $17.00–$18.00 per cwt for short-grain, from $17.50.
price of milk rebounded by about 24% in 2010 and will likely rise moderately in 2011. Cheese prices increased 15% in 2010, and are expected to climb a further 5%–10% in 2011. Prices for butter, nonfat dry milk, and dry whey (key ingredients in processed foods) also rebounded in 2010, and are on pace to increase again in 2011. A composite index of prices for various milk and milk byproducts, which are heavily used by restaurants and in processed foods, rose about 24% in 2010 to $15.92, from $12.84 in 2009. The level of this price index was $18.34 in 2008.
INDUSTRY CONSOLIDATION CONTINUES
In 2011, given our forecast of only modest sales growth for the industry and with cost pressures likely to intensify, we would expect more operators to fail. Indeed, industry research firm NPD Group Inc.
announced in January 2011 that their US restaurant unit count had declined by 1% (a loss of 5,551 restaurants) in fall 2010 compared with fall 2009.
With more than 925,000 food service locations in operationabout one for every 330 people in the US one can make a case that there are too many restaurants. The National Restaurant Association estimated that the number of restaurant locations held steady during 2009, signifying that the number of locations opening offset closures. We had thought that a material consolidation would take place in 2009, but it is likely that very low interest rates, landlords’ willingness to renegotiate lower rents (rather than lose a valuable tenant), as well as the sharp drop in commodity prices, helped save more than a few operators. The list of operators that closed locations grew substantially through early 2009, but closings took at least a temporary hiatus that summer, propelled by cheap financing made possible by the Federal Reserve. In 2010, due to the Federal Reserve’s near-zero interest rate policy, several publicly traded restaurant companies, such as O’Charley’s Inc. and Ruth’s Hospitality Group Inc., were able to obtain new financing. As in those instances, the terms of new financings often carry reduced maximum borrowings and much higher interest rates, but less onerous operating covenants. We would characterize some of these deals as last-ditch efforts to buy some time for fundamentals to improve. Still, we believe time is quickly running out for companies to work out new “extend and pretend” financing with their creditors.
With so many kinds of restaurants with varying operating models, it is difficult to pinpoint how many restaurants the US can support, particularly during a severe economic downturn. With the recent recession turning out to be deeper and longer than the average post–World War II recession, one might consider a
restaurants. Over the course of 2010, we think this resulted in consumers becoming price sensitive to $8 as the starting price point for entrées, whereas previously we viewed $10 as the level where consumers felt comfortable. For family dining, bar and grill, and buffet-style steakhouse chains, we think the new entry point may be $6, or as low as $5.
The price promotion that received perhaps the most attention during 2009 (and was repeated in 2010) was Denny’s Super Bowl XLIII ad promoting a free Grand Slam at all 1,500 Denny’s restaurants for an eight-hour period on the Tuesday following the game. In all, about two million Grand Slams were served, which, along with the commercial, cost about $5 million, according to the company. We think that this promotion, while expensive, instantly re-acquainted consumers with Denny’s and its value proposition (after years in which the chain appeared to struggle to connect) and also boosted repeat business. Denny’s purchased three ad spots during the 2010 Super Bowl and repeated the free Grand Slam promotion, which ran on February 9 from 6 a.m. to 2 p.m.
Other restaurants that provide higher-priced fare are also jumping on the value bandwagon through a variety of means. Prix fixe meals for 30%–50% off what they would cost à la carte help lure traffic at fine dining establishments. From the corner location of your favorite bar and grill, to that little undiscovered jewel that serves all your favorites, new smaller portion appetizers, entrées, and desserts are being offered to retain customers. Limited-time offers, such as coupons, special or “happy” hours, and the more timely “recession busters” and derivatives thereof, are a more direct approach to generating traffic based on price. Some chains prefer to appeal to a more specific target audience with family prices, based on four people, or “two-for” offers for couples.
Nevertheless, value is relative. Full-service operators, particularly at the very high end, have adopted a practice that seeks to offset, at least partly, the negative effect on profit margins of promotional activities used to attract the more price-conscious diner: sharply raising appetizer, side dish, and dessert prices, while keeping entrée and drink prices steady. For customers who aren’t as price sensitive, or simply don’t pay attention, these increases boosted their average check but avoided the “sticker shock” of large jumps in entrée prices. Other strategies for preserving business that were adopted during the recession are likely to be maintained, such as more emphasis on take-out and catering. Many operators have also reduced staffing, and may attempt to keep staffing low even as business turns up. This tactic is very risky, in our view, since it would probably hurt the service component of the full-service restaurant’s value proposition.
