With over 9 years of experience in the food and agriculture industry, Paula Savanti is a Rockstar for our FoodBytes! Companies. A Senior Analyst in Consumer Foods at Rabobank and a FoodBytes! SF mentor, Paula is always ready to share her expert insights and help our startups understand the industry. Read her new quarterly report “Rabobank To Go” below:
US Restaurants: Have Consumers lost their appetite?
By Paula Savanti, Senior Analyst, Consumer Foods, Rabobank
This is the first issue of what will become a regular publication analysing the global food service industry. Rabobank To Go is intended to provide commentary on current market developments, to integrate Rabobank knowledge from across the value chain, and to express our views regarding future trends for the industry. This first issue focuses on the US market, setting the scene in terms of recent performance, challenges, opportunities, and outlook. We hope that this becomes an interactive experience, and we encourage our readership to reach out to the authors with feedback and comments.
Rabobank expects the restaurant industry’s performance to improve, albeit modestly, during 2H 2017.
- Consumers will continue to show restraint as a result of rising inflation, real wage stagnation, and an uncertain policy and global environment.
- Rabobank’s Burger Index shows that food prices saw some strengthening in Q1, which is expected to continue, narrowing the gap between grocery and food service prices.
- While most new minimum-wage increases will not take effect until January 2018, labour costs will continue to pressure restaurants’ cost base.
- Restaurant oversupply will continue to pressure sales, but easier comparable sales will allow same-store sales to return to positive territory. Competition will remain heated as new players and channels continue to gain relevance.
Eating out tonight?
In the US, spending on food away from home has increased steadily for the past decades and surpassed spending on groceries (food at home) for the first time ever in 2015 (see Figure 1).
This structural change in eating habits is a result of changing lifestyles—as time becomes scarcer and the number of people per household shrinks, consumers increasingly favour the convenience of meals cooked by someone else. It is also the result of generational changes and millennials’ eating patterns, as they tend to spend more on food and eating out than previous generations did.
Since peaking in 2015, however, the growth rate of spending on food away from home (measured in sales at food service establishments and drinking places) has slowed down, from 8% in 2015 to 4% for the first five months of 2017. The impact of this slowdown is being felt by the industry’s main players.
According to TDn2K’s restaurant-industry snapshot data, which includes sales and traffic numbers for over 150 restaurant brands, traffic growth has been negative since early 2015, and same-store sales growth has been negative since February 2016. Traffic is down 3.5% YTD, and same-store sales are down 1.4% compared to 2016 (see Figure 2).
These global numbers mask some differences between restaurant categories (see Figure 3). Casual dining has experienced the sharpest decline in same-store sales, with an average decline of 1.6% in Q1 2017, while quick-service restaurants (QSR) reported a modest 0.7% growth. QSRs benefit from a lower price point, as consumers are more likely to cut spending on higher-value meals than on more staple-like QSR menu items, as well as from their recent efforts into store remodelling, and menu innovation and reformulation, which have had a positive effect on consumer spending.
Fast casuals, which until recently were the bright spot in the food service industry, have seen declining same-store sales in the past year, heavily influenced by Chipotle’s losses. But it’s not all about Chipotle. In fact, Q1 numbers show a 0.3% contraction, which actually worsens to a 2.3% decline when omitting Chipotle, since the company’s Q1 numbers put them back in positive territory. In a way, the sector is a victim of its own success. First, higher comparable sales are harder to maintain. Additionally, the success of the sector has led to a proliferation of new concepts, as well as more and more premium offerings at increasingly higher price points, eventually testing consumers’ willingness to spend.
The negative sales and traffic numbers for the industry as a whole are puzzling in many ways—the macroeconomic environment is favourable, so one would expect higher rather than lower sales. But other factors, including deflation in grocery prices, an oversupply of restaurants, and increasing competition from newer channels, contribute to sales from the main restaurant brands flowing away to other players.
We take a closer look at four of these factors driving down sales and examine the role they will play for the remainder of the year.
