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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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Are you implying that there's been inflation in food waste too?
Are restaurants actually throwing away more food than they did a few years ago?
I'm assuming food lost to waste is a fairly constant thing.
minmum wage up 40% is more important so far
Not intended to be anything even remotely approaching a "complete analysis" and I should have clarified that, my apologies.
Judging from the handful of sandwhich shops near my last office, which were packed to the gills between the hours of 11am-2pm (and I mean PACKED), I don't think a few hundred sandwhiches/day is entirely out of the question, but its just a semi-arbitrary number for example's sake. For simplicity's sake, I'm assuming the restaurants were at least breaking-even if not turning a decent profit on their operations pre-food price increase (lest they'd be bankrupt, eventually).
I'm going to try to see if I can figure out some auspices under which I can get some small-to-medium sandwhich shop owners to divulge their cost structures, that should be fun I think!
I worked in the food service industry. Cheese is one of the biggest margin makers the restaurant has. Folks like you almost automatically say "Yes" when asked if they want "cheese on it", and it usually doubles the gross profit per sandwich. Same thing with a soda - it usually costs the resto less than a dime, and they charge $1+ for it.
Look at all the $1 "value" menus at fast food joints; I can assure you they're not making dick on the sandwich. All the profit is coming from the soda/fries/cheese.
Mormal rule of thumb is food cost is 25-35% of final cost. For a lot of lunch spots, they're pushing the higher end of that number. Adding cheese at $0.50 just gets the margin back to where it should be.
Thanks for the comment, most sheeple are painfully ignorant of how things work.
In your next more "complete" analysis...you might want to inquire about what happens to unsold food. In culinary circles it's known as TRASH.
I could be wrong but, rumor has it that you can't get a refund on it.
Nod. Don't forget insurance costs, employee benefit programs, heat & cooling, cleaning and sanitizing, subscription costs to muzak, electrical for cooling the cheese while in storage, rent on the facility and depreciation of all cheese related cooking/preparing hardware, proportionate amount of things the customers aren't charged like napkins ketchup and straws. Did I miss anything? What? Franchise fees and costs of branded supplies, license fees for the shop, alarm systems fees for protection against theft, insurance fees in case an employee or customer slips/croaks/wigs out, contributions to the local chamber of commerce, the BBB, and free meals for the cops. Plumber's fees for unstopping the free toilet last week, along with toilet paper, soap, water, paper towels.
Little bits here, there, (everywhere), but those darn sammy shop owners need to be shown up as insanely rich greedy capitalists...
The intent is not to paint restaurant owners, small or large, out to be the "greedy capitalists" of which you speak. If that is how you interpreted it, that points instead to your bias and preconceived notion(s), not mine.