Nontraditional day parts account for the rest of the increase in traffic. Chains such as Taco Bell and others have strong late-night business, promoting menu items that are easily transportable. McDonald’s, which has dominated breakfast, is fighting back against these upstarts. In 2010, McDonald’s upped the ante by adding a $1 breakfast value menu to its tiered breakfast menu (which has both value and premium items, just as its sandwich menu has). The company has added premium coffee drinks in its US restaurants and has started rolling out other specialty beverages, with a separate counter and additional staffing, in order to challenge beverage specialists such as Starbucks and Dunkin’ Donuts. As part of its commitment to offer healthier products, McDonald’s began selling fruit and maple oatmeal in January 2011.
Value menus squeeze margins
These recent efforts notwithstanding, we believe rising costs and weak pricing power remain a key issue for the fast-food sector. Though food costs were relatively stable in 2008 and 2009, they climbed substantially in 2010 and may continue to do so in 2011.
With value menus now pervasive at most quick service and some lower-scale, full-service chains, we believe that competitive pressure on menu pricing is intense. We do not see pricing power reemerging any time soon. Customers have become accustomed to value-priced menu options. In addition to the lack of ability to raise prices, attempts to cut costs have been controversial. We cite an instance when, in response to record cheese prices in late 2008, McDonald’s removed one slice of cheese from the double cheeseburger on its value menu. In response, Burger King heavily promoted its $1 double cheeseburger with two slices of cheesein ads that directly compared it with McDonald’s double cheeseburger with one slice. However, this addition to Burger King’s BK Value Menu caused some franchisees to sue to block the company from forcing them to sell this item for $1; Burger King eventually relented and raised the price to $1.19. The franchisees contended that their franchise agreements do not give the company any control over pricing. As the low end of the full-service segment is downsizing menu items to compete directly with quick-service premium offerings in the $3–$5 price range, fast food operators are beginning to fight back. Burger King has opened Whopper Bars in select locations, such as airport waiting areas, where customers can custom-build their own burgers. A selection of beers is available at some Whopper Bars, with a burger and beer combo selling for about $8, which is very price competitive with neighborhood bar and grill menu offerings. INDUSTRY’S EFFORTS ON REGULATORY, LEGISLATIVE MATTERS
after an outbreak has already occurred. This bill comes after several prominent outbreaks over the past few years, involving salmonella in eggs and peanuts, and E. coli in spinach and other leafy greens. Better food safety would be a boon for the restaurant industry due to higher quality and safer ingredients. Further, better food safety would hopefully prevent future outbreaks, which are likely very expensive to remedy. That said, we note that some portions of the new law do not take effect for nearly 18 months.
Finally, immigration reform remains an issue that neither party in Congress, nor the administration, appears willing to consider. The National Restaurant Association supports immigration reform, to the extent it neither impinges on business’ ability to hire workers at will, nor increases the costs to verify that workers are eligible. These efforts would essentially shift most responsibility for worker verification from employers to border security and a “workable” employment verification system. In our view, the track record of border security in the US is questionable at best. An employment verification system, as we believe the industry trade group has proposed, would do little to thwart hiring of illegal workers. One could argue that any kind of employment verification system would possibly entail increasing penalties for businesses that fail to verify and that knowingly and repeatedly hire illegal workers.
One area where the restaurant industry is not bucking the trend in regulatory matters is on the environment. Most likely this is because the case is fairly strong that doing so often leads to lower costs. Some areas in which “going green” has caught on within the industry are sustainable building practices, switching to renewable energy sources, upgrading facilities with more efficient appliances and lighting, adoption of local sourcing of foods, and sustainable procurement practices.
INDUSTRY PROFILE
Satisfying the consumer’s appetite
The US foodservice industry comprises a large and varied range of away-from-home eating facilities: everything from commercial eating and drinking places (restaurants, bars, cafeterias, and so forth) to food contractors and institutional providers. The National Restaurant Association, an industry trade group, estimates that overall US foodservice industry sales were $580 billion in 2010, up 2.5% from $565.7 billion in 2009. Given modest economic growth, Standard & Poor’s forecasts that revenues will rise a similar 2%– 3% in 2011.
This Survey focuses on the restaurant sector of the foodservice industry. For additional details and industry breakdowns, see the “Projected US foodservice industry sales” table in the “Current Environment” section. INDUSTRY SEGMENTS
The publicly traded companies that dominate the restaurant industry are varied. They range from fast-food operators, such as McDonald’s Corp., Burger King Holdings Inc., and Wendy’s/Arby’s Group Inc. (formed by the September 2008 acquisition of Wendy’s International Inc. by Triarc Companies Inc.), to companies that run full-service chains, such as Darden Restaurants Inc. (operator of the Red Lobster, Olive Garden, and LongHorn Steakhouse restaurants), Brinker International Inc. (operator of Chili’s Grill & Bar and Maggiano's Little Italy), and DineEquity Inc. (operator of IHOP and Applebee’s). There are also a few public companies in the fine dining sub-segment of the full-service part of the industry. More often, such
restaurants are traditionally run by
individuals, families, or limited partnerships. They are typically located in cities or resort areas, and cater to business people, the affluent, and those who aspire to affluence.
