E&S Industry Forecast Under Pressure: Building Challenges on the Horizon
With rising commodity and gas prices, plus a housing market slowdown, industry members face the added challenge of catering to the changing needs of their clients and customers.
By Joseph Carbonara, Editor in Chief, and Amelia Levin, Sr. Associate Editor -- Foodservice Equipment and Supplies, 1/1/2008
As consumers and businesses alike brace for more challenging economic conditions, the foodservice industry enters 2008 with a state of mind that can best be described as cautiously optimistic. The operator, dealer and manufacturer communities surveyed by FE&S all project higher sales and gross profits for the coming year. Our readers appear to have tempered their projections with a healthy dose of realism, though. They seem well aware of the many challenges that await them over the next 12-to- 18 months, and appear ready to take appropriate action to help the industry continue to grow.
While remaining mindful of larger trends, such as healthy eating, sustainability and all things green, individual members of the industry will need to focus more closely than ever on their core customers and properly manage expenses and pricing pressures to successfully navigate the seemingly inevitable, choppy times ahead.
The Economy's Impact on the Foodservice Industry
If we were to take a macro view of the current short-term economic climate, just the evening news alone could move us to start burying our money in our mattresses. But, according to Ken Goldstein, an economist for The Conference Board, "The doom and gloom is overdone. Most of the folks affected by how bad the economy is work in the financial markets. By any stretch of the imagination this will not be a great year but it is not the second coming of The Great Depression, either."
Goldstein projects that the U.S. economy will enjoy a 5-percent rate of growth for the second and third quarters of 2007, but the economy will not see such levels of prosperity again until the second half of 2009.
The seemingly inevitable economic slowdown does not necessarily mean the foodservice industry will go into a tailspin, however. Hudson Riehle, senior vice president for research and information services for the National Restaurant Association, points to the 2001 recession as the first time the foodservice industry did not follow the lead of the general economy. "Becoming more a part of people's lifestyle buffers the industry from short-term cycles," Riehle says. "The overall national employment growth rate is a recipe for continued real growth in the foodservice industry."
Indeed, with two-income families fast becoming the norm, the foodservice industry will continue to solidify its position as a valueadded partner. To that point, NRA statistics show 48 percent of the American consumer's food dollar is spent on items prepared away from the home. "All the indicators continue to point toward the fact that more of the food dollar is shifting toward the away-from-home market," Riehle says.
For 2008, the National Restaurant Association projects total sales of $558 billion, or 4.4-percent nominal growth and 0.9-percent real growth. If the industry achieves these numbers, it will mark the 17th consecutive year of real growth, according to Riehle. As part of this overall growth, the NRA projects the industry will see $23 billion in real incremental revenue gains this year.
The National Restaurant Association projects that industry sales totaled $535 billion in 2007. While this falls short of the NRA's initial projection of $537 billion, the total represents 4.6-percent nominal growth and 0.8-percent real growth.
In explaining why 2007 did not live up to the initial projections, Riehle points to challenges brought about by the volatile energy market and, indirectly, the well-chronicled deterioration of the housing market. "There has been a whole host of issues facing the industry in 2007," he adds.
Oddly enough, the NRA announced its growth projections shortly after its October Restaurant Performance Index predicted softer sales for operators in the coming months. This was despite the fact that operators reported positive same-store sales that month. Riehle says it's important to focus on what consumers actually do as opposed to what they say they will do.
Housing Market Woes
It could be said that sluggish fast-casual growth relates in part to the slowing housing market. This especially rings true for those operators that set up shop in malls and rely on foot traffic from larger anchor tenants, specifically those in the home improvement segment, to boost their sales. Foodservice providers operating under this scenario will face continued pressure to increase same-store sales as these destinations become a little less traveled. "What is essentially a housing problem affects the entire walk-in trade directly," Goldstein says.
Darren Tristano, executive vice president of Technomic Information Services, a Chicago-based research firm, adds to that notion. "The housing market is going to put people in a position where consumers are taking on more debt, paying higher interest rates, which ultimately pinches their spending," he says. "And it's going to force them to think about eating in more. Plus, with the housing prices declining it's going to hurt people as well in terms of their equity and financial position."
The only good news behind this is that restaurants and chains themselves are not necessarily affected by real estate issues. "Commercial real estate seems to be on the rise, not hurt by the housing crunch," Tristano says. "Usually, restaurants build or lock into long-term leases, so those don't typically affect the short-term economic climate but it still contributes to higher costs."
Yet with all the headlines about the housing slump, it would be easy to chalk up the country's economic woes to just that. But Goldstein quickly points out that the housing market is not the only segment of the economy facing problems and it was far from the first to slump. Roughly three years ago, economists started warning against bad pricing of financial assets such as stocks, bond yields and, yes, housing. That trend has not ceased and at the same time some regional economies have started to slump for other reasons.
