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On the Relationship Between "Increased" Food Prices And Restaurant Margins
This post is from Stone Street Advisors
I
wrote the following from 10/27/2010-11/12/2010, but never published
because I wanted to do some more work. Alas, my ADD got the best of me,
and that never really happened. After paying $1.10 today to have Swiss
cheese added to a buffalo chicken wrap at a diner in NJ, though, I'm
again curious about the difference between wholesale and retail food
price inflation. So, without further adieu, here are my thoughts from
then, which apparently are more valid today then they were just 6 months
ago!
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Over
the past few years - depending on the particular restaurant and time -
I've been charged anywhere from $0.40 to $1.00 for adding cheese,
tomatoes, etc to lunch or breakfast sandwiches. I'm hardly an expert in
agricultural commodity markets and only slightly less out of the loop
re: the finer points of the restaurant business (but also hardly
ignorant of either), so I assumed whatever, not a huge deal, I'm sure my
patronage is padding restaurants' margins, but its ~$0.50 and I'm
(often) too lazy to make my own lunch so I'll keep buying from
delis/etc.
Enough about me and my elasticity of demand/food preparation inclination/etc...
One
would have to be pretty damn naive to think restaurants (from your
local deli to the massive international chains) would let rising input
costs erode their margins. One would have to be similarly - if not more
- naive to assume they wouldn't use the opportunity to actually
increase margins, i.e. pass off >100% of increased input cost to end
consumers, after-all, this strategy is hardly anything new. It's just
the obvious move (depending on price elasticity of demand, market
position, pricing power, and a number of factors I'll address
eventually).
If I ran a deli or restaurant, I could procure a
slice of Land-o-Lakes American Cheese for somewhere in the ballpark of
$0.09/0.5oz slice (yes, 9 cents/slice!).
I imagine this number drops precipitously for larger chains to
somewhere likely half (or less) that. I also imagine if I'd spent more
than 5 minutes googling cheese price and/or had any supplier
relationships I could get it for less, as well. Using a (possibly poor
proxy) index for changes in food prices, let's say that a slice of
cheese costs a deli $0.10 and that since 2005 , prices have increased
50% from $0.067/.5oz slice (~ the increase in the IMF Food & Beverage over that time period).
Using
these numbers and assuming adding cheese to a sandwhich is 2 slices,
the cost of so doing to a business in 2005 was $0.13 and is currently
$0.20, yet anecdotal evidence (working on getting empirical, if anyone
has, please share!) customers are charged $0.50, not only absorbing the
increased input price, but yielding the restaurant an effective 150%
return on the cost of investing in those 2 slices of cheese in 2010.
Since memory doesn't go back that far, I unfortunately have to ignore
how this compares to 2005 (pending finding some additional data).
Of
course, a popular restaurant/deli may only serve a few hundred
sandwiches "with cheese" in a given day (+/-), so while the return
%/gross profit padding is amazing in and of itself, on such a relatively
small base and scale, the improvement/contribution to the bottom line
may be anywhere from a few dozen basis points to several hundred. E.g.
100 "with cheese" sandwiches/day, 300 days/year would yield an EBITDA
improvement of $9,000 for a small-ish restaurant for whom EBITDA (with
passing-along only the increased food price, sans additional margin)
may be anywhere from ~ $50,000 to at most, what, maybe $200,000? Using
these numbers (which may be unrealistic), a single restaurant could
increase its pre-tax profits anywhere from 4.5-18%, purely by tacking-on
a few dimes profit for adding 2 slices of cheese to some sandwiches!
A
few thousand $'s a year may not sound like much in the grand scheme of
things - especially for restaurant operators that pay themselves a
pretty penny of pre-tax profits and/or have other income streams - but
let's extend this logic out a bit where the base is significantly higher
and economies of scale come into the picture.
What if we consider
a chain with 10,000 restaurants, with huge purchasing power yielding
their cost/slice much lower, combined with increased price-making
ability (this may be debatable) due to brand loyalty/etc? How
widespread and to what degree do large restaurants pad margins by
passing-along >100% of their increased input costs? Do they exploit
their position, brand loyalty, purchasing power, etc to earn a
meaningful % of profits not from running their core operations
efficiently and effectively, but rather from "bonus buck" strategies
like nickle & diming customers on things like adding cheese to
sandwiches?
