John Gordon - October 2024

Restaurants: Details Emerge on Thorny Issues

by John Gordon, Principal and Founder, Pacific Management Consulting Group

Through mid-October, macro conditions facing the US restaurant industry have not changed materially. We are still facing a near worldwide “pricing shock” as to our prices. Many guests view things in a 2019 framework, unfortunately. We continue to face traffic challenges generally. Prices per BLS were up about 4% last month, exceeding grocery stores’ prices. The fast food price wars continued, but to little effect (see below). The few top momentum brands continue to outperform: Texas Roadhouse, Chipotle, Cava, Wingstop. Chili’s are now beginning to catch up. Most other brands are trying extremely hard to get momentum.

Industry Wide QSR Price War Result Becoming Clearer

On October 16, Restaurant Business Online authored a report titled, “The value wars don’t appear to be making a dent in restaurant traffic”. It led off with “The value wars are apparently being fought to a standstill, at least as far as the fast food customer is concerned.”  Further, …” there is little real evidence to suggest they’ve brought customers, back at least broadly.’’ Details were that QSR traffic fell consecutively minus 2.2%, minus 3.4% and minus 4% in August. September was minus 2.5%. Sales were up 1% in June, down .5% in July, down .7% in August and up .8% in September. Data per Black Box. Revenue Management Solutions showed a lightly lower decline in traffic. They do not report sales.

The value wars do not appear to be making a dent in restaurant traffic (restaurantbusinessonline.com)

So, we will get actual results and context from more publicly traded QSR companies coming up. With every survey, guests to differing degrees expressed issues with affordability. We as an industry did not communicate what has happened to the cost world since the Pandemic. Someone somehow should have identified this need and executed a fix. That is what expensive ad agencies are for.

It is not surprising that price appeals lead to poor results, counting hundreds of millions of dollars in misused ad funds. Almost every QSR brand jumped into discounting. Everyone did it! No one could stand out. Price wars do not work.

In my view, many brands also deluded themselves rationalizing that they were positively affecting value. But price is but one subset of value. Low prices only mean so much if the food, service, and environment are lackluster or poor. Restaurant Industry Online, for one, contributed to this problem by consistently miscasting price wars as value wars. With these poor Q2 results apparently coming, QSR brands would do well to rethink value holistically as the sum of different experience components. Remodeling has often been cited as the franchisor’s fix, but it must be more than that.

Starbucks Strategy Under Niccol Comes More into Focus.

Many things are happening at Starbucks. We have intel just this week into the Brian Nichols thoughts on strategy and tactics. “Score two meaningful big hits and then execute like crazy.”

Brian has been working for 30 days now and has taken advantage of underway from research at one of the big strategy management consulting houses.  The Niccol tactics as above are common sense. But Starbucks US and China must deal with the affordability problem. It shows up in every analyst report and other related consumer reports. They have dropped the array of discounting deals underway.

One solution to this is to research what the under 30 group really wants, a magic beverage hook, and perhaps put this on side platform for better visibility. Another is featuring a lower priced cluster—no more than 3 items-- of very few menu items. A new drip coffee flavor feature could be added. 

The other thing I am thinking about is the weakness of the overall economy in China. CNBC had a nice China consumer space piece this week, showing incomes and real estate values down. SBUX could remain company operated but cull the less profitable stores. And the rate of development in core Tier 1/2 cities, or perhaps nationwide, can be halted, based on P&L.

I have on the record that SBUX best stores are plus 25% store margin and the lower group trails down to 10%, or below. That is the same range as a US QSR franchisee brand. That range is too wide for a global brand powerhouse.

They could also sell China to a master franchisee if the math works. They can do the culling first and then only sell later if needed. 

Casual Dining and Franchising: The Numbers Matter

It is ridiculously hard to make money in a casual dining box with AUVs of $2.5 million or less. The variable margin (flow through) will be less than the industry hoped for 50% because of royalties paid. On such a small sales base, rent fluctuations above norm, as well as remodeling, maintenance CAPEX and debt service outflows pose free cash flow challenges.

The spate of Applebee’s franchisee bankruptcies is a reminder that such franchised brands have had difficulty. They pay a royalty of course and have both remodeling and new store development CAPEX requirements that can hit at the same time.

Multiple brand reviews I and others have conducted show that $2.5M AUVs or less will not work. Really, AUVs at or above $3M and store margins in the high teens are needed.

Some casual dining brands such as Brinker International and Texas Roadhouse have bought franchisee units back in defranchising moves. One fine dining brand made franchising work in the US. That was Ruth's Hospitality Group. Franchisees were left alone to develop in certain markets, and franchisor/franchisee relationships were good. Their AUVs were much higher, typically $5 million, and above.

The US is always the most competitive for many reasons. International Franchise/JV actions/Master Franchising can work internationally such as Outback Steakhouse Brasil, but in more select geographies. and with fewer units.

About the author: John A. Gordon has a 45-year background in the industry, with operations, corporate staff (financial planning and analysis) and consulting via his founded firm, Pacific Management Consulting Group. He specializes in operations, financial management and brand organization projects.  He can be reached at (858) 874-6626, and jgordon@pacificmanagementconsultinggroup.com