A Look Ahead to 2012

Uneven performance, unit remodels, mergers and acquisitions and healthy eating are all among the factors that will continue to shape the performance of the foodservice industry in 2012.

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Forecast-2012Trying to predict the U.S. economic climate has become as challenging as ever, and riding the emotional waves of the stock market only serves to complicate matters further. And the situation within the foodservice industry is no different. Mergers, asset acquisitions, shaky consumer confidence and countless other factors all serve as flak that keeps the industry from getting a clear look at what's on the horizon.

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Still, there's no denying that, like the consumers it serves, the foodservice industry continues to have the jitters when it comes to the future. That's because business simply does not like uncertainty, and until the United States and Europe can stabilize their respective economic and political climates, uncertainty will continue to rule the day. This lack of clarity will allow industry observers to be more subjective in their views of the industry, resulting in mixed perceptions as to how foodservice is actually faring. Some will choose to be negative, while others will take a more positive view. And given the uneven geographical and segment performances, there is ample data to support these conflicting perspectives. So, anyone looking for answers about the industry's performance on a macro level will continue to see varying results.

Despite the rancor of partisan politics and the uncertain job market, the foodservice industry has been generally stable in 2011, and it would appear as if things will remain that way in 2012. And while "stable" may be synonymous with flat for many companies in the foodservice industry, that's certainly much more desirable than experiencing a period of decline, as was the case a few short years ago.

2011 Performance to Date
According to the National Restaurant Association, the industry is on target to record sales of $604 billion in 2011, a 3.6 percent increase compared to 2010's revenue levels. For its part, Chicago-based market research firm Technomic projects the industry will realize a 0.6 percent decline in sales this year.

"I would call 2011 a mixed bag. We are still seeing success from large players like McDonald's, Subway and Starbucks — the true leaders in their segments. In full service we see some players, like BJs, holding their ground," says Darren Tristano, executive vice president for Technomic. "We are going to see food inflation and rising costs that will make it seem like we have made real progress, but the industry will be in a struggle to gain ground."

Despite the up and down nature of this year's business environment, "2011 is the best operating environment for restauranteurs out of the past four-year period," says Hudson Riehle senior vice president of the research and information services division of the National Restaurant Association. "It certainly is not as robust as several years ago, say 2005 or 2006, but it is certainly a better operating environment."

According to the NRA's Restaurant Performance Index, the industry was running 4.7 percent ahead of last year as of June. This translated into 1.4 percent of real growth. "The industry is not experiencing good growth. It's more modest," Riehle says.

Of course, the cost of doing business continues to be an issue for most foodservice operators. This year, the industry has experienced 2 percent menu price inflation, according to the NRA. This came about because food costs have been among the top two challenges for operators this year, due in large part to a 7 percent increase in wholesale food costs through the first half of this year, according to Riehle. Last year the industry experienced a 5 percent increase in wholesale food costs, he added.

"With menu prices rising at 2 percent, there will be no immediate relief for operators. That means operators will need to preserve margins through gaining greater efficiency," Riehle says. "The investment in equipment that can aid in those efficiency efforts becomes even more important. That was true this year, and it will be even more true next year."

It seems clear that a more efficient approach to going to market is one positive outcome of the industry's recent business challenges. "Fine dining and upper-end restaurants are starting to bounce back, and chains are doing a better job of managing their costs," Tristano says. "So their revenues may not be as strong, but their profits are better. So cost control has been a big factor."

The industry continues to anxiously wait for the restoration of consumer confidence. In July, consumer confidence increased to 59.5 from 57.6 in June, according to data from the Conference Board. But it is important to point out that this slight bit of good news was released just prior to the debate in the United States over raising the debt ceiling, which reached unprecedented levels of acrimony, forcing financial markets into a period of extreme fluctuations around mid-August.

And even before the debt ceiling debate dominated the news, consumers did not have the most favorable impression of the country's economic climate as concerns about business and employment conditions continued to darken their outlook. For example, consumers' assessment of current day conditions weakened further in July, according to data released by the Conference Board. Those stating that business conditions were "good" decreased to 13.4 percent from 13.7 percent, while those claiming business conditions were "bad" increased to 39.0 percent from 38.4 percent. Consumers' appraisal of the job market was also less favorable. Those claiming jobs were "hard to get" increased to 44.1 percent from 43.2 percent, while those stating jobs were "plentiful" remained unchanged at 5.1 percent.