I don't yet have the answers to these questions,
however given the run-ups and resulting higher valuations of some
restaurant stocks, I'm anxious to find them. Look at some popular
restaurant stocks' performance over the past few years, relative to the
Market (using the S&P 500) and the Consumer Discretionary ETF (XLY):
The
S&P and Discretionary index have barely moved the past few years
compared to the stocks of popular restaurants McDonalds, Panera, Yum!
Brands, and Chipotle! Of course there are several factors at play here
such as fast food restaurants finally diversifying and expanding their
menu's away from all fat, all the time to healthier/more popular
alternatives, but I'm still curious how much (if any) of the above
returns (and the $ driving them) are due to restaurants padding their
margins with increased retail prices in excess of any increases in input
costs they've seen.
Similarly, I wonder if grocery chains are
also guilty of this practice as well. I think this may (or not) into a
recent back/forth between financial guru Sarah Palin and several MSM and
blog types about real and/or perceived increases in food prices,
summarized neatly here on Barry Ritholtz' blog.
I'm
going to do some more reading and run some more numbers to see if we
can get a better idea of what is/what is likely to be going on.
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Actually, probably there is an increase in wasted food. Higher prices mean less customers, which means more unsold food that has to be thrown out by its expiration date.
Another opportunity to consolidate an industry into the hands of a few players through systematic squeeze on individual restauranteurs. I have owned a few and typical food margins, depending on the type of cuisine, can range anywhere from 12-15% to 30-35%.
Think about the poor bastard running a small pizza shop and raising a family of three. If he can find someone to pay 22.00 for a cheese pizza, he'll be ok. If not, he's out of business and one is left with Dominos product for half the price and 1/4 the quality and taste...not to mention, another small family business up in smoke.
Gone will be the days where you could choose from dozens of different restaurants. We will be left with 8-10 players accounting for 100 brands. Extrapolate this and it won't be long before we will have even less variety to choose from.
fukashima has wrought peak cheeze
It's the independent restaurants that get hammered. The chains lobby for carve outs like McDonald's exclusion from Obamacare, and Darden for special tax breaks:
While Independent Restaurants Get Hammered By Economy; Darden Gets Handouts, Tax BreaksI have not eaten at a Chain Restaurant (be it MacDonalds or Chipolte or Mortons or any) for at least 5 years.
I prefer to cook (and yes, I'm damn good at it) but when I do eat out, it's always at independent restaurants.
At times it costs a little more than the chains, but the rewards far outweigh the costs.
I try to do the same with everything else. Banking, groceries, bike shops, mechanics, whatever. When I can do business with a small locally owned business instead of a chain, I do. It's my small contribution towards killing the giants and supporting small business.
Quality product has its own price. So does the service you get from a fidelity relationship between small company and regular customer...Nothing to beat it!
This article, as do most articles from Stone Street, tends to ignore the most basic and blaring facts...not the least of which being: How long can you keep raising prices on an already tapped out consumer before they just stop frequenting these establishments?
This idiotic concept that higher prices are always good for business as if the people who are the customers of these business don't matter one motherfucking iota is what makes me want to throw my computer monitor out the window when I read bullshit like this from these sell side whores.
While the price hikes will not affect the clientele of The French Laundry or Per Se, they will certainly affect the clientele of Red Lobster and MacDonalds...whether you want to believe this or not is only determined by how far in the sand your head is buried...and judging by the history of the articles posted by Stone Street here on ZH...these fuckers heads are buried so far in the sand that they must be about to burst out on the opposite end of the fucking planet.
Generally agree, but what happens in the short-intermediate term is that (because Americans believe they have a right to eat at restaurants) consumers still go out to eat, but they trade down. Which is why Taco Bell did very well in the downturn. And Americans tend to keep buying low price point products - hence convenience store merchandise sales (which excludes gas) did very well in the downturn. Folks keep buying $2-3 items -- even if they are priced well above Costco or WalMart.
These same folks who go out to eat will insist they have no way to put away more dollars for retirement or their own healthcare, but that is another matter............
