2007 Industry Forecast: Partly Sunny Skies

Despite potentially higher fuel and raw material costs and a somewhat uncertain economic outlook, members of the foodservice industry remain positive about their 2007 prospects.

By Joseph M. Carbonara, Editor-in-Chief -- Foodservice Equipment & Supplies, 1/1/2007

Most people would rather operate in a world where things are either black or white. Or in the case of the business world, black or red, with the former being the more preferable option. In reality, however, few circumstances present us with black or white options. Such is the case with the economic and industry forecast as the calendar rolls over to 2007.

For example, heading into the third quarter of 2006, the U.S. Department of Commerce had predicted that Gross Domestic Product growth would decline to a rate of 1.6 percent, which would have been its lowest level in quite some time. The actual results exceeded everyone’s expectations when third-quarter GDP growth checked in at 2.2 percent. Still lower than some of the more robust periods from the previous year, but it definitely performed better than expected.

Focusing specifically on the foodservice industry, the National Restaurant Association projects the industry experienced 1.8 percent in real growth last year. “It is a solid performance,” says Hudson Riehle, senior vice president of research and information services for the Washington, D.C.-based association. “It was not robust, but it’s not weak either.”

Looking at 2007 from a more micro level, foodservice operators, dealers and manufacturers remain optimistic about their prospects for the year ahead, according to FE&S’ annual forecast. In addition, the NRA’s 2007 forecast projects industry sales in 2007 will reach $537 billion, up 5 percent from the previous year. Should this come to fruition, it will mark the 16th consecutive year the industry has experienced real growth, according to Riehle, who attributes this anticipated continued prosperity to the fact that consumers spend 47.9 percent of their food budget on meals prepared outside of the home.

At the same time, though, they remain cognizant of the effect that rising costs for fuel and raw materials, among other things, can have on their ability to be successful.

Gray results such as these leave the door open for lots of extra interpretation of economic performance on a more macro level. And exactly how someone perceives the overall direction of the economy really depends on their perspective. In the foodservice industry, for example, operators, dealers and manufacturers alike feel that 2006 was a very good year for them and they attributed this to favorable economic conditions. They feel this way despite the fact that the past year was not without its share of uncertain economic moments.

For example, 2006 got off to an extremely strong start economically, most experts agree. But the unexpected and unprecedented jump in fuel prices slowed the economy’s growth to a modest pace that one can describe as being good but not great, which was in sharp contrast to 2004, a very strong year.

Now as they finalize their 2007 plans, most businesspeople, including those in the foodservice industry, want to know how the economy will fare during the next 12 months or so.

“If you want to know what is going to happen, you have to look back at 2005 and beyond,” says Ken Goldstein, economist, The Conference Board.

A Look Back Prior to 2005, the U.S. and global economies were clipping along at an above average pace, generating above average growth and returns, according to Goldstein. Then the world was visited by, as Goldstein puts it, the three ugly sisters: Hurricanes Katrina, Rita and Wilma. Having one major catastrophic event in one year is significant from an economic perspective, but to experience three in one season is almost unprecedented, he says. And it served as an economic wake-up call for most everyone.

For example, after a decade that saw significant levels of outsourcing across all industries, businesses were now realizing how elongated their supply chains had become. “And it did not take long to put a crimp in that supply chain,” Goldstein points out.

It is important to note the importance of the supply chain in the overall economic scheme of things. For example, every dollar spent in a restaurant generates two dollars in the supply chain, according to Riehle.

At the time the three ugly sisters had their coming-out party, the U.S. economy was showing signs of slowing to a more average rate of growth, as opposed to the above average pace it was previously keeping. The outlook for the first quarter of 2006 looked promising, though, according to Goldstein.

Another unanticipated development, skyrocketing fuel prices slowed economic growth as oil started a meteoric climb to $80 a barrel. Fuel prices are somewhat cyclical and every spring they go up, only to come back down in the fall, according to Goldstein. But when oil prices spiked as high as they did, a new economic era was ushered into play.

Beyond initiating a slowdown in the housing market, which was overdue, the spike in fuel costs made it clear that fuel is no longer immune to standard market forces, specifically inflation. Goldstein points out that prior to the 2006 surge in fuel costs, the price of a gallon of gas, in real dollars, was pretty much the same as it was in 1990. That means, relatively speaking, the cost of gas had changed little over the past 16 years. Those days are gone. “It might be a little more or it might be a little less, but it won’t be flat,” Goldstein predicts.

Of course, this also affected other areas of the economy, including clothing, so all of the expenses a customer incurs en route to a foodservice establishment continue to increase in price and that affects what they can spend. At the same time, consumers’ income continues to rise but their overall confidence is on the decline.

“Raw materials prices are higher and will not go back to what they were,” says Goldstein, who adds that this will force manufacturers and other businesses to raise prices. “Companies that don’t make money are companies that don’t hire.”

