Consumer #1 | Looking at Restaurants in the time of Covid
A new wave of disruption is likely, and a look at how to do things right.
Restaurants are a tough industry.
Margins are low, capex is high, there is a constant threat of substitutes, success in one store is not a guarantee of success in another. Less than 1% of restaurants make it to their third anniversary. Customers are fickle and there is only so much new experience a restaurant can deliver.
Lets Dive in.
1. Historical Observations
Food is a very local business. Unless you are a big national food manufacturer with a FMCG like footprint (e.g. a Nestle, Britannia or ITC), food businesses will likely have catchments that can be measured in tens of kilometres at best.
Restaurants tend to replicate more and innovate less. They look at what works well elsewhere and copy it to their local circumstances. A proven concept is likely safer than the risk of innovation. This replication often ends up putting caps on scalability and adaptability of the businesses.
Most food businesses have negative working capital. It’s a good thing but can breed complacence. It leads to undercapitalization because entrepreneurs seem to think that the cash in the bank is theirs when it really belongs to their suppliers.
A typical restaurant falls out of favour within about 8 months. Then either we are running all you can eat specials or renovating, or failing.
For service businesses (restaurants) - Rent, COGS and Labour are constantly growing costs. This often leads to a store EBITDA of less than 10% - an unsustainable number.
Scaling up is a problem for even the most successful brands. Costs are high (ref. above), standardizing the culinary experience is difficult (commissary vs local, both with unique problems), customer expectations on experiences can be hard to meet and often, Hubris.
Now, this is the state of affairs in the normal course of things. Let's look at what changed with Covid rolling around.
2. Covid Impact - Numbers
As the first lockdowns were announced in March of 2020, the restaurants industry pretty much shut down. Food delivery became almost 100% of the business. Already thin margins came under immense pressure.
Many restaurants were able to still make sales but had to grapple with (now) completely unproductive expenses of everything other than the kitchen which still had to be paid. However, these were not generating any revenue.
Larger restaurants were able to get rent rebates but the other costs kept rising. By some estimates, almost 20% of the workforce permanently quit; food costs shot up by almost 15%.
While we don't have hard numbers, I estimate that the daily traffic (in-store+delivery) is still down by almost 50% compared to pre-pandemic. Net Revenues have been hit harder because of aggregator commission and lower ticket sizes.
Average daily sales for most people I have spoken to have fallen by 30-50%.
18 months later, the net result is that almost 35-40% of restaurants have permanently shut down. Casualties included my favourite restaurant in Mumbai - Mirchi and Mime.
3. Covid Impact - Behaviour
As Covid restricted people to their homes, it also sparked a massive behavioural change. Time spent in commutes was freed up, costs of ordering in mounted. Most working professionals who routinely ate out turned to cooking. Instagram feeds of my friends are now filled with photos of home-cooked meals and baked goods, replacing photos of restaurants. In the space of less than a year, we are back at 1980s levels of home cooking. Yours truly had minor cachet as a baker. I was proud that I could make puff pastry at home. Now everyone is a baker. Bloody hell!
As the economic conditions have become tighter, most people are turning to lower cost models.
Home cooking is a lot more cost effective. I would estimate that ordering in vs cooking at home has a price differential of almost 5x. As an example, cooking for my wife and I for a whole day (3 meals + snacks + tea / coffee) on an average runs us about INR 350/day (including energy and gas costs). Ordering in for 3 meals easily costs more than INR 2500-3000/day.
Clincher - what value can you put on brownie points one gets when you half-ass a pasta dish but your wife still likes it?
4. Ubiquitous Delivery gives birth to Cloud Kitchens.
As the existential crisis has brewed, one part of the eco-system made out like bandits. The Delivery Platforms.
At least two I know jacked up their commissions figuring they should make hay while the sun shines.
Even today, after unlocks and all time high stock indexes, the footfalls aren’t back. Delivery accounts for ~20% of Casual Dining / Indian QSR businesses and almost 50% for Global QSRs (dominos, McDonalds etc). This was sub 10% and 20% (respectively) before the pandemic.
One of the more interesting aspects of the delivery construct is that most Indian food is not very amenable to transportation. Pizza, Rolls, Burgers, Sandwiches, Biriyani - this is roughly the set of foods that can be transported well enough (within certain time limits) to deliver a good enough experience at the Customer's end. These cuisines also have a relatively lower capex requirement. Hold on to this thought.
Now, there has been another creature that has been slowly growing that got a huge boost during the Pandemic - The Cloud Kitchen. Made possible only because delivery platforms replaced the front-end. Guess what these guys focus on for the most part - Pizza, Rolls, Burgers, Sandwiches and Biriyani.
The argument for the cloud kitchen is simple. Optimized footprint should cut down on rent and manpower. Delivery cost replaces the front end costs. Effectively, we have traded a fixed cost (rent and manpower) for a variable cost (delivery and commissions, which you can pass on - this is the “restaurant packaging charge” in Zomato and Swiggy). What could go wrong?