McDonald's makes money off of
When you open a new restaurant, you take time to pick a good location. Over time, McDonald's ended up with a lot of real estate for high foottraffic and became commercial property developers who happen to sell burgers on the side.
With global franchise model, mcdonald's is in food distribution and brand marketing business.
It is nice to do analysis on the actual business
Don't agree with you often....but you are on point and correct here. MCD is a marketing company and a real estate company that happens to sell hamburgers on the side.
FYI: the dairy farmer has been suffering very low prices for over 2 years. Some are throwing in the towel, others are culling their herds and cutting production. But the price doesn't recover. Many factors contribute to their troubles not the least is the lack of competition for their milk! Only a few cheese processors and in general the "food business" is dominated by a few mega companies. No enforcement of anti-trust laws here...move along
I visited a monastery once and observed them making cheese. Yes, there was the initial cost of equipment and at some point a bit of labor intensive work. They produced for the monastery, not the outside world. It seems to me a local smallish dairy op. could do the same and sell locally or in a small region. It would be a shit load better than "American"
cheese. In my rural area there is a small regional cheese producer that continues to expand their sales region.
I live in Ontario's cheese country. There used to be small town cheese factories and co opss every few miles until the government put them out of business through the Milk Marketing Board cutting off their supplies of milk.
Good luck starting a dairy cheese factory or coop. You wil never be allowed to start and if you defy the law you will end up in jail.
Your point is really important because it illustrates how government has become the hitman for big bussiness. Subsidies and marketing boards and the limited options for the producer to sell his production. A farmer I know had a hog operation in addition to being a grain farmer. The prices offered by the slaughter weren't enough to make a buck after investing in the barns and sewage treatment ponds etc and he said it cost him $30 per hog to produce over what he got paid. He shut it down.
That said the local farmers market doesn't deserve much respect either. There is a good selection of meat, cheese, bread, vegetables and more and much of it is priced beyond the reach of the average person. The $0.06 slice of cheese at subway is a $0.50 slice (0.5oz) when purchased at the farmers market. So as long as you have the money you can get decent quality food.
So if you make your sandwich at home with good ingredients it can cost as much or more than a crappy one from Sub(standard)way.
Pricing analyses like these make me laugh, and it explains why so many small businesses fail in this country. The minimum gross margin needed to maintain a typical small business is 60%. It doesn't matter if the business is a sandwich shop, a plumber, or a florist, if they can't sell their product at at least 2.5X cost, they are toast.
So take that "9 cent" slice of cheese, add another ten cents for labor and we have a 19 cent cost to serve it. The restaurant had better get at least 50 cents a slice from the customer or they will not be around for long.
OK, here you go:
Local Mon & Pop Hamburger Stand.
Sales: 1.5 million
Total Cost of Goods Sold (including paper, plastic,cleaning supplies and miscellaneous expenses related to day to day operation): 41%
Your analysis is only faulty in not accounting for increasing costs other than food. Of course we raise menu prices more than the specific input increase.
All aspects of the cost structure are under assault from rising prices.
Prices are local, costs are global. So we do not have the power to raise prices merely because of increased input cost. The local market determines price, regardless of costs.
Fun analysis and a good read.
Nicely done.
Not very useful unless you are also keeping track of shop openings and closings.
e.g. If 25% of the shops have closed up...
Speaking of cheese:
I ordered a pizza a couple of months ago, and it was delivered without cheese! I kid you not. So the next month I ordered from a different pizza place....the same thing happened. I had to laugh at the absurdity of these name-brand restaurants (#1 and #2 in the industry) running the risk of putting themselves out of business just to save a few pennies on cheese. No customer in her right mind (at least not this one) will hand over money for crap.
As for sandwiches, you can make them WAY better at home. With all the cheese you want. :)
Serenity- I ordered 'cheesy' breadsticks from Pizza Hut the other night. I've ordered them in the past and they were awesome. This last delivery had, I kid you not, what seemed like a whole jar of parmesan sprinkled on them but not a single trace of melted cheese. I couldn't believe it. It's like these folks think we aren't going to notice it. And if I might add, if these occurrences weren't happening more and more, it really wouldn't be a big deal but it seems like it's with everything.
