by Saeculum Research
Last summer, analysts took a bearish turn on the restaurant industry: Investment banker Paul Westra warned that a looming 2017 recession “could be the worst ever for restaurants.”
Months later, it appears that the industry has gotten a head start on that prediction: Overall year-over-year (YOY) sales and traffic growth have been in steady decline. What’s going on? Part of the issue is economic. Eating at home is cheaper than ever relative to eating out, while a surging do-it-yourself “foodie” culture is encouraging more people to experience food outside of restaurants (even at home). Looking forward, generational change creates new headwinds—along with new opportunities—for restaurants.
The U.S. restaurant industry has been struggling for the past two years. According to data from industry tracker Black Box Intelligence, same-restaurant sales growth has been declining on a year-over-year basis since February 2015, with growth turning negative in March 2016—and it has stayed negative ever since (through October). Industrywide same-store traffic growth has been negative in each month since February 2015. The latest quarterly data from NPD Group confirm that the restaurant industry is not participating in the overall late-year market boom: Total restaurant visits again declined YOY in Q3 2016 (down 1 percent), while quick service restaurant visits declined for the first time in five years.
These troubles have manifested in a major “restaurant shakeout” that apparently isn’t eliminating restaurants fast enough. The total number of restaurants doing business in the United States has declined in each of the last two years. This year alone, prominent chains such as Bob Evans, Ruby Tuesday, Souplantation, and Don Pablo either have closed locations or have shuttered entirely.
Until recently, the industry at least has been able to count on a surging fast casual segment as a beacon of hope. That’s no longer the case. NPD Group data indicate that YOY fast casual traffic growth was flat in Q1 2016—but dropped by 3 percent in Q2 2016 and 1 percent in Q3 2016. To some extent, the entire segment has been dragged down by Chipotle’s troubles: More than a year after its food safety scandal, Chipotle posted a worse-than-expected 22 percent same-store sales revenue drop in Q3 2016. Also factoring in has been a decline in lunch traffic, the segment’s largest growth driver.
What’s behind these grim industry figures? For one, it is now historically cheap to eat at home relative to eating out. BLS data show that YOY growth in the Consumer Price Index (CPI) for “food at home” has been plummeting since early 2015—and has been negative for all of 2016, with the current rate of decline at its steepest since 2009. At the same time, the CPI for “food away from home” has been growing at over 2 percent since 2011. The growth margin between CPI for food at home and food away from home sits near 5 percent—one of the widest ever recorded. Analysts attribute smaller grocery bills to lower prices on commodities such as wheat and corn, as well as to U.S. producers beefing up their flocks of egg-laying chicken and cattle.
Why aren’t restaurants passing along the cost savings from lower food prices? In reality, food comprises just 25 percent to 38 percent of a restaurant’s total costs. The remaining share of restaurant costs has been growing at a quicker pace than food costs have been declining—thanks to factors such as wage growth due to sustained high worker demand, higher urban rents, and new minimum wage laws in many cities.
Also hurting restaurants is the fact that they now have to compete with a wide variety of nontraditional dining options. Restaurants have more than just grocery stores to contend with: Consumers can get a prepared meal from the convenience store, the gas station, the food truck, and even in the mail. Many grocery store chains are upping the ante with their own hot-and-ready meals—a dining category that has grown nearly 30 percent since 2008.
Another steady headwind for the industry since the last business cycle has been the rampant growth of DIY foodie culture. (See: “The ‘Foodie’ Frenzy.”) Paradoxically, America’s newfound obsession with food has hurt restaurants. While some high-end establishments undoubtedly are reaping the benefits of Boomers with refined palates, the middle and lower tiers are losing Xers and Millennials who can fly their foodie flags without breaking the bank. Instead of spending big on a gourmet meal, thrifty foodies can patronize the local farmers market and whip up an Instagram-worthy meal on their own. The growth of this “informal” economic activity is reflected in employment data showing that working-age adults have more time on their hands than ever. (See: “Why Americans Are Working Less.”)