Looking Ahead to 2007 While all of this may seem overly negative on the surface, that’s not necessarily the case, according to Goldstein. “The economy is not weak. The United States is a $12 trillion economy. So, it’s huge and complex.

“None of this means it will be a horrible year,” Goldstein adds. “What it means is that it will not be a terrific year. It won’t be as good as 2004 but it won’t be as bad as 2005. It might be better than 2005. We don’t know.”

The same can be said for the foodservice industry, whose base is so large now that it not only reacts to economic trends, it also helps create some. “We track sales in 39 segments in this industry,” Riehle says. “Certain ones will grow faster than others, while some will underperform.”

For example, full-service restaurants account for $182 billion in sales, according to Riehle. “That’s almost like an industry within an industry.” This means each will react to changes in the economic climate in their own unique way depending on their core demographic. For example, those foodservice operators that rely heavily on interstate traffic may have struggled last year as a result of higher fuel prices. In contrast, those who draw most of their patrons from the immediate area may not have seen as much of a drop-off.

“Usage of restaurants has become ingrained in the American lifestyle and people are reticent to give it up,” Riehle added. People’s view of their standard of living or lifestyles is tied to their use of various foodservice options. When they feel some economic pressure, they are likely to change the concepts they visit, their ordering patterns or even make changes elsewhere in their spending habits, Riehle says. But they tend not to completely eliminate food purchases made away from the home.

With this in mind, Goldstein advises members of the foodservice industry to take a conservative approach when charting their growth plans. “2007 may not be the time to open a second restaurant or expand your menu unless you know the demand is there for it,” he says.

Goldstein expects the U.S. economy to be somewhat of a mixed bag for a while, with some geographic regions growing while others may decline somewhat. The anticipated net result is a steady if not spectacular level of performance. “The bad news is that we are going to be here for awhile,” he predicts.

Operators Despite traveling a road rife with potential potholes, operators generally concluded 2006 followed on the straight and narrow path toward success. Fifty percent of those operators participating in FE&S’ annual survey indicated that their 2006 sales expectations were met, while another 36 percent said they exceeded last year’s expectations. In addition, roughly two-thirds of those responding indicated that 2006 sales levels were better than those of 2005. Gross profits increased for more than half of the responding operators, with the rate of growth checking in at approximately 12 percent. And 32 percent of operators indicated 2006 gross profits remained consistent with 2005.

The main reasons cited for this success were higher customer traffic than anticipated and solid economic conditions. Expectations for 2007 remain positive, too, as 72 percent of operators project increased sales during the next 12 months. Among those companies anticipating a bump in sales, the average increase is 11-percent.

In an effort to maintain the momentum generated during the past two years, operators will look inside to generate growth opportunities. Specifically, they plan to manage their costs better and control pricing.

Approximately half of the operators surveyed indicated their equipment and supplies budgets will remain flat for 2007 as a result of feelings that their existing equipment remains in decent working condition. Slightly more than a third of the operators surveyed anticipate their equipment and supplies budgets will increase by an average of 21 percent.

Expected outlays for primary cooking equipment consume the largest portion of an operator’s budget, followed by paper goods. Slightly more than one-third of the participating operators indicated that the development of new menu items will affect their plans to purchase new pieces of equipment. The need to replace existing pieces of equipment accounts for twothirds of operator purchases, with traditional dealers serving as the most likely channel, according to our survey.

In 2006, skyrocketing fuel costs seemingly caught the foodservice industry, and other sectors of the U.S. economy for that matter, flatfooted. When some chain operators missed their projected revenue targets, many pointed the finger at the seemingly ever-growing fuel costs. Heading into 2007, however, most consumers and businesses seem to have become accustomed to the higher fuel costs, which are now the norm. Craving some stability in this area, roughly half the operators surveyed indicated they had budgeted for fuel prices to remain relatively consistent in 2007. And 45 percent of the surveyed operators indicated that they have or plan to pass along the higher fuel costs to their customers.

One way operators can potentially cope with higher fuel costs is by purchasing energy-efficient equipment, which can potentially help them reduce overall operating costs. Nearly 30 percent of the operators surveyed indicated that energy efficiency is now a major factor when making a purchasing decision for a new piece of equipment.

The burden of initiating sales in this area, though, will fall on the supplier community. “The typical operator, generally speaking, is focusing on dealing with this week and the next with respect to staffing and supply,” Riehle says. “The supplier community will need to help them understand the potential savings they can realize over the next two-to-three years by moving to more energy-efficient equipment.”

Developing simple ROI models to share with operators is a key step in accomplishing this, according to Riehle. “The awareness and potential return on investments from these technologies are better than they were before,” he said.

Aside from energy efficiency, price remains the greatest influence on a purchasing decision.

