Operators must adapt to shifts from online shopping, meal kits and grocers
June 27, 2017
Steve Rockwell has more than 35 years of experience in the restaurant industry, including as a restaurant analyst, finance executive, investor, investment banker and consultant. This article does not necessarily reflect the opinions of the editors or management of Nation’s Restaurant News.
A number of recent news articles have chronicled the demise of traditional retailers due to growth in online shopping, as evidenced by the expansion of Amazon, which recently acquired Whole Foods.
This trend has long been evident and has contributed to the reallocation of many investors’ dollars to the restaurant industry and away from traditional retailers. With plenty of capital available, restaurant unit growth continues to be relatively strong and entrepreneurial activity high. My impression is that, notwithstanding recent sales softness that many attribute to over-building, there is a general view that the long-term outlook for restaurant sales remains favorable.
A positive secular trend is a greater propensity of Millennials to eat away from home. Cyclically, rising incomes and lower unemployment should help restaurant sales. Nonetheless, there are several trends that could, at the margin, eat into industry sales and unit-level profitability.
One trend that bears watching is the growth of the sale of meal kits by the likes of Blue Apron. Admittedly so early in its growth cycle that some may question whether it is yet a trend, the use of meal kits fulfills a consumer need. Many consumers don’t have the time or skills to prepare meals at home from scratch, Millennials in particular. Sales are insignificant now (estimated to have been $1.5 billion in 2016, compared with combined restaurant and grocery sales of $1.2 trillion), but could be a major threat long term.
While the business models of many of the aspiring meal kit companies are unproven, the consumer need will be met either by a dedicated segment, through grocery stores, or perhaps even by restaurant companies. Papa Murphy’s could be considered one such restaurant company addressing this market.
Furthermore, virtually every grocery store has significantly improved the quality of its prepared food offerings; some are selling uncooked food, either full meals or individual ingredients, that is fully prepared and ready to cook in its existing packaging, making it virtually foolproof for the unskilled cook.
As this niche grows, it is likely to take sales away from restaurants. Based on a 2016 study by analytics firm Cardlytics in the U.K., consumers of meal kits spent 2.2 percent less on restaurants than those that do not use them. The same study showed that meal kits have a greater impact on grocery sales (a 2.8-percent decline in grocery spending), which leads me to believe that grocery chains are going to continue to aggressively develop offerings in this segment. Greater availability and improved quality will likely increase demand and pose a greater competitive threat to restaurants.
A second trend is the growth of delivery. The primary issue facing operators is how to provide delivery profitably. Fees charged by many of the third-party delivery services can run as high as 40 percent, effectively eliminating the margin on incremental delivery sales. Operating a dedicated delivery network is also expensive and exposes operators to legal issues. Many restaurateurs are avoiding delivery for quality reasons. That may be a mistake as some research indicates that consumers, Millennials in particular, recognize that the quality of an in-store meal is higher than one that is delivered, and are willing to accept the difference.
One trend that is currently favorable for the industry, but that could turn negative, is Millennials’ greater propensity to eat out because of a lack of cooking skills. As Millenials age, marry and have children, their lifestyles could change, and cooking at home may become more prevalent, whether meals will be prepared from a kit, from scratch or a combination. According to a recent survey, 53 percent of Millennials eat out more than once a week, compared with 43 percent of Gen Xers and Baby Boomers. If that gap were cut in half, it would have a meaningful impact on sales. This shift, if it happens, is likely to be very gradual, almost imperceptible, until after several years. Restaurants will need to double down on the value they provide to attract customers, as well as offer something not available at home, such as entertainment or a unique or differentiated flavor profile.
To confront these trends, operators must have a good understanding of their guests, how they use the brand, and what the competitive alternatives are. For example, assuming meal kits mainly replace dinner, brands that focus on breakfast and lunch have little to worry about. If kits are predominately used for weekday dinners, sales of convenience-oriented chains with strong sales during that time period are more at risk. Developing strategies to combat the threat will be critical to maintain and grow sales.
A less obvious tactic is to modify the size and capital investment in the restaurant. Over the years, I have observed management teams gradually increase the size of their restaurants to take advantage of demand and drive average restaurant sales. With the entrepreneurial activity in the industry and the prospects for increasing competition, my bias is to engineer a smaller footprint that costs less, which can produce an attractive return on investment at lower sales levels. This may seem counterintuitive, especially if a smaller restaurant provides an opportunity for a competitive concept to develop a market, but it reduces the financial risk and enables the restaurant to be viable at lower sales levels if demand for food kits is meaningful and if Millennials eat more meals at home.
Investors and operators must remain vigilant in their quest for knowledge of their guests, potential threats from non-traditional competition and the most efficient restaurant-level capital investment. A failure to do so could result in more news about restaurant closings in the future.