In the years ahead, generational change will serve up new challenges—as well as opportunities—for restaurants. As we’ve highlighted before (see: “Who’s Picking Up the Restaurant Tab?”), Boomers are eating out more than previous generations of elders. BLS data show that in 2015, consumers age 65 and older spent 20 percent more of their annual food budget on food away from home than they did in 1994—the greatest growth of any age bracket. High-SES Boomers still enjoy the opulence of a pricey steak and a fine wine (especially if they’re on an expense account), while low-SES Boomers have no problem settling for a bag of fast food.
But as Boomers continue to age out of the workforce, the industry will have to count increasingly on Xers and Millennials whose consumption habits pose more of a challenge. Xers are still struggling to get back on track financially following the recession. Many neither desire nor can afford fine dining—or even casual dining. This pragmatic generation is drawn to options (dining in or eating fast food) that provide the most bang for their buck.
Millennials, meanwhile, continue to buck the historical trend of young adults eating out. (See: “Fast Food Slows Down.”) The numbers don’t lie: BLS data show that in 1988, consumers under age 25 spent 54 percent of their annual food dollars on food away from home. By 2015, that share had dropped to 48 percent.
That’s not to say Millennials are a lost cause for restaurant owners. Just look at casual dining standouts like Dave & Buster’s, Texas Roadhouse, and Buffalo Wild Wings—which all posted double-digit YOY sales growth in 2015. What do these chains have in common? A festive, fun atmosphere in which customers can socialize. Dave & Buster’s in particular owes much of its success to a Millennial rebrand featuring youthful TV programming, higher-quality menu items, and cutting-edge games.
The restaurant industry sits at a crossroads, and the possibility of a recession in the next calendar year doesn’t help. But establishments with a sound generational playbook—one that features high-quality food, fun, or a combination of the two—could keep from going stale.
- Beware: Restaurants have it tough heading into 2017. Despite a late-year market rally, restaurant same-store sales growth and traffic growth are in the red. Why? Consumers aren’t eating out like they used to. Plunging grocery prices have made it historically cheap to eat at home. Additionally, consumers have more dining choices than ever at their fingertips. While Boomers remain a key growth driver, Xers and Millennials are a different story. Though DIY Xers and Millennials have fueled a new society-wide obsession with food, they’re meeting their foodie needs outside of the restaurant.
- Keep in mind that America’s love for natural food has not extended to the restaurant table. Going natural poses a problem for restaurants. Fresh food inevitably drives up the cost—a particular problem for price-sensitive fast food patrons. Dabbling in natural also makes it tough to create a coherent brand. Arby’s realized this in 2014 when it abandoned its “Slicing up Freshness” tag in favor of a campaign that showcases what it does best: meat. All-natural is also tough to achieve in a commercial setting because of the myriad health issues it poses. Just look at Chipotle, whose decentralized supply chain opened the door for a disease outbreak.
- Watch for more low-end restaurants moving upmarket—and high-end ones moving down, toward “masstige.” Many lower-tier establishments are classing it up. Last summer, McDonald’s opened a high-end “pop-up” restaurant in Tokyo featuring everything from real cutlery to upscale food. Starbucks, meanwhile, is re-entering the high-end café stratosphere that it once dominated: At the Starbucks Reserve Roastery & Tasting Room, customers can learn about unique coffee preparation methods and taste-test rare brews. High-end brands, on the other hand, are reaching out to the masses. Wolfgang Puck offers everything from a fast casual option to supermarket soups (through a partnership with Campbell’s). Upscale delivery service Caviar brings exclusive brands to consumers’ doorsteps.
- Eateries with delivery operations should maximize their position within the industry’s “middle space.” Sit-down restaurants have been hammered by the rise of alternative dining options. But those with a delivery presence can use stay-at-home dining to their advantage. Domino’s Pizza has posted strong YOY revenue growth thanks largely to its investment in digital delivery infrastructure. CEO Patrick Doyle even says, “We are as much a tech company as we are a pizza company.” Joining in are companies like Panera, which will feature delivery at 10 percent of its stores by year’s end. More drastically, delivery restaurant upstarts like Sprig and Munchery are going all-digital, boasting no physical presence whatsoever.
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