The growth menu: How the U.S. restaurant industry is negotiating a challenging environment
Executive summary
The restaurant industry stands at an inflection point. Over the last several years, amid an economic expansion, the US$800 billion U.S. restaurant industry — a magnet for strategic investment and a source of global food industry concepts — outperformed many other sectors and the overall economy. For much of the current economic expansion, rising average product prices and a range of economic, demographic, and market trends fueled consistent growth in all restaurant segments. But growth has stalled in several market segments, and most analysts are predicting flat to downward same restaurant sales (SRS) in the near term for major, established chains as the competition from new, innovative players intensifies.
The result is likely to be turbulent times for established restaurant operators over the next few years. Despite declining SRS growth, however, deals activity remains robust. The sector in 2016 and 2017 witnessed an uptick in M&A activity from 2015 levels as investors came to see restaurants as largely protected from the likes of Amazon. By focusing the offerings on core consumers, building supporting capabilities, driving efficiency, and optimizing portfolios (both organically and through M&A activity), players can achieve future success. New and innovative restaurant concepts are increasingly capturing a larger share of the market and are projected to continue to experience strong growth. We also expect a rise in portfolio rationalization and M&A as companies seek to preserve and increase their advantage.
M&A outlook
Given the challenging market environment, we expect M&A to continue to play an important role in the industry. Struggling restaurant chains can benefit from aggressive operations management, while innovative formats will look for outside capital and professional management to drive regional and national expansion. In addition, large chains deprived of growth will become a target of shareholder activism and will seek out scaled, successful formats to perform a rollup.
For investors, it is important to distinguish between compelling and noncompelling assets and focus on those with the most potential for value creation. Targets with the potential for growth need to show a strong, differentiated brand and market proposition, combined with innovation to serve as a compelling platform for further rollout. On the flip side, assets that present operational turnaround opportunities need a clear plan for cost improvements, be that within the four walls (e.g., back of house or front of house or menu management) or outside the four walls (e.g., portfolio management, location optimization).
Conclusion
There is no question that established players face a challenging environment in 2018 and beyond. Consumer tastes, habits, and purchase behavior continue to evolve rapidly. The cross-currents of higher labor costs, higher interest rates, and continued economic growth make the environment difficult to negotiate. As is the case in every industry, incumbents face a challenge from well-funded and aggressive disrupters.
Industry players will continue to benefit from the trend of more Americans eating more of their meals outside the home and the resiliency of the restaurant against new online alternative models. In order to capture their fair share, however, companies will have to evolve their menus, business models, operations, and technology to thrive in the new environment. Focusing on differentiating capabilities and controlling costs will put companies in a good position to serve up appetizing results.