Politics and the Foodservice Industry
Heading into 2008 the presidential campaign continued to dominate headlines. Goldstein believes this trend will get a respite soon. "This year, everything has been shifted forward but it will all be over by Valentine's Day," he says. "We will be very quickly down to two candidates and the campaigning won't really start again until Labor Day."
So instead of focusing on the run for the White House, business owners should pay closer attention to local politics. The regional political climate will have more of a direct impact on how many people come into an establishment, how often they come and what they order. "And that depends more on who is in the mayor's office," Goldstein says.
Local regulations also impact the way operators run their businesses. Issues such as taxes, utilities, recycling and even menu requirements have a significant effect on their financial viability, on both a short- and long-term basis. "All restaurant sales are local," Riehle says. "Even multi-unit national operators need to adapt specific units to the specific markets they serve."
Probably the top challenge facing the industry remains recruiting and retaining talent, although Riehle feels this issue is starting to ease. Instead, other challenges have begun to show their ugly heads, namely increased energy and food costs. In fact, the NRA projects 2008 menu price inflation will remain consistent with 2007 levels at 3.6 percent compared to 3.7 percent. Of course, foodservice operators are not the only ones feeling this pinch. Grocery store operators are dealing with 4.2-percent price inflation, Riehle says. "The menu price inflation market is daunting," Riehle adds. "That core fact significantly impacts operators' margins. Consumers are extremely sensitive to price increases. The difference this time is that they are seeing it on the grocery store side as well as on the menu side."
The impetus behind these developments stems from wholesale food price inflation at 7.3 percent, according to Riehle. This represents a historic level not reached in 27 years, he adds. "It does force the operator to push for more internal cost efficiencies in order to offset these gains in operating expenses," Riehle says. This means when it comes time to make equipment purchases, operators will look to invest in those technologies that will enhance productivity.
Goldstein agrees and adds that operators have no reason to expect that the average check size will increase by 4 percent to offset menu inflation. At the same time, however, Goldstein's outlook is not all doom and gloom. "The squeeze operators are feeling now - meaning what people will order and how it relates to what it costs to run the place - will not get much worse. It won't get much better, either."
The good news is that it appears as if operators realize what they are up against and are preparing to deal with these challenges. Despite a softer outlook, 54 percent of the operators participating in the October RPI said they made a capital expenditure for equipment, remodeling or expansion in the past three months. The outlook in this area could remain constant as more operators look to invest in technologies that will help them better manage their costs.
Pricing concerns will not be the only cause for menu scrutiny, however. Consumers' increased awareness of their own health will force operators to wrestle with such issues as calorie and carb counts if they want to remain a viable option in their customers' eyes. "So for the restaurateur, unless the menu is fixed, the big question is about what are they going to serve and what are their customers demanding," Goldstein says. "The biggest challenge they have seen, I would suspect, is not the traffic coming in or the average check size but what it is their customers have ordered."
Spotlight on Segments
It's equally as important to realize that economic trends can cut both ways. For example, Americans continue to decry the fact that their dollars buy them less and less abroad. At the same time, though, the declining value of the dollar makes American tourist destinations, such as New York City, Boston and the like, more attractive to visitors from Europe and other parts of the globe because while on "holiday" these individuals enjoy increased purchasing power.
"Right now, specific segments of the food industry, namely the upscale, are benefiting from the tourists coming to visit the United States," Goldstein says.
If you work in the snack and non-alcoholic beverage bar segment, your outlook for the year ahead is particularly good. The NRA projects this segment will lead the way, accounting for an anticipated $21 billion in sales at a real growth rate of 3.2 percent. "It is an amazing industry in terms of how diverse and flexible it is in meeting consumers' needs for food prepared away from the home," Riehle says.
In addition, concepts that deliver a more ethnic menu appear to be on the rise, according to Technomic's Tristano. "People are looking for different tastes, not the same old, same old thing," he says. "Consumers are going to become even more adventurous in the coming years, especially the younger generation. According to our studies, people in the 18-to-34 group have nearly doubled their interest for ethnic foods."
Specifically, the Asian segment, which really consists of a number of types of cuisines such as Japanese, Sushi, Korean and Indian food, shows promise, according to Tristano. "Barbecue is another area that will probably grow," he adds. "There are indications that barbecue is still popular and it hasn't really hit the mainstream."
Of course, generally speaking, if you work in the casual-dining segment, where many operators struggle to generate foot traffic and same-store sales are well-documented, chances are your outlook is not quite as cheery. "We've seen some pretty negative results from the casual-dining segment," Tristano says. "Most of the casual-dining chains are not experiencing good same-store sales, and growth has slowed in terms of unit expansion. This segment has been sluggish at best."
