John Gordon - October 2019

What Does it Take to Start Up a New Restaurant Daypart in 2020?

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

Restaurants are doing almost everything under the sun to find sales in the hyper competitive and built out US restaurant space. For example, Burger King is using motorcycles and their apps to find customers and make deliveries in Los Angeles to vehicles in traffic jams along the ever clogged 405, while traveling on the shoulder of the road. One that none of us saw coming was the September 9 announcement by Wendy’s that they would implement a nationwide 2020 rollout of breakfast, their fourth such breakfast attempt since 1985.<1>

I wish Wendy’s the best in 2020. I’ll use the current Wendy’s situation as the model for this note but the same issues Wendy’s is facing could apply to any casual diner trying to rollout breakfast or Pizza Hut, KFC or Popeyes eventually doing the same.

After the announcement, Wendy’s (WEN) stock dropped, and several stock analysts downgraded their Wendy’s ratings as a lack of clarity in the breakfast initiative. On October 11, at their Investor Day presentation, Wendy’s management discussed their breakfast plans, essentially a nationwide launch in 2020, along with other planned initiatives.<2> For example, Wendy’s will be entering the UK for the first time ever, with company stores, and hopefully later, with master franchise entities, also in 2020.

The Wendy’s breakfast initiative was tested in some 300 units this summer where it was said favorable sales results occurred with no lunch/dinner cannibalization. It created a smaller, more on the go menu, building on its bacon heritage, that would be easier to execute through the drive thru. And Wendy’s said it built it differently than in the past—with franchisee involvement, no equipment costs, minimum staffing of 3 FTE and “full national media power”<3> The company is investing $20M now for smallwares, menuboards, and recruiting. It is not clear what the 2020 cost is, but it noted “helping fund fully national and incremental media through royalty reinvestment<4>

So, What Does it Take to Build A New Daypart?

In the first place, it will take money—both corporate and franchisee funds.

Franchisors manage the ad fund, collecting ad fund contributions and composing a creative and media plan and advertising outlays.  Wendy’s seems to have indicated it will allocate the royalties generated by the breakfast program back into the ad fund to cover some advertising <5> not covered by the franchisee contributions. The issue is what happens when more advertising is necessary to get a new daypart to breakthrough the existing industry powerhouses like McDonald’s and Dunkin Brands. Post 2019, franchisors have to report ad fund contributions as revenues and post fund expenditures as expenses on the face of the corporate P&L. This implies either franchisees will be asked to pay more or there will be a direct hit to corporate earnings.

Further, on the corporate side, intricate research is required—product attributes, consumer patterns, product mix patterns for example. The implications from implementing a new daypart is not something that can be seen from a 10 week test. For example, consumers take considerable time to notice and react to such restaurant changes.

On the franchisee side, typically new equipment and additional labor cost is required at a minimum as startup expenses. In the case of Wendy’s, fortunately they have flat grills now and corporate indicated at Investor Day no new equipment was required. Labor requirements were said to be two openers and one other staffer at minimum sales levels, more as breakfast sales ramp higher. It is a very difficult time to recruit any restaurant hourly employees of course.

The big number for franchisees to consider becomes what magnitude of breakfast operating loss is generated and for how long at store level while sales ramp up to breakeven and above. Wendy’s management is confident that their breakfast daypart will capture breakfast customers from other entrenched QSR operators.  Labor cost coverage will be tough until sales really ramp higher. My rough calculations show breakfast labor cost at about 45% of breakfast revenue if breakfast sales are at 10% of the 2019 daily sales rate.<6>

The second major issue is that of focus. There is only so much time.

Both Wendy’s corporate and franchisees have additional things to do in 2020 and future years. Wendy’s is expanding its international program with about 20 company units and franchisee units going into the United Kingdom, and perhaps into more Old Continent nations later. This is notable because of the higher land, lease and labor cost structure there. With the presence of local national and US legacy operators McDonald’s, Burger King, Nando’s and Pret it will take time and money to build a beachhead.

US Wendy’s franchisees are about 50% remodeled to the current standard.<7> The remodels look very nice but put a CAPEX burden on the franchisees. And 50% of the franchisees are new<8>, meaning they are now amortizing their investments. My intelligence is that that Wendy’s franchisee debt to EBITDA ratio is about 5.2 to 1, on the high side.  This means that there needs to be solid operating profits going forward so the franchisees can pay down debt on schedule. This gets at the issue of focus. If too many balls are in the air at a time, it becomes more difficult to juggle.

Any way you look at it, Wendy’s will be fascinating to watch going forward.

About the author:

John A. Gordon MAFF is a long time restaurant veteran with years of operations, corporate staff and management consulting experience. He is a Master Analyst, Financial Forensics and founded his niche restaurant analysis consultancy, Pacific Management Consulting Group in 2003, and works operations, financial analysis and strategy engagements. He is always reachable at (858) 874-6626 or jgordon@pacificmanagementconsultinggroup.com.

<1>   See: https://www.restaurantbusinessonline.com/financing/wendy’s-take-another-shot-breakfast

<2>    See https://www.ir.wendys.com/news/news-details/2019/The-Wendy’s-Company-Holds-2019/Investor-Day

<3>   Wendy’s Investor Day Presentation, Page 80 of 185.

<4>   Ibid, page 86 of 185.

<5>   Ibid, Supra.

<6>    3 employees, 5 hours breakfast shift, $11.00 direct wage plus 25% indirect wage burden, or $202, divided by daily breakfast sales of $441.

<7>  Wendy’s Investor Day and CEO Penegor Interview, Yahoo Finance, October 14 2019.

<8>   Wendy’s Investor Day and Penegor Interview, Yahoo Finance, October 14 2019

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