Dealers An impressive 94 percent of dealers indicated that 2006 was better than expected (51 percent) or, at the very least, met their expectations. Dealers cite several reasons for 2006’s stellar performance. They point to higher customer levels and a strong economic climate as two critical factors. Dealers also cite an increase in new construction, the opening of new restaurants and renovations of existing facilities as contributing factors to a solid 2006.

These factors, in turn, opened the door to higher sales volumes. In fact, a robust 73 percent of the dealers recorded an increase in sales for 2006, compared to 20 percent who reported a decrease in sales. Among those dealers reporting an increase in sales, the average rate of growth was 17-percent. Gross profit increased (61 percent) or remained stable (27 percent) for an overwhelming majority of the participating dealers. Among those dealers reporting an increase in gross profit, the average growth was approximately 11-percent.

Dealers remain cautiously optimistic for 2007, as 98 percent said they expect their sales volume to increase (85 percent) or remain consistent with 2006 levels (13 percent) over the next calendar year. The average increase anticipated is 14-percent, which would be slightly less than 2006’s average growth level of 17 percent. The major factor driving this growth is an expected increase in design build business. Roughly twothirds of the dealers anticipate gross profits to increase in the coming year and 31 percent anticipate their gross profits will remain consistent with 2006 levels. Among those anticipating higher gross profits, the average increase is 9-percent.

Dealers see independent restaurants (62 percent) as offering greater potential for sales in 2007 over chains (38 percent). Specifically, dealers cite the family-dining (55 percent) and casual-theme restaurants (52 percent) as the segments with the greatest potential. Turning to the non-commercial segment, healthcare (40 percent), senior care (35 percent) and colleges/ universities (32 percent) offer the greatest opportunities for growth in the dealers’ eyes.

Pricing pressures remain top of mind for dealers, with those responding saying that the biggest obstacle to new sales is the fact that the competition offers products at lower rates than they can. In addition, dealers anticipate having to raise prices on one or more products in response to rising manufacturing/material costs. Dealers also plan to or already have passed along increased costs associated with the higher price of fuel to their customers, according to 84 percent of those responding.

The most common way (74 percent) dealers are coping with the higher cost of fuel is by raising prices in general. Some dealers (32 percent) have added a fuel surcharge on deliveries, while others (23 percent) increased the minimum order size they require to deliver product to a customer. When it comes to budgeting for fuel costs, some dealers (49 percent) seem to think the current conditions will carry over through 2007, while others (28 percent) anticipate dramatic increases.

Despite the fact that non-traditional forms of distribution remain within the market, traditional equipment and supplies dealers remain the greatest sources of competition for those responding dealers.

Manufacturers While closing the books on 2006, equipment and supplies manufacturers did so with a smile as a staggering 94 percent said that sales met or exceeded their expectations. Among the impressive 84 percent of manufacturers reporting higher sales volume over the previous 12 months, the average increase checking in at roughly 16 percent. Roughly 57 percent of the participating companies showed an increase in gross profit, while an additional 29 percent reported similar levels to 2005. Among those companies reporting an increase in gross profit, the average growth was 16-percent.

Manufacturers’ outlook for 2007 remains bright, with 86 percent predicting their sales volume will grow, while 13 percent expect to match 2006 levels. And the average growth is expected to be approximately 15-percent. Additionally, 71 percent of the participating companies anticipate gross profits increasing by an average of 15 percent. Roughly 23 percent of the participating manufacturers anticipate their 2007 gross profit will remain consistent with 2006 levels, while 6 percent predict a slight dip in this area.

The main reason cited for the manufacturers’ 2006 success was the introduction of new products and enhancements made to existing lines. They expect similar courses of actions to produce positive results in the coming year.

Despite the manufacturers’ bright disposition, the road ahead is not without its potential potholes. Specifically, manufacturers cast a wary eye toward increased competition from existing players and those off-shore players looking to enter the market with lower-priced goods and services. The factories remain mindful of the impact increased costs of manufacturing and raw materials will have on their pricing and the customers’ willingness to purchase new products. A solid 91 percent of manufacturers surveyed anticipate higher raw material costs in 2007. Along those lines, more than half of the manufacturers surveyed plan to impose a price increase to meet these challenges.

Like dealers and operators, rising fuel costs remain an important issue manufacturers must address. More than three-in-five companies surveyed said they have or plan to pass along large increases in fuel costs to customers. Another 22 percent indicated that the rising fuel costs have affected their profitability, but they still plan to absorb them. Approximately half of the manufacturers surveyed are planning for 2007 fuel costs to remain consistent with 2006 levels, while an astonishing 26 percent have not budgeted for fuel cost factors.

Among the markets offering the best opportunities for growth, topping the manufacturers’ list are casual/theme restaurants as well as family dining, which is similar to how their dealer partners view the 2007 market. Other segments manufacturers cite as presenting growth opportunities include the hotel and motel segment, colleges and universities, QSR, healthcare, primary schools, and business and industry.

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