FE&S' Outlook for Operators
While the overall industry outlook may be questionable for 2008, the vast majority of the operators responding to the FE&S survey appear to be well aware of the task at hand. For example, 60 percent of the operators expect their food and beverage-related expenditures to increase this year by an average of 16 percent.
Despite the potentially challenging times ahead, operators continue to maintain a positive outlook for 2008, with 62 percent projecting increased sales at an average rate of 13 percent. Only 6 percent of participating operators forecast a decline in sales, while the other 32 percent project revenues will remain constant with 2007 levels. Anticipated higher customer counts represent the primary factor driving these growth projections. This positive outlook may be a result of the operators' 2007 experience, where 82 percent indicated their sales expectations were met (50 percent) or exceeded (32 percent). In addition, roughly two-thirds of the operators surveyed reported an increase in sales at an average rate of 13 percent.
Sales projections aside, profitability remains the critical metric for operators. Last year, 79 percent of the operators reported gross profits increased (45 percent) or stayed the same (34 percent). Only 21 percent reported a decrease in gross profits. When forecasting for 2008, though, the outlook tends to be a little more conservative among operators with half anticipating higher profits and the same amount predicting profits will decrease (13 percent) or remain flat (37 percent).
Taking a somewhat realistic approach, those companies projecting higher profits plan to achieve this through tighter cost controls, increased customer counts and by being able to lower costs in other areas of their business. In contrast, those projecting their profits will remain flat or decline, cite increased costs and expenses as one of the main reasons for this. They remain wary about their abilities to raise their menu prices to cover the overall increase in the cost of doing business.
As a result of this uncertainty, only 35 percent of the operators surveyed plan to increase the equipment and supplies budget, compared to 65 percent who project their spending levels to decline (21 percent) or remain the same (44 percent). Among those companies planning to increase their equipment expenditures, the two main reasons are the need to replace existing items or to add other pieces to keep up with customer demands. According to the study, the top three factors that influence an operator's purchasing decision are price, perceived quality of the equipment and the ability to increase production volume.
In 2007, operators invested in a variety of technologies, the top three of which were food safety, point of sale systems and food production systems.
The Deal for Dealers
In an odd juxtaposition, dealers enter 2008 in a more positive state of mind than their operator customers. Typically, dealers tend to be the more conservative of the two parties. But an impressive 78 percent of dealers project higher sales for 2008, at an average rate of 14 percent.
Perhaps dealers continue to ride the wave of a solid 2007, during which 89 percent reported sales either met (45 percent) or exceeded (44 percent) their expectations. In addition, 60 percent of the dealers surveyed report an increase in gross profits, compared to only 12 percent reporting a decrease. Among the dealers reporting an increase in gross profits, the average rate of growth was 12 percent. Refrigeration and ice machines (60 percent) and primary cooking equipment represented the dealers' top two selling product categories in 2007 and they expect this trend to continue in 2008.
Commercial operators (85 percent) represent the greatest growth opportunity in 2008, according to dealers. And among those commercial operators, dealers anticipate writing more business from independents (58 percent) than multi-unit chains (42 percent). Within this category, the top five operator segments with the greatest potential, according to participating dealers, are family-dining, casual/theme restaurants, healthcare, colleges and universities, and hotels/motels.
Not unlike their operator customers, dealers remain aware of other outside factors affecting profitability. By far, the biggest issue affecting their profitability, according to dealers, is increased materials costs. Other factors on the dealers' radar include increased fuel/gas/oil prices, overhead/ labor and freight/delivery expenses. To help offset these pricing pressures, dealers' top three business priorities for 2008 are building market share, developing their sales force, and improving customer service.
Manufacturers: What's at Stake
Like their trading partners in the foodservice industry, manufacturers enter 2008 riding a healthy wave of optimism. In fact, a mind-numbing 99 percent of the manufacturers surveyed expect 2008 sales to increase (83 percent) or remain consistent (16 percent) with 2007 levels. The growth rate among those companies projecting an increase in sales is 15-percent.
In addition, a robust 91 percent indicated that 2007 either exceeded (36 percent) or met (55 percent) their sales expectations. Along those lines, 87 percent of the manufacturers surveyed said their gross profits increased (40 percent) or remained consistent (47 percent) with 2007 levels. Likewise, those reporting an increase in gross profits did so with an average growth rate of 14.8 percent.
The main reasons cited for this success include the factories offering new or improved products that expanded the markets they serve and increased operator demand due to new construction of restaurants and remodeling of existing units. As a result, the median number of products manufacturers launched in 2007 was three. Looking ahead to 2008, they expect to introduce a similar amount to the market.
Tempering the manufacturers' rosy outlook is a healthy dose of realism in the form of anticipated cost increases. In fact, 96 percent of the manufacturers surveyed project their raw materials will increase by an average of 9.1 percent. Interestingly, only 61 percent plan to impose a price increase on their customers.
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