Combating Shrinking Margins

1. Combating Shrinking Margins Overview of online research conducted with 150 operators in January 2008. The general economy, rising costs, and increased competition have all had a profound impact on operators’ profitability – resulting in an industry-wide need for effective strategies for improving the bottom line. Datassentialhas prepared this short guide to explore how operators and suppliers can work together to counteract these margin pressures and ultimately enhance mutual profitability. You can download this document at: www.datassential.com For more information, contact Jack Li at 310-922-6299 or jack@datassential.com

2. IFMA: COEX 2008 It’s an increasingly challenging business environment for operators, with higher costs in several areas impacting margins and profitability. What’s more, the vast majority of operators believe that things will only get more competitive in next few years, although only a small minority acknowledge that they are prepared for such changes. This brief examines the operator perspective – what the challenges are, which strategies work, on how suppliers can help. A far more competitive environment. As these figures show, operators today are facing an increasingly competitive landscape – with a vast majority (76%) indicating that the business environment has become more competitive, and just a scant 3% who say it has become less so. Recognizing the increased pressure to perform, it’s natural for operators to seek out help from suppliers, peers, and industry sources – providing food manufacturers and trade organizations with an excellent opportunity to offer effective tools that enable operators to compete more effectively. Higher food, labor, and energy costs.These three factors have had the most severe impact on operating margins, with a majority of operators indicating that they have had either a “negative” or “very negative” effect. This suggests that operators are more concerned with the expense side of the profitability, most often attributing shrinking margins to their most visible costs. Revenue is a factor too (nearly 40% indicate that increased restaurant competition has hurt their margins), although it’s costs that appear to be foremost on operators’ minds. p.2

3. IFMA: COEX 2008 Dairy, meat & produce. Higher food costs have hit operators the hardest in the dairy, protein, and produce categories A whopping 89% of operators, for example, state that higher dairy costs have impaired their operating margins over the past 3 years. And while higher prices for beverages, sauces (condiments, dressings, etc.), and prepared foods are less of a concern, they too have impacted a significant population of operators. That operators are so quick to attribute shrinking margins to higher food costs may be partly a function of perception; their most direct expense, operators are likely to notice food costs first. Regardless, it’s important to keep in mind that operators are prone to be particularly price sensitive these days – as food costs are firmly top of mind. “…Health conscious consumers have harmed the business since they do not associate eating out with eating healthy; also, the mandatory switch to trans-fat free oil altering fried foods’ taste; and the cost of transportation of goods has increased, decreasing my net profit…” Pressure from everywhere.Rising food costs are of course not the only concern. When asked what external factors (those things that are beyond their control) have had the most severe impact on their margins, operators responded with a range of issues from ethanol to minimum wage laws. Major industry trends – such as the move toward health-consciousness – are perceived negatively by many, as the switch away from unhealthy foods has caused operators to drop some of their most profitable menu items. “…The economy, gas prices, mortgage crisis...people just aren't spending as much as they used too. Also the cost of food has increase, and my prices have not yet reflected this…” “…Higher food costs, mandated nutrition standards that have caused us to drop popular choices thus affecting participation levels and decreasing revenue, higher employee costs…” Key External Margin Pressures • Rising energy costs • Rising transportation costs • Ethanol • Rising labor costs (minimum wage) • Rising disposables costs • Changing weather patterns • Health consciousness • Chain proliferation • Increased competition • General economy / macro issues “…Corn used as a biofuel has hurt more than anything. Everything that is tied to the petroleum industry is causing a sharp increase in price. Since corn is a primary feed source, this in turn has caused items to become more expensive. Many purveyors are adding fuel surcharges to their invoices.…” “…The cost of food has skyrocketed and our customers are not willing to pay the difference. Also, more and more restaurants are opening up…” p.3

4. IFMA: COEX 2008 Operators adapt. Despite the range of external forces exerting pressure on their margins, many operators have found a way to stay profitable – and in some cases to even enhance their profitability. As seen here, just one-third of operators indicate that their profitability has dropped over the past three years, compared to over 40% who have experienced an increase. [note: this analysis does not take into account operations that have gone out of business; as such, the true percentage of operators that have experienced a decrease in profitability may be somewhat higher than is reported here] Higher menu prices, cost control, and other profit strategies.Operators have adopted a diverse range of profit-building strategies to combat margin pressures. Most often, they attempt to pass along their higher costs to the end customer – something that nearly 80% of operators have done. Cost control mechanisms are also quite common, such as improvements to procurement / inventory control, lower cost products, and kitchen simplification. Furthermore, operators are prone to enhance their menus, either with an upgraded look or through the addition of more premium items. And operators are increasingly turning to the Internet to generate business, as web-based marketing edges out traditional marketing below. p.4

5. IFMA: COEX 2008 Inventory control works. When asked to name the three strategies that have been most effective at strengthening margins, operators most often cited improved procurement / inventory control. In fact, nearly all operators who have used this strategy indicate that it’s one of the three best they’ve used. By contrast, while more operators have increased their menu prices (72.9%), substantially fewer have found it to be a particularly effective approach (41.9%). Tips and tools.Operators want tips and tools for lowering their operating costs and raising menu prices (without losing customers, of course). Worth noting is that there is significantly greater demand for helpful tips than for specific products – as only a minority are interested in more premium or fully-prepared products. Just as importantly, there is little demand for cheaper, lower quality products – even if the difference in quality is only minor. p.5

6. IFMA: COEX 2008 Go local, get healthy. Dishes featuring locally-sourced and healthy menu items are regarded by operators as the best opportunities for generating menu premiums. Organic and all-natural items – which have accelerated considerably over recent years – are also viewed strongly in this regard, as is the usage of ethnic and innovative flavors. For suppliers, these should all be noted as important opportunities to help operators. More pressure ahead, but few are prepared.The vast majority (75%) of operators expect the business environment to become even more competitive in the coming years, yet few indicate that they are prepared for it – just one in six state that they would be “very well prepared” to handle further margin pressure. This suggests an enormous and continuing opportunity to help operators build more profitable businesses – through products, tips, and other support for lowering operating costs and delivering higher check averages. How to help.While operators are seeking help in a variety areas, a few are noted as being most critical: “…Training manuals. Hire a consulting team to revamp the training process, which increases efficiencies in the workplace and can have a positive impact on the revenues…” • Staff training • Proven menu ideas / recipes • Suggestions for premium menu items • Tips on in-demand foods / flavors • Labor-saving items • Tips for lowering food cost • Accounting procedures / controls • Energy and waste control • Labor attraction & retention “…Finding products that are cost effective that would add variety to the menu. A web site with proven menu items listed where we could go as a resource…” “…More labor saving menu items either fully prepared or semi homemade. Recipes that use products that are stocked in present inventory, instead of items that are used just for one menu item.…” p.6