Fast food
Quick counter service, meals to eat in or take
RESTAURANT MARKET SHARES2009
Convenience store 1.2% Bakery café 1.2% Snack 2.7% Hotel Buffet 0.8% Other 2.1%
and healthy alternative to sandwiches. Tacos and burritos are also included in the sandwich category, and a number of chains have taken advantage of the tortilla’s portability to offer a variety of wraps.
Nontraditional service hours, including the breakfast, snack, and overnight parts of the day, have been a major source of growth for sandwich chains in recent years. New menu items, such as dessert-like coffee drinks and fruit smoothies, are seen as a future source of growth, as well.
Several large competitors, with chains that are generally recognizable throughout the nation, dominate the sandwich chain category. With $30.0 billion in US sales in 2009, McDonald’s is the largest fast-food chain by a wide margin. However, the concept faces strong competition from Subway (operated by privately held
Doctor’s Associates Inc.; $10.0 billion), Burger King (about $9.0 billion), Wendy’s (approximately $7.9 billion), and Taco Bell, a division of Yum! Brands Inc. ($6.8 billion).
In 2009, annual sales at sandwich chains in NRN’s Top 100 averaged $1.09 million per unit, according to data from company reports and industry publication Nation’s Restaurant News (NRN).
Company results varied widely. Among publicly held companies, McDonald’s was the leader, with an average of about $2.22 million in annual per-unit sales. However, a privately held company that made the list for the first time in 2008 topped the home of the Big Mac for the second straight year. Jason’s Deli, which has about 215 locations in 28 states, topped all sandwich chains with $2.25 million per location, while the predominantly
California chain In-N-Out Burger was third with $2.19 million per unit. These
Table B02: largest
restaurant chains
LARGEST US RESTAURANT CHAINS
(Ranked by 2009 US systemwide foodservice sales)
--- US SALES (MIL.$) --- - US UNITS ---CHAIN 2008 2009 % CHG. 2008 2009 % CHG. McDonald's 29,988 31,033 3.5 13,918 13,980 0.4 Subway 9,638 9,999 3.8 21,881 23,034 5.3 Burger King 9,152 8,882 (3.0) 7,233 7,263 0.4 Wendy's 8,009 7,919 (1.1) 5,905 5,877 (0.5) Starbucks 7,755 7,415 (4.4) 10,992 10,553 (4.0) Taco Bell 6,700 6,800 1.5 5,588 5,604 0.3 Dunkin' Donuts 4,955 5,110 3.1 6,395 6,566 2.7 Pizza Hut 5,500 5,000 (9.1) 7,564 7,566 0.0 KFC 5,200 4,900 (5.8) 5,253 5,162 (1.7) Applebee's 4,487 4,373 (2.5) 1,875 1,868 (0.4) Chili's Grill & Bar 3,961 4,000 1.0 1,292 1,297 0.4 Sonic Drive-In 3,811 3,837 0.7 3,475 3,544 2.0 Olive Garden 3,271 3,365 2.9 685 717 4.7 Chick-fil-A 2,962 3,217 8.6 1,423 1,480 4.0 Domino's Pizza 3,057 3,097 1.3 5,047 4,927 (2.4) Jack-in-the Box 3,048 3,072 0.8 2,158 2,212 2.5 Arby's 3,254 2,983 (8.3) 3,633 3,596 (1.0) Dairy Queen 2,600 2,640 1.5 4,584 4,540 (1.0) Panera Bread 2,447 2,579 5.4 1,197 1,251 4.5 IHOP Restaurants 2,419 2,511 3.8 1,380 1,433 3.8
Two newcomers that joined the Top 100 list of pizza purveyors in 2008 saw mixed results in 2009. Papa Murphy’s Take ‘N’ Bake Pizza saw sales rise 8% to $626 million in 2009, by offering pizza (with the customer’s choice of toppings) that is then taken home and
cooked. The mostly franchised chain has nearly 1,175 locations in 32 states and Canada. Not faring as well was CiCi’s Pizza ($564 million), which saw sales dip 3%. CiCi’s takes the pizza concept in a completely opposite direction by offering an all-you-can-eat pizza, pasta, salad, and dessert buffet for about $5, as long as you like the selections that CiCi’s offers.
