Crain’s Chicago Business – McDonald’s reheats its value menu

By Peter Frost March 19, 2016

Riding a wave of momentum triggered by the launch of all-day breakfast, the world’s largest fast-food company is grappling with the next stage of its turnaround plan: its new value platform.

Turning McPick, as it’s called, into a consistent, advertising-backed national program that appeals to its core cost-conscious consumers is crucial for Oak Brook-based McDonald’s, whose big bet on breakfast is paying off but won’t last forever.

McDonald’s needs McPick to be a supersized hit.

“The reality is 67 percent of transactions (at fast-food restaurants) are under $6,” says John Gordon, a restaurant analyst and consultant in San Diego, citing data from consumer research firm NPD Group. “It’s very
important for them to get a sustainable value menu, and there are so many different ways of doing it. You would hope there are whole floors of corporate staffers in Oak Brook that are thinking about these things.”

Its customers want a new value menu, too. Offering one ranked as the top change McDonald’s could make to drive more customer visits, according to a national survey conducted in August on behalf of Crain’s by Chicago-based research group 8Sages and the late pollster Leo Shapiro. The survey found that 32.4 percent of respondents would dine at the Golden Arches more often.

But executing such a program across more than 14,000 U.S. restaurants owned by McDonald’s and hundreds of franchisees is complex.

“We’ve been trying to develop a new value menu for six years and, obviously, it hasn’t worked out all that well,” says one franchisee from the Southwest, who requested anonymity.

McDonald’s declined to make executives available for interviews. Spokeswoman Lisa McComb says in a statement that the company “is continuing to try new approaches and at a speed not seen before.”

McDonald’s kicked off 2016 with the debut of McPick 2, which allowed customers to choose two items from among four—the McChicken, the McDouble, small fries and mozzarella sticks—for $2. The five-week pilot,
which analysts believe helped boost traffic, may have hurt profitability in some markets because of a “trade-down” factor, in which customers chose the $2 deal over a regular-priced entree or value meal.

As soon as that deal expired, McDonald’s introduced a McPick 2-for-$5 deal, featuring some of its best-known products—the Big Mac, the Quarter Pounder with Cheese, the Filet-O-Fish and Chicken McNuggets. That
promotion remains in most markets today. Others, including the Atlanta market, have kept the 2-for-$2 deal.

“In spite of the mixed success of 2-for-$2, we believe McPick 2 can represent (a meaningful) value brand for McDonald’s,” RBC Analyst David Palmer wrote in a March 7 note to clients.

Franchisees prefer the richer 2-for-$5 promotion, which has enough shine to lure customers and, if bundled with fries and a drink, can bring the average check size to $7 or $8.

McPick represents the restaurant giant’s first major foray into value since its successful Dollar Menu in 2001. While Oak Brook futzed with it, eventually morphing it into the Dollar Menu and More, newly energized
competitors Burger King and Wendy’s went all-in on value offerings of their own, which analysts say took share from McDonald’s.

Indeed, the company lost U.S. market share for 71 consecutive weeks, a streak that finally ended in late September when McDonald’s began to claw back share, in part because of publicity surrounding the launch of
all-day breakfast.

An East Coast franchisee, who asked not to be named, says Big Mac’s lack of a national promotion has hurt the brand. All franchisees are “missing the key element of everyday pricing,” he says. “We need to give the
customer choice and control. That is why (the) Dollar Menu was so successful.”

But much has changed since the introduction of the Dollar Menu, which sparked a decade-long run of robust sales growth in the U.S., its largest and most important market.

Perhaps the biggest difference today is the disparity of wages between certain urban stores and others, the result of minimum-wage laws. That’s led to friction between the regions, and Oak Brook has accomplished little
in the way of getting disparate franchisee groups to march together on a sustained value platform. A deal that makes financial sense in Omaha, Neb., for example, may be a money loser in Manhattan.

Some franchisees are pushing for a customizable value menu that differs by region, an approach McDonald’s plans to test later this year. But that could discount the effectiveness of the chain’s national advertising, which is
paid for with a pot of money funded by franchisees.