1. Consumer concerns over finances, despite favourable economics
Spending in general remains lacklustre in the US, despite some favourable macroeconomic indicators: the economy finished 2016 growing at a modest, but still positive annualised rate of 2.1% and is expected to show a similar performance in 2017; unemployment is at 4.7%, a number usually associated with ‘full employment’; consumer confidence indexes show all-time highs; and both personal income and wages are rising.
Nevertheless, consumers remain cautious with their spending and are concerned about their finances.
Since 2015, disposable incomes have been growing at around 4% per annum. Food away from home is a discretionary spending item that correlates quite closely to the consumer’s disposable income. When incomes rise, spending on out-of-home food tends to go up, and vice versa. Food service sales have been growing at a faster rate than wages, meaning that people have been spending a larger proportion of their wages on restaurants, particularly in 2014 and 2015. In our view, part of the current spending curb is an adjustment of that gap, particularly as real disposable income and wage gains are decelerating and are partially offset by rising inflation (see Figure 4).
Looking forward, Rabobank expects wage growth in the US to remain subdued, despite the low unemployment rate. Talk of potential tariffs could increase the price of some imported foods—say ‘goodbye’ to mango, banana, and avocado smoothies—further constraining the consumer’s purchasing power, while lower taxes could benefit the restaurant industry through tax savings and also through their effect on consumers’ pockets. The net effect of these potential policy changes will depend on specifics of the policies if and when they are introduced. Overall, however, wage and disposable income growth are likely to be modest in our view, implying that consumers will remain cautious and price-conscious.
2. Large gap in price inflation for food at home vs. food away from home
Another negative factor impacting restaurant sales is the large gap in price increases with respect to grocery prices. While food prices in grocery stores have been falling since 2015, as a result of lower commodity prices, restaurant prices have remained fairly stable, producing a three-percentage-point gap in Q1 2017—although at its widest (in October 2016), this amounted to a five-percentage-point difference (see Figure 5).
Restaurant prices are typically less volatile than grocery store prices, as the food costs only represent about one-third of the overall cost structure. In the past two years, rising labour costs have offset most of the gains from lower food prices for most restaurants, making it harder for them to lower prices. Some restaurants have increased the promotion and value-meal activities in an effort to retain consumers, while others have actually increased menu prices to offset rising labour costs.
Several food prices have begun strengthening somewhat in 2017 compared to last year, and although grocery prices will continue to be pressured by competition and price wars in supermarkets (see Talking Points: Cheaper Food—A Tale of Commodities and Competition), rising commodity prices will cause some food prices to increase, reducing the price gap with restaurants and enticing some traffic back into foodservice (see Box 1).
3. Restaurant oversupply
Restaurant oversupply is another cause for declining same-store sales, and in fact, the industry did go through a period of expansion until 2013, with supply expanding faster than foot traffic. Total restaurant-unit growth has continued since, although at a slower pace of 1.8% per year (see Figure 6).
Expansion has been greater in the limited service sector (QSRs) as compared to full service restaurants, which is consistent with their relative performance in the past years—QSR comparable sales have outperformed casual dining since the recession.
Evidence suggests that there is a high rate of turnover behind these net numbers. Chains are closing underperforming units at the same time as they are expanding, and new concepts emerge and expand as many others contract or disappear. Survival of the fittest seems to be the name of the game in the current hypercompetitive environment.
4. Increased competition from non-traditional players
Increasingly, consumers are able to purchase food from a number of outlets that fall outside the traditional definition of restaurants or grocery stores. Meal kits, meal delivery services, food trucks, convenience stores, and pop-up markets are all seeing strong growth, and restaurants are having to update and modernise both their menus and facilities to compete for the consumer’s food dollar.
Food delivery is certainly not a new concept, but—aided by digitalisation and a whole slew of new providers making food available with a few taps on your smartphone—use of delivery services through online ordering has risen sharply in recent years. In the US, weekly use of delivery services doubled in just five years (2010 to 2015), and NPD reports that 1.9bn mobile orders were placed in 2016.
The new era in online ordering and delivery represents an incredible opportunity for existing players and others in the food industry, estimated at over USD 60bn (see our report Food Delivery 2.0). Blue Apron’s sales alone are on track to reach USD 1bn this year, and Grubhub, the largest aggregator of restaurant deliveries, has reported annual gross sales of USD 2.4bn.
