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John Gordon - June 2021



Restaurants: Everything Relates to Everything Else

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

The restaurant industry continues to recover from the Pandemic Year. Looking back over history, while there were all kinds of signs of an over development and easy money finance bubble, and too expensive rent cost bubble in place pre-March 2000. The industry overall was in pretty good shape then. All that changed in a few days in March 2020. But within weeks, aspects of the industry began showing signs of strength in the US with recovery in some segments within months.  The US has fared better than some international markets due to its drive-thru penetration, rounds of stimulus, and vaccine advances. The March Biden stimulus was immediately successful in lifting restaurant sales, but it has likely worn off. Now, summer seasonality, travel, general reopening, and improved dining out confidence will be key. Parts of the industry have not recovered yet. And a lot of things are happening at once.

The Pandemic Year Tail Is Long and Wide

As we might have expected, the global supply chain is now a mess. The Bureau of Labor Statistics reported that US inflation jumped to a 13 year high in May,  up 5% versus year-ago, the highest since August 2008. In the restaurant space, corn, wheat, and soybeans are all problems and causing cost spikes throughout the food complex.  Hedging programs in place in some brands will soon expire. Plastics, lumber, steel, paper, and labor are fundamental parts of the problem. Availability of drivers and wage costs; availability of ocean freight containers and diesel are problems.

The BLS FoodStuffs Index began moving up in November 2020, plus 10.6%, and rose steadily, then spiking at plus 39.6% in March, 66% in April, and 57% in May. <1>  As a consequence, full-service restaurant prices jumped 4.1% in May and limited-service restaurants increased priced 6.1% annually. <2>   While high inflation gives us some cover, there is a limit to what amount of price increase we can pass along. For decades, restaurant price increases rose 3% per year on average.

In addition to commodity cost issues, labor availability has been an issue as every operator and industry observer knows. We don’t need to have both a food, labor cost, and CAPEX problem at the same time! Many factors seem to be responsible. Recent polling notes that restaurant operators blame overly generous unemployment authorizations while employees say they have left the industry because of too low pay. Such talk does not change the on-the-ground reality. Restaurant brands with true brand strength (and corresponding pricing strength) and a supportive progressive employee culture that isn’t just talk comes are now essential.  That may be a particular challenge for certain franchisors whose only culture is “us versus them”.

The Right Product Mix (and Store Mix) Covers a Multitude of Problems  

Our best bet is to work to retain the check and product mix we have and get more of it. Darden (DRI) is doing it in its media; McDonald's (MCD) and Jack in the Box (JACK) are among restaurant chains to launch loyalty programs this year to retain the digital customers they gained during the pandemic.<3>  And via price where we can. Chipotle (CMG) took a 4% price increase last week to cover its transition to a $15 wage. Earlier, it took the price to cover eroded delivery transaction margins.  It is adding windows everywhere it can.

Any QSR brand working on its CAPEX plan not thinking about trying to build find or transform any logical location to a drive thru or curbside or popup drivethru should revisit their plan quickly.

McDonald’s Misspeak at Bernstein Conference

On June 2, at the Bernstein Strategic Decisions Conference, McDonald’s CEO Chris Kempczinski answered a question regarding a dispute with its US franchisees regarding prior technology fee billings. He mentioned that the amount in question, $70 million was a “rounding error” in the immense cash flow that the franchisees generate. “ If you look, 2020 was a record cash flow year…So three consecutive years, we can say confidently of record cash flow levels.”

The problem here is the definition, not the raw numbers. Many McDonald’s franchisees have noted that McDonald's officers are speaking of the store level EBITDA number, which is before taxes, capital spending, debt service (interest and principal), and overhead, among other expenses and outlays.  McDonald’s has extensive unit CAPEX standards and a mere EBITDA number doesn’t tell the story. What’s up maybe actually down and vice versa.  McDonald’s has contributed much to the modern-day restaurant industry. Ray Kroc’s grill man and later Senior Chairman, Fred Turner, wrote the industry’s first operations manual, for example. They have the data. They can communicate more appropriately on this important store economics topic. Many investors would like to know.

John A. Gordon is a long time restaurant industry veteran, with 45 plus years in restaurant operations, restaurant financial management corporate staff roles and the last 20 years, via his founded restaurant management consultancy, Pacific Management Consulting Group. Gordon, works complex operations and financial analysis engagements, and can be reached at (office) 858 874-6626, email: jgordon@pacificmanagementconsultinggroup,com, website: https://www.pacificmanagementconsultinggroup.com.

<1>   https: //chainrestaurantdata.com/rr-dashboard-may-2021/

<2>   May 2021 BLS Report, as reported by Restaurant Business Online, June 10 2021.

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