The pizza segment continued to struggle in 2009 to find the right balance of promotions and pricing to keep both customers and profits. Top-ranked Pizza Hut was the
biggest loser in the market share battle, as its US systemwide sales fell 9% in 2009.
Chicken.KFC Corp. (a division of Yum Brands) is the leader in this category, with US systemwide sales totaling an estimated $4.90 billion in 2009. KFC stumbled again in 2009 as sales fell for the second year in a row, while the next largest competitor, Chick-fil-A Inc. ($3.22 billion) saw sales rise 9%. Revenue growth at Chick-fil-A has increased more quickly than at its competitors over the past several years, fueled by aggressive expansion and high customer satisfaction scores, especially for speed of service. The latter is a category in which the company maintains the highest scores in the fast-food industry. Other competitors include Popeye’s Chicken & Biscuits (operated by AFC Enterprises Inc.; $1.49 billion) and Church’s Chicken (operated by Cajun Operating Co.; $858 million).
Table B03: FASTEST-GROWING US RESTAURANT CHAINS
FASTEST-GROWING US RESTAURANT CHAINS (Ranked by percentage increase in foodservice revenues)
% CHANGE IN REVENUES ---FISCAL PREV. CURRENT YEAR END YEAR YEAR
Five Guys Burgers and Fries Dec-09 74.3 69.0 Buffalo Wild Wings Grill & Bar Dec-09 20.9 20.4 Chipotle Mexican Grill Dec-09 22.3 14.0
Chick-fil-A Dec-09 12.2 8.6
Zaxby's Dec-09 18.0 8.2
Bojangles' Famous Chicken 'n Biscuits Dec-09 8.2 8.1 Papa Murphy's Take 'N Bake Pizza Dec-09 16.1 7.8 Panera Bread Dec-09 16.3 5.4
7-Eleven Dec-09 3.4 4.5
Steak n Shake Sep-09 (4.9) 4.0 IHOP Restaurants Dec-09 4.4 3.8
Subway Dec-09 17.2 3.8
Panda Express Dec-09 15.5 3.7
McDonald's Dec-09 4.9 3.5
Dunkin' Donuts Dec-09 3.8 3.1 In-N-Out Burger Dec-09 5.3 3.0
Wawa Dec-09 2.6 3.0
Olive Garden May-10 7.3 2.9 Texas Roadhouse Dec-09 9.5 2.6 Golden Corral Dec-09 (0.7) 2.5 Source:Nation's Restaurant News.
Family restaurants. A family restaurant aims to appeal to customers of all ages by offering a relaxed
atmosphere, low prices, and menus geared to both children’s and adults’ palates. These restaurants are sometimes referred to as “midscale.” Category leader International House of Pancakes/IHOP, operated by DineEquity Inc. (systemwide sales of $2.51 billion in 2009), grew despite the tough economy in 2009, while second-place Denny’s (a division of Denny’s Corp.; systemwide sales of $2.16 billion) saw its sales decline. Cracker Barrel Old Country Store (a division of CBRL Group Inc.; $1.88 billion) was in third place with nearly flat sales growth in its latest fiscal year.
On a sales per unit basis, Cracker Barrel led this segment, averaging an estimated $3.22 million per unit in the fiscal year ended July 2009. This was well ahead of IHOP ($1.76 million per unit), Bob Evans restaurants (operated by Bob Evans Farms Inc.; $1.73 million per unit), Perkins Restaurant and Bakery (a division of Perkins & Marie Callender’s Inc.; $1.60 million per unit), and Steak ’n Shake ($1.48 million per unit).
Coffee/Snack.These chains have grown up specializing in one or just a few particular food or beverage items, although menu expansion has almost always been tried as a way to spur growth. Starbucks Corp. is perhaps the best example of a restaurant chain thriving in the specialty area of the industry. With about 10,500 locations in the United States, sales in the US were approximately $7.56 billion in its fiscal year ended September 2010. While Starbucks does sell food, the company specializes in coffee products. Other examples of chains specialized by product include Dunkin’ Donuts ($5.11 billion) and Baskin-Robbins ($578 million), both owned by Dunkin’ Brands Inc., and Krispy Kreme Doughnuts Inc. ($464 million).
Other
Within the restaurant industry, there are chains that do not easily fit into specific categories, due to the kind of product they sell or the way in which they serve the product. Examples include bars and taverns, caterers, and snack and beverage bars. These loose categories accounted for sales of approximately $57.0 billion in 2009, or about 10.0% of total US foodservice sales.
INDUSTRY TRENDS
The restaurant industry is highly competitive. This has forced operators to find ways to continue to boost market share, to find and retain employees, and to control costs, as they strive to maximize profits.