“Value today is a necessary evil,” says Darren Tristano, president of Technomic, a Chicago-based consumer research firm. All fast-food companies are “playing in that space because they have a deep fear of losing
share,” which has set up a sort of race to the bottom.

The prevailing thought is: If they don’t discount as deeply as their peers, customers will go somewhere else. It’s a risk McDonald’s can ill afford to take.

The Columbus Dispatch – Bob Evans’ prepared-foods unit growing while restaurants struggle

By JD Malone
The Columbus Dispatch • Friday February 5, 2016 6:05 AM

In a refrigerated case at a QFC grocery store in Portland, Ore., mashed potatoes and macaroni and cheese bearing the red and white
Bob Evans Farms logo await the hands of hungry shoppers.

The side dishes are almost 1,800 miles from the nearest Bob Evans
restaurant (in suburban Kansas City, as it happens) and they are
selling like, well, hotcakes.

“Most people who grow up here think of Bob Evans and they think
sausage,” said Mike Townsley, president of Bob Evans Foods, the
company’s prepared-foods division. “We sell more mashed potatoes than sausage.”

Bob Evans’ side dishes are in more than 30,000 stores in every state and parts of Canada. The lack of brand awareness — the company’s 547 restaurants are in just 18 states, mostly in the Midwest — hasn’t dampened
sales at all. Bob Evans side dishes command 50 percent of the market and have three times as much market share as the closest competitor, Hormel.

“When we first introduced into QFC (a subsidiary of Kroger) in the Portland area, within the first three months, Bob Evans was the leading item in the category,” Townsley said.

Bob Evans, based in New Albany, launched side dishes and breakfast sandwiches in the 1990s to complement its retail sausage business. Sales of side dishes grew so much the company bought its largest supplier, Kettle
Creations, in 2012 and invested $25 million to expand a plant in Lima, Ohio which can now make about 100 million pounds of mashed potatoes and macaroni and cheese a year.

The company is spending $20 million this year to increase capacity in Lima by 30 to 40 percent.

Bob Evans restaurants have wrestled for years with declining traffic and sales, but the food division has been a very different story. Though it makes up less than a third of the company’s overall revenue, the food
division has made more money than the restaurants in recent quarters and is growing at a double-digit clip.

The success at Bob Evans’ prepared food division has made it a target for activist investor Thomas Sandell, who has called for the division to be sold or spun off. In December, Sandell released a letter stating that at
least one potential buyer had stepped forward and he believed the sale price could approach $1 billion. Sandell hopes to reward shareholders like himself with a windfall dividend or expansive share buybacks.

At least one analyst agrees. It is time to sell the division now that a new CEO, Saed Mohseni, is on board, said Gordon sees all those side dishes as a distraction. In his view, Bob Evans’ core business is restaurants and
needs the company’s full attention.

Townsley said his team tries to ignore the chatter, but admits that it is human to be distracted by such talk.

“Our business is doing very well and let’s stay focused on what we can control,” Townsley counsels his staff. “If we do all those things, everything will work out just fine.”

The same market forces that have sent former Bob Evans and Bravo Brio patrons to faster, cheaper and more convenient options like Wendy’s and Panera are also apparent in grocery stores, said John Rand, senior vice
president of retail insights at Kantar Retail.

“Refrigerated side dishes are a huge time saver at what is perceived as moderate expense,” Rand said.

And to Gordon’s point that the two Bob Evans’ divisions have diverged: At the grocery store, the brand name doesn’t matter; product perception is everything in the cold case, Rand said.

“The restaurant’s own brand may be largely irrelevant. It may assist early trial and adoption, but the item has a stand-alone value even if a shopper is not particularly aware of the restaurant chain,” Rand said.

Households headed by a pair of working adults seek out food items that make life easier, no matter where they live, Rand said. That means even in Portland, Ore., people who have never sunk a fork into Bob Evans’
pancakes or sausage will buy its side dishes.

