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John Gordon - August 2018

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Restaurant Risk Can be Foreseenby John A. Gordon, Principal and Founder of Pacific Management Consulting Group Some news and developments out of restaurants this summer have been dramatic.  Who would have guessed that all of the following would have occurred in last few months:

  1. Papa John’s brand meltdown: founder Schnatter removed after media reports of misconduct and difficult company culture. Schnatter launches a legal battle against the company in response.

  2. Subway is just now testing new flavor and beverage enhancements via franchisor grants, ad fund and vendor allowances to franchisees. This comes after a period where Subway is said to have been dormant for years. Subway AUVs are down and store closings are up.

  3. Starbucks (SBUX) loses its delivery agent in China. At the same time, China same store sales plunge from positive upper single digits to negative 2 as of the last quarter.

  4. Starbucks acknowledges too many stores in the U.S. via upping U.S. store closings (150) and announces development change from overdeveloped to less developed U.S. areas.

  5. Bravo Brio is sold but notes $5.6M in wage and hour actions settlements were recognized prior to the transaction closing.

  6. Real Mex files bankruptcy again, notes it didn’t have basic human resources and risk management training systems relating to alcohol in place that lead to legal actions.

  7. Tim Horton’s franchisee litigation breaks out in the United States, after starting in Canada last year.

  8. Misconduct claims are made against celebrity Chef Mario Batali; three of his company’s high profile Las Vegas strip restaurants close in July.

  9. UK suffers a spate of high profile chef/restaurant brand failures, concentrated in the overdeveloped casual dining and fast casual space.

  10. KFC in the UK runs out of chicken after switching vendors, and most of the country’s stores are shut down for over a two-week period. The reality is that no one should have been surprised by any of these developments.  Our business has always been exciting; consumer facing businesses must meet consumer demands of a largely bifurcated US and rest of world, there are pressures on price and margins; it is difficult to get sites and recruit and retain employees. The US is divided culturally and socially with great political tension afoot; social media has changed much. Our industry has well-developed revenue and cost control systems and warning lights will blink like a Christmas tree, if discounts at unit X are too high or if labor hours in district Y are over guideline by 3%. Heads turn and attention is put on that issue. But it seems that recognition or plans to deal with larger issues of risk--bad things that can happen-- don’t occur until after some blowup. McKinsey notes three forms of risk dimensions in a recent<1> white paper:

  11. Market risk (commodities, foreign exchange and credit conditions)

  12. Operational, technical and project risk

  13. Political, regulatory and portfolio ownership risk.

Risk management is not about the Insurance Department, and it is not figuring out what to do if same store sales or the stock price declines. It is much more strategic. My restaurant risk dimensions model is a bit more granular to our people, consumer, and capital intensive world:

  1. People and culture.

  2. Product, to include supply chain.

  3. Brand reputation, to include sales channels.

  4. Store development related: development, franchising and licensing, location, CAPEX building and future remodel cost, operating cost tail, site and market concentration.

  5. Economics: store margins, company-owned stores, franchisees, G&A, capital spending and debt, mergers and acquisitions.

  6. Corporate ownership characteristics. My observation is restaurant creators, owners and operators tend to be self-confident: it means these people exhibit supreme self-confidence to create and operate against so many challenges in a dynamic consumer world. But at some point, some self-assessment is required. Companies with a board of directors—or even an informal advisory board—should include organized discussion and review of what are the brand’s assets that need protection, and outline what could go wrong. Restaurant store level operations do this all the time now—labor audits, equipment audits, temperature logs. Risk management isn’t about buying insurance-it is about planning, prioritizing what should we do if x happens. This includes reaching agreement on what kind of risk is tolerable, and what then is over the line and must be avoided at all costs. In its risk management white paper, McKinsey notes that there should be early warning signals of risk and that speed of reaction to risk are important..  It also advocates having three lines of defense, actually insiders and outsiders that can be preplanned to act and deploy.  <2> Me, I would be happy with an audit and agreement of what is risk and what should we do about it before the “unexpected” happens. <1>  Enterprise Risk Management Practices, McKinsey Working Papers on Risk, Number 53, 2014. <2>  Ibid. page 11. ==================================================== John A. Gordon, a long time restaurant industry veteran, in 2002 founded Pacific Management Consulting Group, a restaurant space management consultancy focused on strategy, operations and financial management topics.

5980 Mission Center Road, Unit A, San Diego CA 92123-3860Office: (858) 874-6626, Mobile: (619) 379-5561Website: http://www.pacificmanagementconsultinggroup.comEmail: jgordon@pacificmanagementconsultinggroup.com——

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