Last week, we went to our favorite pizza restaurant on the other side of town. Same thing. Poor ingredients in small quantities. It used to be top quality. (And the waiter was rude, and the kitchen messed up the order.) I complained, and got a card for a free meal the next time we go. But I certainly won't eat that garbage again
Disappear Liberals, use their cheese, problem solved.
the dairy farmers in my family are having a fuck hard time of it, I'm pretty sure they ain't "liberals" in the conventional sence..
but there's a point when producing becomes useless..
so i guess maybe you're right?
If the fucking gov. wasn't subsidising remote mega farms maybe you would have a chance.
The more fuel costs the better the chance of you selling local and making a profit. It's not
just for Libs. to buy local and pay more. Your time is coming.
I'll take the common sense of Sarah Palin over Bernanke and Obama any day ... does anyone wonder why this country is so f'd when that becomes a better choice.
Maybe SP like bunga bunga...just a thought...Shades of WJC.
I'll take a proven business leader like Romney over all of them, any day, no matter what religion he practices in his spare time, as long as he keeps it that way.
Romney told Kudlow that Bernanke was doing a fine job and that he would not replace him. That was the last straw with Romney. He's either 1. a puss, or 2. ignorant. Maybe both.
The sooner people stop paying for the 'convenience' of having someone else prepare and serve their meals and start 'brown bagging' their lunch, and also preparing their breakfast and dinner at home with food they buy in the grocery store the sooner at least this particular aspect of 'hyperinflation' will disappear. People who understand the revolutionary nature of buying physical silver and gold really ought to also understand that the sooner they stop eating fast food the sooner these games will stop and the megacorporations who are getting rich off our laziness will have to start offering real value or they will go belly-up.
By silver - kill JPM. Make your own breakfast and lunch - kill McDonalds. Grow a garden - kill them all.
Only problem : you're wife will kill you if you expect her to make every meal! She may be cordon bleu, but she likes to go out and eat and be served by others every once or twice a week. But having a garden to grow your own tomatoes, parsley and sage is nice. Along with the vine yard of course! All it takes is a plot of 2000 square yards! In addition to grass and flower garden.
Agreed. I've become incredibly stubborn and have completely boycotted McD's, coca cola and Walmart.
Starve them of everything you can i say.
Bingo. No Walmart, McDs, BK, etc. No sugared pop.
We splurge on local beer, fancy cocktails, and locally owned resauraunts.
Wife & I share cooking duties. She always packs lunch. Me, most of the time. Today I am making chicken stock from last weeks 2 for 1 free range chickens & working on installing a raised bed garden.
Last week I had direct experience getting a turkey sub from JimmyJohns and the cheese was $0.50 extra. That said it was a decent sandwich and there was a line out the door. Bicycle delivery is $0.25 extra per item.
Been fixing my breakfast and lunch most of my life. Since I got rid of the little woman I fix most of my dinners too. Yeah, if I haven't planned ahead and get stomach growling while on the road I'll stop at Burger King (I can't stomach anything but fries and McD) and get a Jr. Whop.a small fry and WATER. Otherwise I'll stop at a short order restaurant or grocery and get back on the road.
Maybe that's why I'm not a porker.
Every Thursday I get a Subway breakfast flatbread sammich on the way to work. I usually have to wait in line. Today I went in there and all the usual breakfast items were replaced with new items and no pictures. I ordered the closest thing to what I ordered last time, which was $2.25 instead of $2.50. It was HALF the size! They cut everything in half, left off the cheese, and knocked 25 cents off the price. When finished, this was no bigger than a playing card. Yes, I was still hungry, having run 4 miles earlier.
Oh, and the $5 foot-long is now $6.75.
And this is at Subway, master of the undersized, lower-quality (that isn't Boar's Head/Thuman's/etc meat you're getting) foodstuffs, and oversized rolls/buns! They don't have much room left to cut before even the most ignorant/naive start to notice...although being private helps, I'd imagine. The question is how strong is the brand addiction and how does that compare to elasticity of demand?
This one is easy. I'm never setting foot in a Subway again.
