Is Restaurant Business any good?

If I ask you whether you want to have your restaurant, you will say YES is very high.

Everyone wants to have their restaurant. Isn't it?

There is a generally a fascination towards restaurant business irrespective to wherever you are in the world. The company or restaurant seems pretty easy as the general argument is there is a demand for food, so the business should work.

Fine. Makes sense. However, it's not that easy.

And if you ask me, I will never invest in a restaurant where I have to establish the brand. It's tough to establish the brand and hence scaling the business.

So what works then?

Glad you asked. The answer lies in Franchises.

Let's look at some numbers.

Here's a broad overview of the USA restaurant industry. The data suggests that,

• Many people are employed in this industry, and a lot of these units cannot scale.

So what's happening here?

Think of a restaurant; what levers of growth do they have?

• Time? - Limited inventory - 7 days/at best 24 hrs
• People? - customers will have limited appetite, so the average bill at any given point per customer won't change much unless the prices are increased
• Prices? - can't increase much as customers will shy away
• Size of the restaurant? - sure, a bigger place can accommodate more people during peak hours, but then rentals will be extremely high

This is what we call a classic Operating Leverage business. Heavy fixed cost business. Costs won't move much even if the business is high or low.

So then what's left?

• Do more business with lesser space/cost - more takeaways/deliveries can achieve this.
• Leverage the brand - allow others to put capital and you lend your brand name and take a cut for it (royalty).

Does this work?

Sort of.

I am not saying that a company that owns all restaurant locations can't scale; they can sort out the supply chain issues and have a brand name.

However, if the company has a brand and decides to go with the franchise option, it is generally safer + scalable.

The below data will make it clear.

What can we infer?

• Margins are less if the company operates most of the stores - the case being Chipotle and Starbucks.
• To have a global presence, the franchise model is the fastest model to achieve scale.

But is that it? No. there's more to it.

Let's see the final set of data.

• The outlier is Chipotle here - it commands higher valuation despite the revenue per owned store is lesser than McD and Jack.
• So only the franchises have higher valuation - the remise is not true always.

Final Takeaways

1. The restaurant business is a tricky business. Unless the company have good capital, the growth is going to be extremely tricky.
2. A franchise is a way to diversify risk - margins may not change, but the risk will certainly go away and can be scaled faster. The company needs a brand name + can be scales fasted in terms of # of store presence.
3. If you have a brand like McD, you can command a premium (look at net margins), but that may not translate to share price.
4. You can have a brand like Chipotle - still opening more than 150+ own stores in the USA (compared to Domino's and McD - less than 20 new stores), and generating profits + returns for shareholders.
5. Brands like Domino's doing wonders in International markets :)