Article

Caught in the crisis

Economic conditions batter the industry, but operators insist quality still key.

October 6, 2008

The news reports that franchise lender GE Capital was halting new lending to potential restaurant franchisees was just another bit of bad news for operators feeling the fallout from the Wall Street meltdown.

Tightening credit markets have forced restaurant operators from all segments of the industry to put expansion plans on hold as sources of financing dry up.

Tony Vanjohnson, founder of the six-unit fast casual chain Margaritas in Cincinnati, is already seeing the economic crisis put a damper on his company's expansion plans.

"We have some licensees who are ready to go, but they are going to wait it out until the spring," Vanjohnson said. "This has put them on hold."

At the end of September, an official from Oklahoma City-based drive-in restaurant operator Sonic was quoted by Dow Jones Newswires as saying that GE Capital's franchise lending unit was calling a temporary halt to loans to new franchisees.

Industry analysts warned that limits on financing could hurt restaurant operators such as Sonic and Panera Bread, who rely on franchising to fuel expansion.

Sonic officials were quick to downplay the impact of GE Capital's move, however. The franchise lender provided less than 10 percent of the lending to Sonic franchisees, they said.

"GE is just one of many lenders who finance Sonic franchisees and, in fact, many franchisees maintain access to other diversified sources of financing," the company said in a followup release. "Furthermore, Sonic has not received any notification from GE Capital, either directly or indirectly, that it will stop financing new loans to Sonic franchisees."

Softening sales

Operators from all segments agree that the current economic climate has battered the industry.

"Consumer sentiment is poor and the economy is challenging, while at the same time you are getting increases in energy, increases in the cost of goods through ingredients and increased labor costs due to indexing of minimum wage," said Steve Romaniello, president and CEO of Atlanta-based FOCUS Brands. "You have all these things happening at one time."

FOCUS Brands operates more than 2,200 restaurants, including the Carvel, Cinnabon, Schlotzsky's and Moe's Southwest Grill brands.

The National Restaurant Association 's comprehensive index of restaurant activity, which tracks the health and outlook of the U.S. restaurant industry, stood at 98.3 in August, the 10th consecutive month the index has been under 100. Index values under 100 represent a period of contraction for key industry indicators.

The index is based on the responses to the NRA's Industry Tracking Survey, which is fielded monthly among restaurant operators nationwide.

Restaurant operators reported negative same-store sales for the eighth time in the last 10 months, said Hudson Riehle, senior vice president of research and information services for the Association.

"The uncertain economy and rising food costs continue to pose a challenging business environment for restaurant operators," he said. "A record 31 percent of restaurant operators said the economy is the number-one challenge facing their business, while 22 percent identified food costs as their top challenge."

Forty-eight percent of operators reported a same-store sales decline in August, down from 50 percent who reported similarly in July.

In addition to soft sales results, restaurant operators continued to report negative customer traffic levels. Fifty-five percent of operators reported a traffic decline in August, down slightly from 57 percent who reported negative traffic in July.

Vanjohnson is seeing a softening in traffic in Cincinnati, he said.

"Our average customer would come in normally four or 4.2 times a month, and our base is now about 2.5 times per month," Vanjohnson said.

Finding solutions

Operators have employed a number of strategies in order to combat the impact of the economic crisis. Vanjohnson, for example, hired an industry consultant to help the company revamp its menu, adding meal bundles to combine low-profit items with high profit ones.

The company also adjusted its prices and worked with vendors to persuade them to adjust theirs as well.

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"The first thing we did was bundle our lunch menu," he said. "All our lunch entrees include a soft drink or tea, which gives the customer the feel of having some added value."

Romaniello reported taking similar steps at FOCUS. One step he won't take, he said, is to weaken the company's standards in an effort to cut costs.

"We have been working on pricing and how we price our products, but we have not in any case sacrificed quality," he said.

And Peter Stamos, executive vice president with Chicago-based retail industry consultant Miller Zell, warned that now was not the time for operators to cut back on marketing efforts.

"They are going to have to coordinate their brand messaging better than they have ever done before, their Web presence, and their retail circular presence, their advertising via trade or newspaper or journal," Stamos said. "It all has to be coordinated with what is happening in the store."

Although operators do expect the economic turmoil to eventually settle down, some aspects of the situation are likely to remain, especially when it comes to commodity prices.

"I have to believe that better times are ahead and this will not continue," Romaniello said. "However, I do believe that there is a new floor for many of our ingredients and we won't get back to historical levels."