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John Gordon - June 2024




Restaurants: How Did We Get Into This Pricing Problem?


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

 

Early in our management careers, we were taught to “manage what was measured”. As we grew more senior, that modified slightly into “measure what matters”. Whether we were at start-up, private or public firms, the essence of key restaurant success factors remain the same: sales, comps, restaurant level margin, unit growth, free cash flow, ROIC, franchisee profitability. Unfortunately, the SEC patterned income statement shows a simple this year/last year format.  So that is what comes into our mind first. We as an industry took the easy way out: we took a lot of price: over 30% in LSR restaurants and a bit less in FSR restaurants from 2019 to present.

 

This set the stage for our current conditions.


The signals of consumer price sensitivity showed up everywhere in 2023. Darden (DRI) two quarters ago noted less alcohol sales mix and then last quarter negative SSS at all brands but one; McDonald’s, then coming off a great 2023 warned of weaker lower income guest mix for 2 quarters earlier and finally poor Q1 results; Wendy’s two quarters ago mentioned in their call they would test dynamic pricing and social media and then mainstream media blew up; and then Starbucks (SBUX) reported both US and China weakness as we noted last month. Not all of the SBUX variance was due to pricing.

 

Food at Home, e.g., grocery store inflation plunged, while restaurants continued taking price. That trend continued throughout 2023 and 2024 to date. We restaurants did have horrendous food and labor P&L shocks to cover, along with higher interest rates and CAPEX for new units and equipment in 2021-2022, with 2023 moderating food cost inflation.    

 

Looking back to Quarter 1 earnings , a review of the transcripts reveals except for the standout brands—Texas Roadhouse (TXRH), Chipotle (CMG), CAVA (CAVA), Wingstop (WING), Dutch Bros (BROS)—that many CEOs reported getting pressure on pricing.

 

Most major restaurant brands are featuring price currently. McDonalds (MCD) took considerable time to get a late June $5 30 day LTO Burger or Chicken package in place.  A problem is Burger King got their offer approved by franchisees more quickly and is on the street now, beating McDonald’s.  Franchisee intelligence sources expect that the $5 MCD LTO will become permanent. Olive Garden now is running a $12.50 “Create Your Own Pasta” offer on TV highlighting the usual brand benefits. [1]  There is no such rumoring about a permanent $12.50 platform at Olive Garden, it would be contrary to years of CEO guidance.

 

In a telephone interview, my friend, Lisa W Miller, CSP, consumer insights strategist and expert, who I trust greatly, wondered if this discounting deluge was too late. Too little, too late, actually. More work had to be done on the value side as opposed to the pure price side. [Lisa W. Miller & Associates, https://www.lwm-associates.com]

 

NRN’s Joanna Fantozzi wrote a great analytical piece[2] in May compiling several analytical reports and sources. The conclusions were that price is a subset of value and are closely related; that both about half of guests in 2020 (50%) and 52% in 2024 picked restaurants with lower prices. The exact same percentage of guests (68%) said they pay close attention to menu prices in both Q1 2020 and 2024. [3]  HundredX data shows price perception has gotten much worse in the last six months, especially QSR brands, but that value has only slightly declined.[4]  Both Sysco (SYY) and US Foods (USFC) noted the falloff of chain QSR cases sold in their recent investor days. [5]

 

I am wondering how do we get out of this “price problem” cleanly. For those brands that do a lower priced LTO, eventually the LTO can end when market conditions improve. For those QSR brands that overindex with lower income guests, how do you move away from a fixed price value platform in say, 3 years, when needed. Casual dining does not seem to have this problem. This should be a signal to Wall Street.           

 

So, in my opinion, we got to this pricing problem by taking automatic price increases and not looking elsewhere in the P&L more to cover expenses. Operators did not help by installing “tip me” software almost everywhere, although the reason for that is understood. We should have moderated price immediately once grocery store inflation fell in 2023. But that is a hard thing for a decentralized franchisee centric QSR segment to do.

 

Red Lobster, Rubio's and the spurt of other Restaurant Bankruptcies: What is up?