I used to eat at a local Subway once or twice a month. They started cutting the tomato slices diagonally in half and spreading them (only 2 half slices) on each 6 inches of the sub. So you only get 2 full slices of tomato on an entire foot long. Say what? I cancelled my order the last time and have not been back since. I can imagine what they did to the little meat bundles that they put on the sandwiches...
My senior year in college 1967
MacDonalds
Double Cheeseburger, Fries and a Coke $1.00
Oofaa..!
That's $33.85 in pre 1964 money!
Jesus, no wonder I could date more girls in a week than the average guy today can in two months! Besides, the slimy dickie gets his GF to pay for the meal nowadays! What a world...
It's inflation (actually Hyperinflation but they won't say that until it's to late), and McDonalds and Walmart is telling the truth. I shop at Walmart and they where already making packages smaller and giving less for the same item a few months ago you would have gotten more back in early 2009. But this time it's exponentially going up and service is getting reduced. As an example I bought off and on precooked Tony Romas 24oz ribs, but now they have cut the package down to 3 servings (8oz's) per pack and costs 1 dollar less than the 24oz one that they don't carry anymore. This isn't inflation, it's hyperinflation and it's showing up slowly but surely.
You posted the same comment in another article, Buck, so I'll post my same answer:
You can rest assured that Walmart is making their money while they can. Package size, in-store promotions, and other marketing schemes will let them make money all the way down (up?). Walmart is not run by a bunch of dummies; they have the long-term mentality of the Chinese. Innovation and mechanization of the entire store operations have given them the ability to make money on very slim margins. Walmart is like the proverbial cockroach: They will survive the Kondratieff winter.
Here is my same answer, abridged. Walmart is no longer a low cost store. In the one in my town, food costs more than the supermarket across the road. Other items also cost as much or more except for a few heavily advertised cheap items.
I try to stay away. When they were doing their initial expansion to every town 10 - 15 years ago they killed a lot of small shops and the town centers in favor of the commercial strips on the fringes of the city. I knew it would end with them having a commercial monopoly and raising prices because they are the only game in town.
Soviet style communists were monopolists just as are western so called capitalists. Both are accomplished through the use of fiat money.
With all that reduced portion packaging the current and past cookbooks are going to have to be adusted.
ie:
1 can 14.5 oz tomato sauce
1 package 12 oz swiss cheese
1 box 12 oz elbow macaroni
etc.
For single people the reduced contents are ideal. I buy those packets of Swiss Cheese for my sandwiches ( not the individually wrapped pseudo cheese slices) and, usually, the last slice or two would go bad before I used it. Not anymore. I actually used the last slice this afternoon on a pastrami sandwich. Now if they could only make a smaller head of lettuce. I know, buy the prepacked 'salad' but paying $4 for 50 cents worth of lettuce and a few specks of carrot and radish is ridiculous and there is no way to know how old it is when you buy it.
packed in nitrogen so it won't rot. convenient for you too that you don't have to take the time to clean, peel, and cut everything.
as the coffee buyer would know, 12 oz is the new pound.
Fomenting ignorance in math is paying off for the large corporations.
I love analysis like this.
However your not even factoring in the rise in costs in all materials in a sando (and labor?). Not just cheese.
How do you know sandos sans cheese were even profitable in the first place?
You do realize pushing 575 sandos w/ cheese a week is quite a bit? Thats 36 lbs. of cheese per week.
BTW the local sandwich really is a great measure of inflation. It covers all your basic food groups, and has transportation, energy, and labor aspects too.
Another thing that is left out of this so called "analysis" is waste. Restaurants serve FOOD. Unsold food is called TRASH...But they still paid food prices for it.
I know more than a few restaurant owners and Chefs...It's a hard business and they are all taking a hit lately. the only ones doing "well" are the publicly traded companies. Why are they doing so well? Easy : they're cooking the books. It's largely bullshit and slight of hand.
I found this article to be maddeningly ignorant. It felt like some pumper trying to get my to buy stock...gee...why would it feel like that? I wonder...
We disclose all positions. Notice how there was no disclosure? That's because there's no positions, relevant or not. Keep that tin-foil hat on, it looks good on you.