"From the restaurant industry perspective, the less anxious consumers are, the better it is for the industry," Riehle says. "Consumer confidence is still down in the 20 percent to 30 percent range in some parts of the country. You would like to see that around 80 percent or higher. But this is all linked to getting a job and with the unemployment rate being as high as it is, consumer confidence remains low."

An improving jobs situation would go a long way toward calming jittery consumers. And there is some good news in this area thanks to the Bureau of Labor Statistics report that said U.S. companies added 117,000 jobs in July and that national unemployment levels were holding steady at 9.1 percent. "Obviously, there are still millions of jobs to be added to get the economy back to where it was, but even those additional positions bolster the need for convenience and income growth rates. They are not robust growth rates, but they are heading in the right direction," Riehle adds.

Looking at the industry from a glass-half-full perspective, it would seem as if consumers still have a strong appetite for using restaurants, if their pocket books allow. "There is pent-up demand for consumer usage for restaurants. Our research shows that two out of five consumers are not using restaurants as much as they would like," Riehle says.

And this pent-up demand represents an opportunity for the savvy restaurant operator. "Operators can use that basic want and market to that to nudge the consumer into patronizing their business. We are fortunate enough to be in an industry that consumers want to use," says Riehle, adding that restaurant industry employment gains are running at roughly double the rate of the rest of the country. "So the employment growth for the industry is substantially better than the national employment picture. That will hasten the industry's recovery when the national economy improves."

The net result means the industry will most likely experience incremental improvement in 2012, but it will not be as robust as many would like. "Just as 2011 was better than 2010, we would expect 2012 to better than this year," Riehle says.

2012 Outlook
Most industry observers feel 2012 will mark another year where the foodservice industry will need to scratch and claw its way down a path toward real growth. "There is nothing in our economic forecast that says consumers are going to come back to dining out," Tristano says. "With this being an election year, you will have the Democrats and Republicans fighting about how bad the economy is, and that will not be a positive impact for the industry. The longer it takes to get people to get back to dining out, the harder it will be."

The industry did get a small piece of encouraging economic news last month when the Manufacturers Agents Association for the Foodservice Industry (MAFSI) reported greater activity among foodservice design consultants in the form of requests for quotes. But the data from MAFSI's business barometer also showed the regional differences in economic performance, further highlighting the uneven nature of the business climate. For example, MAFSI members in the Northeast recorded sales growth of 7.1 percent in the third quarter of 2011, followed closely by Canada at 7.0 percent. The other regional sales increases include the Midwest at 6.0 percent, the West at 5.7 percent and the South at 3.2 percent.

Because the local economic conditions have a great impact on a restaurant's operating environment, expect 2012 to be another year in which performance varies widely depending on location. "A full-service operator in Miami will have different concerns than a quick-service operator running a roadside location somewhere in Middle America," Riehle says.

In addition to geography, the outlook by market segment seems to vary considerably, too. "We will probably see some growth among limited-service restaurants while full-service restaurants will be flat to slightly down," Tristano says. "It will be an environment in which big chains continue to thrive, the fast-casual segment continues to grow, and more traditional quick-serve restaurants continue to struggle. So the big continue to get bigger, and others continue to struggle for a reason. There are some dominant brands eroding, and some up-and-comers really pushing it — all with fast casual nipping at everyone's heels."

While consumer traffic levels may experience peaks and valleys again in 2012, that does not mean restaurant operators, particularly those with multiple units, will sit idle, waiting for the business environment to improve. "A lot of efforts will be made to remodel existing units to make these locations more relevant from a consumer standpoint," Tristano says. As a result, some locations may experience a slight decline in revenue, and their cash positions may take a hit during the remodeling efforts. "But in the long term, it may make them more efficient and could drive sales."

The operator market will also remain ripe for mergers and acquisitions. "I think because of the economy and the restaurant performance, and the appeal of the industry to private equity, we are going to see more of this," Tristano predicts. "If a company can't maintain their financial performance and needs money to move the needle forward, we will see more private equity get involved in the industry."

Another phenomenon that will likely remain prevalent in 2012 is "restaurant reincarnation," a term coined by Riehle. Restaurant reincarnation occurs when one foodservice provider vacates a premise and another one takes its place in the same location. "During this prolonged period of economic weakness, some prime real estate sites were available at historic lows. So some operators used that opportunity to position themselves for better times ahead," Riehle says. "And the importance of operators adding those prime points of access can't be overstated."