 

Everything relates to everything else of course, and the general industry sales, traffic and profit weakness took their toll on these two brands. We are NOT in “Restaurant Apocalypse”; these brands had long standing problems. 


Red Lobster was Darden’s original brand and seems to have began its long decline in the early 00s. Under CEO Clarence Otis, Darden used LTOs and a mix of coupons and FSIs to sustain business. But financial visibility during calls was poor and Darden’s attention was on Olive Garden, and later Long Horn. It was impacted by the 2008-2009 recession like all casual dining operators. It overindexed with older guests who responded to discounts.

Red Lobster became a lighting rod in the 2014-2015 Starboard v. Darden proxy battle. Darden sold Red Lobster and its underlying real estate for $2.1 billion before the proxy shareholders vote to PE firm Golden Gate Capital Group in 2015. Golden Gate immediately sold the real estate to a REIT. Red Lobster then had to assume rent and other lease expenses for the first time. That was a significant blow to the P&L. Later, by 2020, Golden Gate sold its entire stake to Thai Union, a seafood supplier. While Thai Union had international restaurant partners, they did not have US casual dining experience. Red Lobster’s long time CEO, Kim Lopdrup retired in 2021, and Thai Union was unable to recruit and keep a industry veteran CEO afterwards. Internal struggles at Red Lobster cumulated in a money losing $20 “All Day All You Can Eat Shrimp” offer. The Red Lobster bankruptcy documents revealed an on going investigation regarding machinations and potential fraud in the supply chain benefitting Thai Union, who became its exclusive seafood supplier.


Red Lobster has closed about 100 units to date with app. another 100 units “on the bubble” pending lease negotiations prior to Bankruptcy Court rulings. That would still leave a significant national presence, but with a tremendous amount of work to do. Law360 has reported a logical linkage with Fortress PE and SPB Hospitality as a logical bidder through bankruptcy.


Rubio's goes for Chapter 22: Rubio’s was one of the first fast casual dining restaurants, opened in 1983 in San Diego. Growing in Southern California in the 1990s via IPO in 1999. It went private in 2009 via a $91 million buyout by Mill Road Capital, with 195 units at the time. Via my conversations, Rubio’s made a cluster of bad development in the late 1990s and early 00s and could not grow out of the Southern California. Some have speculated its Baja Mexico theme did not work away from the coast. Rubio’s continued to close a modest number of units annually until 2020, when the first Chapter 11 was filed. 26 units were closed and leases were reworked.


After April 1 2024, none of us in California were surprised to see marginal restaurant operators close. This is a result of the $4 wage hike, AB-1228. Rubio’s closed 48 company units and may close more. Not surprisingly, franchisees have to continue operating, which is not right, but correct. If these units close cleanly, Rubio's will have 86 units left in CA, NV and AZ. Similar to Red Lobster, new management and funds will be needed. The media reports alone will drive down Rubio's sales for months.


Other restaurant bankruptcies are on the cusp—public BurgerFi, Tijuana Flats, Oberweis for example.


Building Company Culture Remains Critical

In this period of high stress, with  focus on the top and bottom line, the top performing company companies work to achieve a blend of being the most attractive and rewarding places to work. One of my close friends and colleagues, Mr. Mac Brand shares with us a venue from his new book, Tending to your Garden (2023), Building and Sustaining Business Relationships  


Mac explains one of his projects where he begins to build and identify identity charts that organize field and corporate staff members by contributory function to ease communications and blockages. See more at  www.bellwetherfoodgroup.com


About the author: John A. Gordon is a long time restaurant industry veteran with experience in restaurant operations, corporate staff (20 years in FP&A) roles) and 23 years now via his founded management consultancy, Pacific Management Consulting Group. He is a certified master analyst of financial analysis, (MAFF), and works complex financial analysis roles for clients.  


[1]   Cable TV watching, ION Network, June 9 2024.

[3]   Id. Technomic data.

[4]   Id. HundredX data, Andre Benjamin.

[5]   Restaurant Business, “Fast Food restaurants are hit hardest as customers cut back”, May 23 2024.

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