The key question is whether delivered meals are incremental to restaurant sales or whether they cannibalise existing business. Technically, deliveries still count as food service sales, even if consumed at home. So increased use of these services shouldn’t have an impact on the negative traffic numbers we are seeing. But it may well be that these orders are not placed with larger chains, therefore shifting sales from casual dining concepts and even QSR segments to independents or other players not captured in the traffic data.
Notably, of all the major QSRs, the largest outlier in terms of skipping the same-store sales-decline trend (with three consecutive quarters of double-digit same-store sales growth) is Domino’s Pizza, a company that has mastered the art of delivery and digital ordering.
We see online ordering and delivery as an opportunity to drive top-line sales, not as a threat to existing ones. In contrast to non-food retail, where consumers purchase online instead of going to the store, part of the rationale of food service is the event of eating out. So while consumers may sometimes choose to eat at home, by cooking or ordering delivery, the experience of eating out is something that cannot be replaced online.
But technology can be used to facilitate and improve the consumer experience through, for example, order-ahead coffee, mobile payments, or delivery, and consumers will increasingly look for these features. In order to capture all of the online opportunity, restaurants need to take a cue from those ahead of the curve and join the online game.
About these costs…
Rabobank’s Burger Index
In order to track the evolution of food costs for restaurants, we have developed an index—the Burger Index—that tracks the food-cost component of a burger-and-fries meal for a typical fast-food operation (see Figure 7).
Cost elements included in the index are: bread, beef patties, bacon, eggs, cheese, potatoes, lettuce, tomatoes, and vegetable oil. Beef has the largest weighting, as it represents the largest cost element, followed by vegetable oil, cheese, potatoes, and bread. Lettuce and tomato have the lowest weighting, but have the largest variability in pricing.
We understand that any fast-food operation will have longer-term contracts that fix prices for these input costs, but the index is built to provide an idea of pricing direction, historically and, most importantly, going forward. We provide Rabobank’s view on the evolution of prices for the future.
The Burger Index has been consistently negative on a year-on-year throughout 2016, as most components saw price declines in 2016, with beef and eggs declining sharply. In Q1 2017, the index showed signs of an uptick, led by strengthening prices for pork, cheese, and vegetable oil. Beef prices, although still down from the previous year, have been strengthening since the beginning of 2017, on the back of tight supplies, and solid domestic and export demand.
Going forward, we expect the index to increase as a result of stronger beef and chicken prices, and a supportive view on corn and wheat, as well as cheese.
Labor costs: no relief in sight
Labour costs have dominated the conversation on costs among restaurant operators for the past two years, as food costs remained relatively low while labour costs increased.
There are three main drivers behind the increasing labour costs: the implementation of the Affordable Care Act (ACA), increased mandated minimum wages in many states, and a tightness in the labour market that has restaurants competing for labour and driving prices up.
Rising labour costs will continue to be a concern for the industry in the coming year, as a new healthcare bill is still being negotiated in the Senate, minimum wage increases are already embedded in state legislation, and tightness in the labour market will continue.
Healthcare costs. Expectations were high for the Trump administration to fulfil its campaign promise of repealing ACA, and dialling back health and regulatory labour costs. However, a new healthcare bill is still under negotiation, which will likely take longer than expected to make it into legislation. As such, our view is that healthcare costs are likely to remain as they currently are for the foreseeable future.
Minimum wages. Raising the federal minimum wage is definitively off the table under the current administration, but there are still 19 states that began 2017 with higher minimum wages due to pre-approved increases, and three more are scheduled to raise theirs on 1 July 2017. Pre-approved legislation means that many states will continue to have mandated increases into 2020.
Tight labour markets: Legislation aside, most industry players would agree that labour shortage—far more than minimum-wage increases—is the biggest reason for rising wages. The month of May saw the largest increase in private-sector hiring since 2014, and increasingly, businesses across sectors are pointing to a shortage of labour as one of their main challenges. More restrictive immigration policies, if anything, will exacerbate the labour shortage. All in all, we expect high labour costs to continue to be an issue for the restaurant industry in the foreseeable future.
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Read the full RaboResearch report here.