Townsley thinks it is even simpler than that.

“Once we get the product in people’s mouths, the quality of that product sells itself,” he said. “I’m sure your mom and grandmother can make great mashed potatoes, but not in 5 minutes. That’s the crux of it.”

By JD Malone
The Columbus Dispatch • Friday February 5, 2016 6:05 AM

jmalone@dispatch.com
@j_d_malone

Blue MauMau – 2015 Restaurant Franchisee Profitability Reporting and Implications

Posted Tue, 2016-04-05 00:41 by john a. gordon

I’ve noted the reluctance of virtually all restaurant franchisors to report the profitability of franchised stores. But there are a few franchisors that do.

After watching fourth quarter and year-end results for 2015, Popeye’s (NASDAQ:PLKI) and Domino’s (NYSE:DPZ) continue to stand out in reporting franchise store level “profit,” which is likely an EBITDA
number. Both franchisors have done so for some time, three years now by my count.

The table below shows the trends.

Restaurant Franchisors Who Report Franchisee “Profitability”
Source: Company year-end earnings calls

Brand      2015 US Unit    “Profitability”     Net US New Stores Trend
Popeyes          $340,000             +72                          Up, from $177,000
Domino’s      $120,000              +133                         Up from $80,000.

To its credit, Dunkin’ Brands (NASDAQ:DNKN) typically reveals new year Dunkin’ Donuts Western U.S. opening cohort (i.e., class) sales and simple unlevered (i.e., no debt service) cash on cash return. The McDonald’s (NYSE:MCD) chief financial officer noted in March that the U.S. franchisee “cash flow” was $350,000 per store unit. As with Popeyes and Domino’s, the $350,000 is of course before many costs and expenses. McDonald’s CEO reported franchisee numbers in 2013, when franchised stores reached
$500,000.

Despite the fact that store EBITDA is profit before everything—profit before taxes, franchisee overhead, debt service and future years capital spending (CAPEX), these are still important indicators.

There are two implications that can be easily seen.

1. The timing of the lack of franchisee visibility is unfortunate given the current state and municipal push for minimum wage increases
This week’s minimum wage increases in California and New York were made without the general awareness of how marginal franchisee true cash flows could be, after allowing for brand royalties, rent margins, price discounting, capital expenditures and other fees. The policy makers and the politicians didn’t have the data and have to be educated in any event. Most have only a very hazy understanding of the difference between the large franchisor corporations and franchisees, and most importantly, who pays for what. Some will say the wage increases would have happened anyway; but the small business advocacy game has to be played with all the cards in the deck. Franchisors can improve the odds with better disclosure.

2. The store economics for Domino’s and Popeyes show that franchise unit growth follows the store profitability of a system’s franchises
In other words, profitable franchises produce an environment for franchise expansion. Take for example, both Domino’s and Popeyes. They were in the midst of a recent period of rising store level profitability. The profitability gains of their franchised restaurants encouraged and enabled future unit expansion, as both CEOs noted to analysts. Future franchisee unit growth was funded via retained profits and positive cash flow that franchisees accumulated. Why? Because almost every franchise loan requires injected franchisee capital, and because most franchisors target their own franchisees for expansion. That means profits for the franchised stores first, then franchise unit expansion, not the other way around.

History shows that massive increases in franchise store count without the average store being profitable bodes poorly for a franchise system in the restaurant industry.

Wray Executive Search – Subway’s Face Lift: Fixing Franchisor Flexibility

Posted Mon, 2015-08-31 22:16 by john a. gordon

By now news of Subway’s version 2.0—it’s hoped for rebirth and revival– are available via the New York Post’s Monday piece. Insiders in the restaurant industry knew it was inevitable. Still, there are several
lessons seen in the Subway experience to date—and not coincidentally McDonald’s, too– that are gaining steam at approximately the same time in the US (McDonald’s problems in certain world markets like Japan
were building for years).

