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John Gordon - April 2023



Restaurants: The Need to Look Under Every Rock

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

Moving now into the seasonally higher sales Quarter 1 period, all things considered, the restaurant industry has recovered well. Consider that three years ago we were at a dead stop; only a few drive-thru concepts had any traffic; we were in the process of laying off the vast majority of our workforce; and some brands were almost out of money. Now, the industry is mostly solid, with some spot softness in pizza and some recovering brands.  However, a legacy of problems from the Pandemic follows us today and leaves us with imperatives for action.

Clear Imperatives Looking Ahead: I’ve termed this as the need to “look under every rock” first, versus going to price first. This is not a foreign concept to some. Some examples follow:

Price/cost/consumer/food at home relationship:   We experienced restaurant margin dollar and percentage erosion from Q4 2021 on due to double food and labor rate inflation. This rate of cost increase is forecasted to moderate in 2H 2023. But our advantage versus grocery store inflation, solid since 2021, is quickly eroding. This means that we have to get more out of the P&L and CAPEX efficiencies quickly other than price.

Capital Inefficiencies are predominant now: With Interest costs up 500-600pts over the last year, construction and transportation labor costs up and shortage of raw materials for equipment have driven up costs of restaurant new builds and remodels. On its recent earnings call,  Darden noted restaurant construction costs, especially, FF&E, were up 25% vs. 2019.  That means that site and proforma planning must be spot on no one can be stuck with a bad site with high a high cost and a bad ROI.  This also has implications for franchisors trying to meet a pre-set development target with franchisees that may or may not have funds or financing.  Some leading franchisors have done work in developing alternative store prototypes and even dedicated, lower-cost backstopped loan pools.

More work in marketing messaging, testing, and product execution is needed: Unfortunately, there are many hidden costs with the marketing discipline, predominately that discounting is not a P&L line item and that marketing campaigns and strategies done badly are only broadly apparent over the long haul.  For example, a Tier 2 QSR operator spent vast sums from their marketing fund and franchisee OPEX gearing up for a heavily discounted chicken sandwich, that flopped for operational complexity and timing reasons. No one saw the immediate costs. These costs can be avoided, and it lowers P/L stress on both the franchisor and franchisee.

Rebuilding and Leveraging The Staffing Model  After the mass cuts of 2020, studies show we as an industry burnt relationships with a lot of our laid-off staff, both hourly personnel and junior staff management. Later polls showed they would not consider coming back to work for us. Some brands, notably, Darden, built relationships and continued benefits for both hourly and temporarily laid-off corporate associates. Darden flexed back to full staffing much more quickly.

We still have holes to dig out of. As Restaurant Business Online reminded us in Late March, many restaurant brands count the value of a stable, high-performing unit general manager as the number one factor that explains store profitability more than any other factor, including location. So, coaching, motivating, and designing new plans for GMs is vitally important. At the same time, keeping a promotion window for GMs and having a good quality learning work environment is important for retention. While all are important, some needs are more critical than others, and creative spillover benefits.

HEARD, AND SEEN:  Chapter -11s and Small Acquisitions both picked up in April. X Burger King Zees, 1 MCD, 1 PLK Zee. And Corner Bakery all file Chapter 11. Small acquisitions show some money is available: Main Squeeze Juice. Port of Subs acquired by PE. MCD's huge HQ consolidation is not clear even today, but US field offices are now all virtual. The subway/DAI sale/auction is still underway. Note from an insider: interest and reaction to date has been less than hoped; families are willing to settle for a lower price than first hoped.  Total EV might be $7B or less, versus the $10B initial goal. The Subway US unit count declined again.  Darden’s strength in the casual dining segment sets the curve.

More: waste of marketing ads/GRPs seen in some hours on cable TV where 4-6 identical spots run in 30 minutes. That is the fault of ad-buying shops that can't manage the spot inventory.

About the author: John A. Gordon is a long-time restaurant analyst and management analyst, with 45 years in the industry. He is a Master Analyst of Financial Forensics (MAFF) and works in complex operations, managerial finance, and brand strategy/investigation for clients. He routinely supports investors, restaurant operators, franchisees, Wall Street entities, and attorneys in many roles. Please call him at 858 874-6626, or jgordon@pacificmanagementconsultinggroup.com.

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