Heightened Deal Activity in the Restaurant Sector: Any Idiot Can Buy in, the Profitable Exit is the Hard Part

Bloomberg reporters Leslie Patton and Tara Lachapelle noted today that Benihana is the latest beneficiary of the markets’ bullishness on the restaurant industry.  The economics of this soft turnaround story certainly look promising enough to prompt some enterprising PE firm or firms to make an offer:

  • Gross Margin of 72.5%
  • Operating Margin of 1.1%
  • TTM Price/Sales of 0.61
  • Price/Book of 1.30

Lost in the midst of the deal heat, though, are some of the lessons learned over the past few years about how restaurants succeed, and how they can fail.

  1. A Growth Strategy is no Excuse for Ignoring Costs.  Friendly’s Ice Cream filed for chapter 11 last year after steep increases in dairy prices made the company’s cornerstone promotional offering (buy a dinner, get an ice cream sundae for free) a money pit.Commodity costs show every sign of continuing to be an impediment to profitability in the food and restaurant industries.  Doubters that the commodity story is over as a threat to profitability need look no further than the recent performance of General Mills.
  2. Align Promotional Strategy with Company Identity.  Burger King recently lost its long-standing ranking as the number two U.S. burger chain to rival Wendy’s.  Jordan Weissmann at The Atlantic notes that while Burger King focused its marketing strategy on lifestyle (targeting young males with its “The King” campaign), Wendy’s focused on the quality of its product.  Not surprisingly, quality won.
  3. Attack Rental Expense.  Lease terms that made sense five years ago can appear almost comically imbalanced now.  Restaurant operators must be aggressive and savvy in working with landlords to renegotiate terms.  These negotiations can be contentious, but the potential savings are substantial.
  4. Invest in a Strong Finance Function.  At my firm we have seen too many cash cow restaurant companies brought down by a weak finance function.  Dazed management teams will explain that everything was going fine until BANG!, the company went into a tailspin.  A strong CFO and accounting/finance team is the best preventative measure against that BANG! moment.
  5. Systems & Reporting.  Advances in business intelligence and big data have considerably widened the gap in operational sophistication between the Fortune 1000 and the middle market.  Management must be willing to invest in a clear-eyed assessment of where the shortfalls are, and commit to remedying those shortfalls in a timely manner. Any company lacking the ability to rapidly take raw operating data, convert it into actionable business intelligence, and report that intelligence to senior management is blind.  And blind companies fail.

A successful restaurant company, whether consisting of a single location or several hundred, can be a money machine.  Unfortunately, healthy cash flow has a tendency to breed complacency.  But the line between success and failure is a thin one.  Continued success requires well-choreographed operations, a strong finance function, disciplined promotional strategies and a holistic approach to marketing. 

David Johnson and his firm, ACM Partners, have considerable experience working with restaurant operators to manage performance improvement initiatives and turnaround engagements.

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