Here is a list of observations to speed Subway’s revival process along:

Fix the over store development: Certainly in the US—with over 1 million foodservice venues– can be jammed with too many restaurants. There is no life or death need to go out to eat, just to eat. Subway is aimed at the lunch market, which itself is finite, and has been declining in market share the last few years. With over 27,000 US restaurants—and negative same store sales for three years, the general upward bound of Subway US unit counts has been reached, (though certainly there are some good replacement locations can be found.) Subway is not publicly traded and does need to put up big store development numbers every quarter. Pause the US store growth, smooth it out, and let the market catch up. As US
Subways stores close, don’t replace them. Try to find that point of reverse cannibalization where the closures benefit the remaining franchisees.

Test, test, and test: one of Subway’s strengths is that it has 27,077 test stores in the US, where a multitude of new products and techniques can be tested. But yet, they didn’t, apparently until now. Both
Subway and McDonalds have hit dead momentum. System wide national rollouts, like this one, should be tested in whole markets. Unfortunately, Subway has no company stores and it has to rely upon getting the
franchisees on board or bludgeoning them with the franchise agreement and operations manual to agree. There should be hundreds of tests underway.

Not everything has to be the same everywhere: rigid restaurant consistency from unit to unit was a selling point in the 1950s and 1960s, when restaurants chains began to develop after World War Two, with
the birth of the Interstate System. Back then, consumers were turned off by lack of consistency experienced along the country roads. Since then, franchisors have perfected inspection rights, to insure everything is
the same. As circa 1948 Dairy Queen Franchisee in Minnesota (not bound by the same contracts as today) said recently, “The corporations want everything to be the same”.

Today, the US is hundreds of times more diverse than the formative 1960s, with different consumer socioeconomic, national heritage, communication, income, work and education patterns; vastly different traffic,
neighborhood and psychographic consumer behavior drivers everywhere. Does everything need to be the same everywhere? A good Subway example is the sliced prepackaged apples: I’m glad they are on the
menu. But it must be considered to be a never out item, and this is enforced by the franchisor inspectors. If the sliced apples don’t sell in some units, figure it out and get to a lower, build to on hand level, by unit.
Once the store is out, it is out. A sure sign is if the store is throwing out more than are sold. A product yield for products like this should be 90% plus.

The business shouldn’t be run for the ease of the ad agencies and franchise field consultants. Subway now has a new ad agency—BBDO, replacing the long time incumbent. This is a sure sign of corporate unease. It is easy for ad agencies to devise discounting and big TV media heavy spending plans,
and for franchise field consultants to work off one inspection checklist if everything is the same everywhere. But this is how all the restaurant chains begin to look alike, where everything is the same everywhere. Subway had years of lazy marketing—discounting—which is puzzling since it was not publicly traded and didn’t have to put up quarterly same store sales numbers. What makes it worse is that Subway measured ad spending rose in 2014 despite negative sales. Advertising levels cannot solve brand momentum problems.

Fix the bread and the aroma marketing: my high school memories of walking in Subway was a yeasty bread baking aroma. Today, however, that is not experienced, other mixed food and burnt odors predominate. The bread isn’t toasted fully and is a mouthful of carbs. Dirty ovens? Too many products? Changed bread formulation? It is important because it is the first bite, the first impression.

Starbucks had this same aroma problem in 2008/2009 but fixed it, and once again smells like a coffee store when arriving. They had to change the ovens. Is this something that Subway would have caught if it owned and operated some stores?

The New York Post – IPO lands Shake Shack’s Danny Meyer $342M in 1st day

By Richard Morgan

January 30, 2015 | 11:21pm

What started out as a hot-dog cart in 2001 has emerged as Shake Shack, the 63-store chain with a valuation of $1.63 billion after its first day of public trading.

New York restaurateur Danny Meyer, who conceived the cart to help restore a then-downtrodden Madison Square Park, saw his wealth increase by $342 million Friday as stock soared 118.6 percent above its initial public offering price of $21.00 per share to end the day at $45.90.