Pizza, voluntarily underwent leveraged recapitalizations. Many others were taken private in similarly leveraged transactions by private equity groups. Underlying these strategies was the premise that growth would reduce financial risk over time, and that higher debt would always result in a higher return on equity. Indeed, a wave of deals in 2010 demonstrates that private equity groups have developed a taste for the industry, though given the sector’s recent run-up in valuation, it remains to be seen whether this trend will continue. The largest of these deals was 3G Capital’s $4 billion takeover bid for Burger King, announced in September 2010 and completed in November 2010. Other firms that saw bids in 2010 include On the Border, Papa Murphy’s, and Rubio’s. Meanwhile, Wendy’s/Arby’s Group put the Arby’s sandwich chain on the auction block in January 2011, just days after Yum Brands announced it was seeking a buyer for Long John Silver’s and A&W All-American Food Restaurants. It remains to be seen if buyers emerge for these properties and, if so, what they are willing to pay.
Clearly, flat GDP growth in 2008 and a 2.6% decline in 2009 have demonstrated the risk in this premise. Most restaurant operators now take a longer-term view when considering changes in their capital structure. Most are increasing the cash that they hold, paying down debt taken on earlier to grow, or buying back stock. Now that trends seem to be stabilizing, many have resumed expansion plans, but the recent downturn has left its mark. Most capital projects now are focused on more modest efforts and utilize less aggressive funding methods. Indeed, cash flow is once again a key driver of near-term operations and prospects. COMPETING FOR CUSTOMERS
To improve or simply maintain market share in the competitive restaurant industry, companies employ strategies to improve consumer choice, convenience, and value. Techniques include adding cuisine types, discounting prices to attract customers, expanding takeout service, and using technology to improve customer satisfaction. Restaurants are also extending their menus to draw in both value-conscious and premium customers. More fast-food chains are offering breakfast options, and many are catering to a late-night clientele by extending operating hours.
Driven by demographic changes, many restaurants have begun to diversify their menus across various cuisine types. For instance, with the Hispanic and Asian-American segments growing at a faster pace than the overall US population, many restaurants are developing new products to target these groups’ tastes, often attracting other customers in the process.
Qdoba chains, respectively, while Chipotle Mexican Grill has developed the niche for Mexican food made with locally grown fresh and organic ingredients.
Besides menu development, each of these companies has increased its sophistication with respect to
marketing, hiring, and recruiting franchisees with advanced knowledge of the broad and diverse Hispanic community. McDonald’s is the fifth highest ranked spender on Hispanic media spending. Wendy’s is
actively pursuing Hispanic customers in its marketing program through media sources that are popular with this group. Jack in the Box offers classes in English as a second language to attract Hispanic employees.
Brands come and go
The industry downturn has resulted in a substantial retrenchment in the trend of restaurant companies developing multiple brands. Popular in the 1990s and earlier in this decade, multiple concepts were favored for two main reasons. First, adding new concepts can boost long-term growth in sales and earnings: because customer tastes are fickle, companies must come up with new ideas to stimulate demand. Second, the
strategy gives a company the advantages of diversification, as success in some of its concepts can provide a buffer against poor performance in others.
In several notable instances, however, these multi-brand strategies were not successful enough or failed to satisfy impatient investors. For example, McDonald’s divested Chipotle Mexican Grill and Boston Market, and Wendy’s divested Tim Horton’s and Baja Fresh. Perhaps, in some cases, the problem resulted from a clash of cultures between a relatively large and conservative parent brand and a quick-on-its-feet upstart brand that was more interested in top-line growth than short-term profits.
Other companies have been adding and shedding concepts at the same time. Darden Restaurants Inc. decided to sell Smokey Bones Barbeque & Grill at approximately the same time that it acquired RARE Hospitality International Inc., operator of Longhorn Steakhouse. Some fast-food purveyors have been more successful with their multi-concept strategies. Jack in the Box Inc.’s Qdoba has more than quadrupled the number of restaurants in operation since Jack in the Box acquired it in 2003.
Yum Brands has taken the multi-concept idea a step further, seeking to “multi-brand” individual restaurants by incorporating more than one concept under a single roof. The company believes that by combining two or more of its major concepts (Taco Bell, KFC, Pizza Hut, Long John Silver’s, and A&W), it will draw customers to its locations by creating more choice. It also expects to leverage additional sales
spurred full-service chains to invest significant sums to improve pick-up access and packaging, and on menu development. According to Technomic, takeout food has been growing about twice as fast as the overall restaurant industry. A leader in this category was Outback Steakhouse, which has aggressively sought takeout customers by retrofitting its units to serve them. Applebee’s has significantly improved takeout packaging and rolled out curbside delivery service at its restaurants. It also has begun to test technology that would enable it to use handheld remote devices to accept credit cards for payment.
