Early holiday sales, both in stores and online, reached new records in late November. Whether or not this favorable trend will continue remains to be seen, but it is an encouraging sign that consumers may be on the verge of loosening the grip on their wallets.
Still, there are too many crosscurrents to break out the champagne. High unemployment — still elevated at 8.6 percent in November — political uncertainty as the next election cycle heats up and weak income growth all continue to temper confidence. In fact, if holiday spending remains strong, it could be bad news for restaurants and retailers when consumers’ bills come due after the new year.
This backdrop suggests that the difficult conditions restaurant operators have faced over the last several years will continue in 2012. Layer on further hikes to the commodity costs we saw in 2011, and profitability will likely remain under pressure.
Act for the long term
Weak demand and higher costs mean management teams need to be highly disciplined and focused. Their emphasis should be on the long-term competitive position of their chains to at least maintain, and preferably improve, their relative value positions. Chains that are able to do that will benefit substantially through increased market share when demand improves.
For the time being, economic pressures have heightened consumers’ sensitivity to prices, portion sizes and service levels. Guests will move to a competitor if they notice changes in any of those variables.
Consequently, in spite of food-cost pressures, menu price increases or reduced portion sizes should be implemented only as a last resort, to avoid alienating customers. One option that some companies, such as The Cheesecake Factory, have successfully implemented is a small-plate strategy that addresses higher food costs and maintains perceived value.
Know your brand
While most management teams would agree that they need to be disciplined and focused, simply taking steps to that end will not be enough to maintain profitability when demand is weak and costs are rising. However, there are ways to improve efficiencies without impairing the guest experience. Among them, a company can focus on improving its supply-chain management and information technology systems to provide the business greater awareness of and control over cost inconsistencies behind the scenes.
To effectively manage a chain — and uncover areas for potential savings — management must also have an objective and accurate view of how consumers perceive it compared with dining alternatives. In some cases, management may need to increase costs, such as those spent on labor, to improve service levels and raise the concept to the standards set by the competition. Improved sales would be expected to pay for such an action. Marketing, with a special emphasis on social media, is another area of focus that could have an impact on sales.
Despite the best efforts of management, however, near-term profitability is still likely to come under pressure as the economic environment tests all but a few chains. Share prices of public companies can be expected to perform poorly in the coming months. The exceptions will be the stocks of those companies that are able to demonstrate pricing flexibility, unit growth and rising earnings — in other words, only a select few.
Investors in companies that experience earnings pressure need to fully understand those pressures and evaluate whether or not the companies are taking actions that will enhance their long-term competitive positions, or if they are losing ground relative to their competitors. Management teams must not be influenced by investor pressure to maintain near-term profitability by taking actions that could potentially damage the long-term health of the company.
Cut costs carefully
Private companies have the advantage of not having to disclose financial performance and satisfy public investors. They therefore may be under less pressure to take short-term steps that could be damaging to the business’s long-term profitability.
As a rule, though, private companies are smaller than public ones and may not have the same economies of scale as their larger public competitors. Consequently, margins are likely to be thinner, and there is less room to absorb higher costs. For smaller companies, it is even more imperative that management analyzes every aspect of the business to reduce costs that will not affect the guest.
Franchisors also can be in a difficult position of balancing their own profitability with the health of the brand, if the financial viability of their franchisees deteriorates. Should they grant some form of fee relief and, if so, how much and to which franchisees?
In many cases, some form of relief is in order, since the overall strength of the brand is heavily dependent on the health of the franchise system. Also, franchisors should be willing to work with franchisees, if requested, to help them operate their businesses more efficiently.
Because operating conditions for the restaurant industry are likely to remain difficult given continued commodity-cost pressure and weak demand — in spite of what appears to be a loosening of consumer spending this holiday season — management teams need to keep looking for ways to lower cost structures without hurting the guest experience or impairing value.
If the company is public, management teams must accept the likelihood that share prices will be under pressure if their actions to improve the long-term position of the company result in lower profitability. Conversely, investors need to differentiate between those companies that are losing their competitive edge and those that will come out of the current environment stronger — giving everyone something to celebrate.
Steve Rockwell has 30 years of experience in the restaurant industry, including as a restaurant analyst, finance executive, investor and consultant. He is a partner in Results Thru Strategy, a consulting firm based in Charlotte, N.C., and can be reached at [email protected] .