Meyer owns 7.4 million of those shares for a 21 percent stake in the hot-dog cart he turned into a humble hamburger kiosk in 2004.

 An even bigger winner from the IPO was Leonard Green & Partners — the private-equity firm took a controlling interest in Meyer’s Union Square Hospitality Group in 2012.

The splitting of Shake Shack from privately held USHP, which remains home to such upscale eateries as Gramercy Tavern, The Modern and Maialino, left Green with a 26.0 percent Shack stake — valued at $423 million after the IPO — in the new public company.

The share’s upward trajectory Friday didn’t completely surprise analysts, who noted the halo over Shake Shack’s so-called “fast-casual” eating category has burned brightly since Chipotle Mexican Grill conducted its IPO in 2006.

The dearth of publicly traded restaurants added to the IPO excitement, as did Meyer’s contacts in the media and top-tier ranking in the restaurant firmament.

That most Shake Shacks are in areas frequented by financial types — including Dubai, Kuwait and London, as well as lower Manhattan — created even more sizzle with just the right segment.

The chain is undeniably popular in Manhattan, where the average store rings up $7.4 million in sales annually.

Yet, even its domestic non-Manhattan Shacks, with average sales of $3.8 million, throw off enough business to stir the envy of the food industry.

That said, however, is a self-styled chain of “roadside” burger stands that offers classic American fare of upscale burgers, hot dogs, crinkle-cut fries, shakes and custard really worth $26 million an outlet?

Never mind that Meyer plans to expand the chain by 10 outlets a year; John A. Gordon of restaurant advisory Pacific Management Consulting Group dismissed its implied stock valuation as “unsustainable over a long period.”

This is especially the case, he said, on comparing metrics commonly used for restaurant companies. Gordon estimated Shake Shack’s EBITDA to be $18 million last year and its enterprise value at $1.7 billion as of Friday.

That suggests the chain began life as a public company with a 94.4 Ebitda multiple — compared with a 10.7 multiple for McDonald’s.

Granted, Shake Shack is no McDonald’s — but the multiple will move lower as the quest for finding what Gordon called “premier sites” and additional customers escalates each year.

At the end of “a very exciting day,” CEO Randy Garutti told The Post, “We gave options to every manager in our company. “They could also buy stock at the IPO price.”

The New York Post – Subway founder’s sister takes over operations

By Josh Kosman

February 8, 2015 | 11:16pm

Suzanne Greco, 59, whose official title is still senior vice president, has taken over day-to-day operations for the closely held company with some 40,000 outlets around the world.

DeLuca recently sent a memo to top executives with a new organizational chart that showed all departments now reporting to Greco, a source said.

“On paper, she is running Subway.”

DeLuca, 67, has declined to discuss succession plans despite chemotherapy and a bone-marrow transplant that sidelined him for months, leaving franchisees to grapple with the question of who will step in for the legendary founder.

Subway, which a teenage DeLuca borrowed $1,000 to start in Bridgeport, Conn., in 1965, has been secretive about its management and doesn’t have to divulge financial details as a private company.

“While Fred DeLuca actively leads our family-owned company, he’s sharing more responsibilities with Senior VP Suzanne Greco,” a Subway spokesman said.

Greco has taken the lead at a tumultuous time for the Milford, Conn.-based company, which will mark its 50th anniversary in August. Like other major fast-food chains, Subway is struggling with sagging sales, changing tastes and cutthroat competition.

In January, Greco took center stage at Subway’s annual franchisee meeting in Miami, where execs acknowledged “there had been problems and they are fixing the problems,” according to one attendee.

DeLuca was also at the meeting but appeared frail, the source added.

The ubiquitous chain has been making some substantive changes, such as distributing refrigerated roast beef instead of frozen, and is planning to roll out free-range chicken in some markets to appeal to more health-conscious consumers.

At least one franchise operator took a dim view of Greco as heir apparent, saying he doubted she would make the wholesale changes needed to reverse slumping sales and profit.