The buffet restaurant segment is also increasingly emphasizing takeout. Golden Corral Corp. has rolled out “Golden to Go” takeout stations and reserved parking for takeout buyers at many of it locations, charging customers by the pound. Luby’s Inc., where takeout accounts for about 15% of systemwide sales, has adopted a new cafeteria prototype with curbside-to-go service. Buffets Holdings Inc., which owns the Ryan’s Grill & Buffet Bakery chain and others, is looking for ways to introduce takeout to its all-you-can-eat buffet formats. The challenge for many of these chains is not to undermine the existing concept by cannibalizing sales or disrupting the normal operating flow of the restaurant.
Although an increasing number of restaurants are seeking ways to win in the growing and lucrative carryout market, success in this sector is not guaranteed, and pitfalls are manifold. Competition is everywherefrom local food stands to casual restaurants to supermarkets that offer takeout and delivery.
In serving the takeout market, supermarkets have some advantages: a successful formula that they have used for years, and experience in managing food spoilage and wastage to avoid hurting profitability. In contrast, restaurants are relatively inexperienced in this business segment and are bound to have difficulty in gauging demand, average order size, and quantity of food to order and prepare. They also have the disadvantages of higher cost structures and labor costs that comprise a higher percentage of sales. The higher labor costs and food wastage can erode their profitability in the takeout sector.
Standard & Poor’s anticipates that, over time, full-service casual dining and fast-growing quick-casual chains will gain a larger share of this market. However, we think they will remain second to limited-service chains, where takeout has always been a significant part of the business. Supermarkets will likely remain major players in takeout food and a potent threat to restaurants, given their numerous regular customers and convenient locations.
the effects of currency translations) during the year. Numbers such as these have attracted other chains such as Dunkin’ Donuts, and have led to a native Chinese fast food industry that is just in its infancy. (For further discussion of global expansion by restaurants, see the “Current Environment” section of this Survey.) INDUSTRY FOCUSES ON HEALTH
In recent years, the fast-food industry has been hit with lawsuits alleging that specific corporations are responsible for obesity-related health problems faced by consumersparticularly children. Plaintiffs have sought remedies such as menu changes, nutritional labeling, advertising restrictions, and monetary damages. Lawsuits have also centered on better disclosure of menu contents, as evident by a recent suit against Yum Brand’s Taco Bell that claims the chain’s beef actually only contains 36% beef.
These lawsuits reflect an American culture that has become significantly more health-conscious and litigious over the last several decades. This is a result of rising obesity rates, skyrocketing healthcare costs, and growing concerns about the impact of obesity on overall health. Customers who might have paid lip service to healthy diets in the past are now beginning to practice what they preach.
An important driver in the new health-conscious trend has likely been various diet crazes. Though the popularity of low-carbohydrate diets, such as the Atkins Diet and the less intense South Beach Diet, seems to have ebbed, whole-health diets and back-to-basics eating seem to have taken their place. An increasing awareness of foods’ glycemic index, or the effects of carbohydrates on blood sugar levels, also seems to be on the rise.
In response to strong customer demand, and perhaps to help insulate themselves from potential liabilities, many restaurant chains have made significant changes to their menu offerings. In the casual dining industry, for instance, Brinker International announced a new menu at its Chili’s unit that includes significant low-fat and low-carbohydrate options. Ruby Tuesday Inc. dedicates a section of its menu to “Smart Eating” foods. Some restaurant companies have sought to distinguish themselves by combining with brands associated with the new trends. For instance, Applebee’s now dedicates a segment of its menu to items that were developed with and approved by Weight Watchers International Inc.
The fast-food industry has seen even more dramatic changes, perhaps because it has the most to lose from consumer perceptions about the healthfulness of its food offerings and from potential lawsuits. For instance,
Establishments that receive grades lower than ‘A’ will be visited by health department officials more
frequently. New York is not the only city with such a system, as Los Angeles has been using a similar system for over 12 years. Other cities now include Dallas, Louisville, and San Diego, as well as states like North Carolina, South Carolina, and Mississippi. Standard & Poor’s expects the health grade trend to continue expanding to new cities, as restaurant goers continue to raise their disclosure expectations.
Fast-food chains recently dealt with new laws in various states and cities across the United States t o ban trans fats from the food they serve. Despite legal challenges and other efforts by individual restaurants as well as chains and industry groups, these laws have largely been upheld by the courts. Although not the first such law, a new law went into effect in July 2008 in New York City (which had been passed by the city’s Board of Health in December 2006). It requires restaurants in the city to remove trans fats from the ingredients of the items on their menus. Since then, numerous municipalities have followed New York’s lead.