Of course, the concept of restaurant reincarnation is not exactly new to the industry. "Even during the depths of the recession, it was still occurring but at a more modest rate. Because the industry is so entrepreneurial in nature and the barrier for entry is so low, it is a place for people who want to start a business," Riehle points out.

2012 Segment Performance
As the industry has struggled to keep its head above water in recent years, fast casual has feasted on the faults of other segments and gobbled up market share. This is a trend that most industry observers feel will remain prevalent in 2012. "Fast casual is a much better play today and will continue to attract more customers from other segments. So we will see struggles in the family and casual-dining segments," Tristano says.

One factor impeding casual dining's ability to be successful in a changing market is the fact that so many players have larger unit prototypes, and that means they have to fill more seats to remain profitable. Another critical consideration is that a growing number of consumers have a ceiling on what they can spend, which impacts their choices. "It is like trying to stop a train: it takes time to stop and reverse the trend because you have so much baggage with you," Tristano says.

The successful casual-dining concepts are the ones that offer smaller- portioned menu options, usually in the $4 to $15 range. This attracts more consumers and allows the casual-dining operators to compete with limited- service restaurants, Tristano points out.

The quick-service restaurant segment will be a mixed bag, too, according to Tristano. He feels pizza is poised to do well because it presents value and family-dining opportunities. Another quick-serve segment poised to do well is Mexican because it generally functions at a lower price point. And beverage will likely continue to do well due to innovation and because many operators in this segment continue to add food to their menu mix.

But not every concept is as well-positioned. "Burger chains like Wendy's and Burger King will continue to lose ground to chains like Five Guys and Smashburger," Tristano says.

The simple fact is that the economy continues to shape consumer dining choices. "Even though the confidence of people with higher income levels is getting stronger, their sense of wealth has still been affected," Riehle says.

In addition to the economy affecting consumer dining habits, many of these trends are the result of generational shifts. "You are seeing the impact the Millennial and next generations are having. The boomer can't afford to eat out as much anymore because they are concerned about their retirement," Tristano says. "So each generation is impacting restaurant traffic."

Trends Impacting 2012 Performance

Overall, will consumers' appetites for more healthful dining options continue to grow? That's a question restaurants will continue to ask as they try to position their businesses as a healthier choice in the minds of consumers. "McDonald's certainly has a more healthful offering that may not be purchased as often as other options," Tristano says.

In some instances this means swapping the french fries for apple fries (apples sliced into smaller pieces to resemble the potato version) and even encouraging chains to refrain from offering the caramel dipping sauce that has become synonymous here. "They are trying to force it on the customer. It's not unlike the books that used to be written in the past about how to get children to eat vegetables," Tristano says.

One key variable heading into 2012 will be the various forms of legislation requiring operators to disclose information about the nutritional aspects of their food, such as fat content and cholesterol levels. "What will the consumer do? Some will ignore it, while others will pay close attention to it," Tristano says. But the exact impact on the foodservice industry overall remains unknown.

In the K-12 foodservice segment a number of school districts now require their foodservice operations to meet some rather stringent nutritional requirements. Meeting these requirements can cost more than previous menu options, but few school districts are seeing their funding increase at this time. As a result, some industry observers feel this emerging trend opens the door for contract feeders to grow their businesses, particularly in the K-12 arena as administrators look to take advantage of the perceived economies of scale these companies can provide.

"When you think about managed services having a growth rate higher than the industry average, that means they are taking over more of the self-managed operations," Riehle says. "The ability to understand what forces are driving that market on unit level will be important."

Regardless of whether consumers or the various government entities are leading the charge toward better-for-you menu choices, healthier preparation will continue to be a point of emphasis in foodservice kitchens across all segments. Key considerations in this area include portion control, whether to bake or fry certain items, and other concerns. "This will play into the frequency and choices consumers make," Tristano says.

Adjusting portion sizes, presumably down in response to rising food costs and customers beginning to eat in a healthier manner, opens the door to more creativity when it comes to defining value for the consumer. "For operators, how they manage the challenge through value meals and smaller portions will be important," Tristano says. "Pricing and purchase decisions will continue to shift toward lower price and higher value. All consumers are becoming more frugal and value seeking."

Oddly enough, though, Tristano feels that the influence of daily deals in the restaurant industry is decreasing. "So many people have taken advantage of the daily deals and have not used the coupons yet. Plus, when consumers do not use these daily deals, they lose value," he points out.

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