Greco started as a sandwich maker at age 16, and went on to head research. She gets credit for the cold cut combo and sweet onion teriyaki subs.

Keeping it in the family also sends the signal that there won’t be an IPO or sale of the chain in the near term — options DeLuca has long resisted.

While Subway surpassed McDonald’s as the biggest chain in 2011, it has never been as profitable. A Subway restaurant earned, on average, an estimated $40,000 to $55,000 before interest, taxes and depreciation last year, down from $70,000 in 2012.

During the same period, average annual sales fell 4.6 percent to $460,000, according to estimates from John Gordon at Pacific Management Consulting Group.

Subway, which saw explosive growth 17 years ago with Jared Fogle’s now-famous Subway sandwich diet, expanded too much and failed to roll out many new products, Gordon said.

“Like McDonald’s, Subway enjoyed a long run of success but has hit a sustained difficult patch,” he said.

Nation’s Restaurant News – How Starbucks operates like a tech giant

Jonathan Maze
Wed, 2015-06-17 16:49
This post is part of the Reporter’s Notebook blog.

Three years ago, Starbucks Corp. bought a popular local bakery chain out of San Francisco, called La Boulange Bakery, for $100 million — an extraordinary price for an 19-unit concept, at least back then.

At the time, Starbucks indicated it wanted to grow the brand. But it mainly
wanted access to what La Boulange did: Make quality food. Facing tough
competition from McDonald’s Corp. and Dunkin’ Donuts, the Seattle-based
concept wanted to improve its food offerings.

Three years later, almost to the day, Starbucks backtracked on that decision, announcing late yesterday that it will close the 23 La Boulange locations, as my colleague Lisa Jennings reported earlier. The company
“determined that La Boulange stores are not sustainable for the company’s long-term growth.”

Starbucks is instead focusing on building La Boulange as an in-house brand, to continue to build its food business inside coffee shops. In hindsight, $100 million is a lot of money for an in-house brand.

The move wasn’t really surprising, however. Starbucks has bought a few brands over the years and then integrated them into their operations. It bought Seattle’s Best in 2003 as a lower-end coffee option, and has
since turned that brand into a retail brand with licensing opportunities.
It also bought the Evolution Fresh juice bar in San Francisco, and now sells Evolution Fresh juice in its coffee shops. Indeed, tucked in the same release as the La Boulange announcement was this little nugget: The
Evolution Fresh retail location in San Francisco will close, too.

In 2008, the company bought the maker of the Clover French press brewing system and then rolled that machine out to its locations.

In this, Starbucks acts more like a tech giant than it does a restaurant chain. Rather than developing a juice line or a set of food offerings from the ground up, Starbucks spends a few bucks and buys an existing concept,
integrating that knowledge into its system and adding those products into its coffee shops.

That strategy is relatively rare in the restaurant business. In general, restaurants buy existing brands to grow and develop them, rather than to integrate their knowledge into their system.

To be sure, some will buy awfully small concepts. PizzaRev was a one-year-old chain with three locations when Buffalo Wild Wings scooped it up in 2013. Pizzeria Locale was a concept little known outside of Colorado when
Chipotle Mexican Grill decided to partner with the company in 2011.
But rarely do restaurants buy a concept for the talent and technology the way Starbucks does. When McDonald’s wanted to add a new beverage line a few years ago, it developed the drinks itself. It didn’t buy a small coffee
chain first.

“Most restaurant brands take pride in food engineering themselves — it’s a core competency — and feel creating internally has to be cheaper than a bolt-on acquisition,” said John Gordon, a restaurant consultant out of San
Diego.

So while La Boulange didn’t quite become the national bakery chain that Starbucks planned back in 2012, the coffee chain did succeed in its primary goal to improve food sales at its coffee shops, which are up 16 percent.
That added 2 percentage points to the chain’s same-store sales number.
And investors care almost exclusively about what happens inside Starbucks’ 21,000 locations.

Contact Jonathan Maze at jonathan.maze@penton.com
Follow him on Twitter: @jonathanmaze
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