Chains such as Burger King and Wendy’s are using new kinds of trans-free cooking oils or have already reduced the amount of trans fat in the oils they use for frying and cooking. McDonald’s has switched to zero trans fat for its French fry cooking oil as well as the fats used as ingredients and to cook nearly all other items on its menu. According to the company’s nutrition website, remaining items, such as fried pies and baked cookies, were switched to zero trans fat by the end of 2008.
Other recent governmental efforts are aimed at helping consumers to be better informed about their dining decisions. Various states and municipalities have begun requiring chain restaurants to post calorie and fat information for items on their menu. A 2008 Los Angeles City Council moratorium on new fast-food restaurants was subsequently extended. The moratorium covered a portion of the city where it was deemed that a lack of alternatives to fast-food establishments was resulting in rising obesity.
High-profile salmonella and E. coli outbreaks in the recent past increased calls from Congress in 2007 and 2008 to increase funding for, and to make changes in, FDA food safety activities. On January 4, 2011, the Food and Drug Administration Food Safety Modernization Act was signed into law by President Obama. (For further discussion of the bill, please see the “Current Environment” section of this Survey.)
FOOD-AWAY-FROM-HOME TRENDS STABILIZE
The resumption of the long-term trend toward eating more meals away from home will likely depend on a resumption of personal income rising faster than price increases in the restaurant industry and for food in general. Higher growth in personal income from 1985 to 2005 meant that total food expenditures declined from 11.7% of disposable personal income to 9.9%, but subsequently rose to 12.4% in 2010. Food away from home rose to 43.5% of total food expenditures, from 41.3%, during this 20-year period.
Further boosting the dining-out trend is the decline in free time. Dual-earner households account for more than 50% of US families, according to the Bureau of Labor Statistics. In many families, both parents hold full-time jobs, which leaves less time to prepare meals at home. With the rise of dual-income and single-parent families, and with numerous moderately priced restaurants to choose from, dining out is often the most convenient choice. Any prolonged period of high unemployment, sufficient to reduce the expectation of having two incomes to support household spending, could cause a permanent trend change in food consumed away from home.
A key challenge for the restaurant industry as baby boomers start to retire will be to entice this generation of retirees to eat out more than prior retirees. A significant part of demand for food away from home is driven by being at work. In 2009, the National Restaurant Association reported that those 65 or older spend approximately half as much on food away from home as do those from age 45 to 54. It remains to be seen if future retireesmembers of the baby boom generation, who have lived their entire adult lives eating outwill continue to do so in their golden years.
HOW THE INDUSTRY OPERATES
Over the past 50 years, eating out had gradually become part of the way of life for many Americans. As a percentage of total food expenditures in the United States, meals eaten away from home as a percentage of total food expenditures have risen fairly steadily from just 26% in 1960, according to the US Department of Agriculture. According to the National Restaurant Association, a trade group, projected industry sales for 2010 were $580 billion, which would account for 3.9% of the projected US gross domestic product. With a projected 12.7 million employees in 2010, the industry is the nation’s largest private-sector employer.
Contributing heavily to this trend has been the rise of fast-food dining that began in the 1950s with industry trendsetters Jack in the Box Inc. and McDonald’s Corp. By offering drive-through service and
about $46.4 billion, and military foodservice was worth an estimated $2.1 billion. For 2010, institutional foodservice sales are expected to be $47.2 billion, while military sales are expected to come in at $2.2 billion. (Institutional and military foodservice are not covered by this Survey.)
In the commercial foodservice business, the largest segments are full-service and limited-service restaurants. Full-service restaurants usually feature moderate to high prices and sit-down service. Average check prices generally exceed $8. Meals are served with flatware and china, and alcoholic beverages are often available. Limited-service (also called fast-food or quick-service) restaurants typically offer rapid food preparation and low prices, with or without seating. Food packaging is often disposable, and the average check price is
almost always less than $7. Take-out orders account for a large portion of this business. In recent years, another concept, aptly named “quick casual,” has emerged to bridge the two categories. Quick-casual restaurants have a slightly higher average check price than fast-food concepts, generally $7 to $10, presumably in exchange for higher-quality food and fresher preparation.
LOW ENTRY BARRIERS, HIGH RISK/RETURN
Small operators run a substantial majority of all restaurants, according to the National Restaurant Association, which estimates that 91% of all operators have fewer than 50 employees. This includes the large number of small franchisees that operate single or a few locations of the major fast-food brands. The restaurant business’s low barriers to entry are partly responsible for its popularity among small-scale entrepreneurs. Some of these ventures succeed, but because of the industry’s intense competition and high fixed costs, many fail. For restaurants that do succeed, however, the payback on investment can be
considerable. Once sales reach the break-even point, a relatively high percentage of incremental revenues can become profit.
In recent years, casual dining chain concepts have taken market share from independent operators through geographical expansion. Fast-food chains have long used proliferation to their advantage: McDonald’s now has about 14,000 units in the United States and 32,700 worldwide. Now, however, multi-concept casual dining operators, such as DineEquity Inc. (formed through the 2007 acquisition of Applebee’s by IHOP) and Darden Restaurants Inc. (operator of the Red Lobster, Olive Garden, and Longhorn Steakhouse chains, among others), have come to dominate the mid-price segment.
Franchising is a widespread phenomenon around the world, but it is especially prevalent in the restaurant industry. According to a PricewaterhouseCoopers report for the International Franchise Association, an independent trade group, franchisees of restaurants in 2009 were expected to operate nearly 229,000 restaurant locations in the United States, up 1.4% from 2008, with a combined 4.4 million employees and $251 billion of economic output.
The percentage of franchised versus company-operated units varies widely among individual chains. For example, fast-food giants McDonald’s, and Yum Brands Inc. franchised 89% and 84% of their US units at year-end 2010, respectively, versus only 46% at Jack in the Box. Even among concepts owned by the same company, however, franchising strategies can vary. At Jack in the Box Inc.’s Qdoba chain, franchisees accounted for 69% of total units.
Why franchise?
Many restaurant chains opt to franchise their businesses to enjoy superior returns. Franchising eliminates the need to focus on the day-to-day concerns of operating units, while generating a steady stream of royalty fees. Furthermore, since franchise royalties are based on a percentage of sales, rather than profits, they can ensure a steady stream of revenue even in a difficult operating environment. In return, the franchisee enjoys the benefits of brand-name recognition and, often, training and marketing support from the parent
company. The franchisee also can participate in cooperative purchasing, enabling it to sell food at a lower price than an independent operator can.
While franchisors avoid some of the hazards of expansion, they face other risks. Licensing and franchising involve some loss of control of the business. With the day-to-day operating decisions made by franchisees, one poorly run franchised unit can reflect badly on the whole chain. Individual franchisees depend on the overall success of the entire chain to maintain their own standing.
Strong and vital franchisees are essential to the continued success of many restaurant chains, particularly in the fast-food segment. Companies that employ the franchise business model rely on maintaining successful franchisees and attracting new, entrepreneurial-minded franchisees to assure long-term success and safety. A company that tries to profit at the expense of its franchiseesfor example, by charging high prices for
suppliescan damage the trust needed to have a good working relationship between franchisor and franchisee.
Training takes a variety of forms. For employees who have development or supervisory responsibilities, extensive restaurant operations training courses are standard at most companies. CBRL Group Inc., which operates Cracker Barrel Old Country Stores, sends new managers through an 11-week training program, consisting of eight weeks of in-store training and three weeks at corporate headquarters. In addition, training is conducted for all restaurant employees. Brinker International Inc.’s training program includes a four- to f ive-month period for managers and supervisors. Training teams also instruct employees on opening a new restaurant, remaining on location for two to three weeks to ensure a smooth transition to operating personnel. Franchisers such as Applebee’s International Inc., McDonald’s, and Wendy’s operate extensive training programs in a classroom setting. These companies also give periodic training to their restaurant employees. McDonald’s dubs its school “Hamburger University.”
Often, a company may raise staffing levels in order to improve service and thus increase sales. In a
competitive environment, customer satisfaction levels can be an important determinant in improving sales volumes. If a company can use its increased manpower to speed service times, fast-food restaurants may serve more customers at the register over a period of time, while casual dining restaurants may increase the speed in which tables turn.
COST STRUCTURE
The costs of owning and operating a restaurant vary by format. Obviously, larger units cost more than smaller ones, as do upscale formats with a greater investment in interior design and higher spending on costly food items. To justify the expense, large units are typically located in areas with greater population density or that have a larger geographic draw. They generally see greater revenues than smaller units, though this is not always the case. In any event, if a unit’s volume does not reach the company’s revenue
projections, its profitability also will be below plan, and it is likely to be shut down.
Food and beverages, labor, and real estate constitute the
restaurant owner’s largest cost categories. (See “The restaurant
Table B04: restaurant Industry dollar
THE RESTAURANT INDUSTRY DOLLAR2009
(As percent of total)
LIMITED-$25 AND SERVICE UNDER $15 $15-$24.99 OVER RESTAURANTS
Cost of food and beverages 32.2 31.8 31.9 31.9 Wages & benefits 33 7 33 2 33 7 29 4
FULL-SERVICE RESTAURANTS AVERAGE CHECK PER PERSON