Turns out, a lot. Making money is not as easy when you are a new brand. Brands take time to become profitable. Think of the brands / names that come to mind when one thinks of any category of food. Most likely, it is Dominos, McDonald's, Subway, Pizza Hut, Karim's, Moti Mahal, Rajinder da Dhaba, Indigo, Sagar Ratna. The limited point I am trying to make is that food is a highly intimate and trust driven endeavour. A new brand popping up on a delivery platform website is not very appealing or trustworthy - no matter how many 5 star ratings are attached to it. Top-of-mind recall brands have taken ~15-20 years to earn their trust. They have brick and mortar presence and historical context. No cloud kitchen is going to come close in less than 5 years. And if there is a problem, who do you hold responsible? I can call up Karim's if I get bad food. Good luck trying to get any baseline quality of customer service from a Zomato or a Swiggy. And you certainly can’t interact with the cloud kitchen most of the times….
One of the best known cloud kitchen companies is Rebel Foods. They have a portfolio of ~12 brands and they try to make at least 5-6 of them successful in each location. The portfolio is intended to work at a broad level. But even they take ~36 months to get to profitability. Now, this is an extremely sobering thought. Rebel has all advantages - loads of experience, quality food, good sized war chest, optimized business model. And even these guys take 3 years to break even. I estimate that less than 20% of cloud kitchens break even, let alone generate operating profits.
5. A Case Study of Doing it Right - Dominos
For the few readers who have had this discussion with me, you know how much a fan I am of Dominos business model. Almost every best practice one could think of is followed at Dominos. It's astounding.
Dominos makes money off the product. The COGS is less than 25% of the overall mix. They do charge for delivery but its an offset, not a profitability driver. It's not dependent on any delivery platform because it has its own delivery setup - a.k.a Cost Control.
Capex is sensible and has been optimized basis operational insights. The initial stores were large. I remember as a student in Noida that the first Dominos store in Sect 18 market was easily a 120 seater. Over time, they kept the location but kept reducing the size of the store. The average dominos store is now a 10 seater. Why build the front end and pay rent when ~85% of revenue is delivery?
The Dominos kitchen is a masterclass in Capital Efficiency. Here is a comparison of Dominos and McDonald's for store dynamics. It's hard to fail when the numbers stack up like this. Think about it - a burger chain will need at least 5-6 years to break even with these numbers. In comparison, Dominos can easily do it in 3 years1.
The supply chain is highly optimized. The SKU count depends really on only ~30 raw materials, all of which are centrally procured. There are ~5 pizza bases, about 20 or so toppings and sauces. And all of it needs only an oven to make cook for the most part. The operational leverage inherent in this is hard to capture, but again reflects itself in the numbers.
Dominos has been very careful in building itself up in India. In 1996, they started with 3 stores. Today, they have ~1500 stores. For the first 10 years, they didn't add more than 15 stores in any year. Establish a beachhead, understand the market.
Jubilant Foodworks (Dominos' India Franchisee) went public in 2010. its market cap at listing was ~INR 20bn. Today, it's INR 550bn. If someone told me in 2010 that Indians will be eating ~$700mn of pizza each year from Dominos, I would have asked them what they were smoking. And yet, here we are.
Post Listing, Dominos Indian started moving its expansion from Width to Depth. They figured out what places were working for them and doubled down on them. Dominos has ~1500 outlets in 290 cities. In top 6 metros of India, they have ~500 stores. These 6 regions contribute ~45% of their revenue today.
By pretty much all standards, Dominos story in India is a masterclass - great strategy and vision coupled with adaptation, improvisation and ruthless execution.
Lastly, Customer Service is top-notch. If you have an issue, they will replace the order. No questions asked. Once that happens, you feel confident ordering and recommending.
Now, you may want to ask me - why is Dominos relevant? How could anyone have foreseen a once in a Century Pandemic? Here’s why - its model has durability and resilience built in. And it has been doing this for far longer than we see. Dominos owns each of its most critical systems. Ordering is in-house, PoS systems are in-house, Supply chains are controlled so tightly any despot will be proud. 85% of their business is online deliveries. They have decided to completely cut out dine-in from their stores, trying out a concept called DELCO2. Think about that for a moment. There were few companies that were as geared up for the Pandemic as Dominos was. It’s not a food company. It’s a last mile logistics player.
6. What Lies Ahead
Some crystal gazing -
Delivery is here to stay. It's effectively a two player market and it will eventually get disrupted but for now, there is way too much silly money in the system distorting economics.
There is a case for 2-3 more B2B, pure play delivery companies focused on restaurants. There's Grab. I think at least 5-6 more will emerge and a couple should become successful. There is too much unhappiness in the ecosystem with the aggregators and the way they treat their constituents.
Old School Restaurants will move online. We can already see that happening with institutions like Kareem's, the Pandara Road fixtures. However, they are using Grab, not Zomato or Swiggy. There is really no reason why discovery should cost 40% of revenue for a 20 year old brand.
DIY / Recipe Kits will become ever more popular. The home cooking trend is addictive and it gives a sense of accomplishment.
Home cooks will find social commerce a great way to build businesses. In my condo's WhatsApp groups, there are at least 10 cooks taking orders on WhatsApp and they are easily generating 10-15k per day in revenues.
Single food outlets are and will likely continue to boom. It's a new thing for India. Historically specialising in a single item meant you were basically a hawker. Historically it has been associated with questionable hygiene and relative lack of affluence in the Indian Context. As a country, we are seeking better culinary experiences today. Instagram etal are making discovery for that great vada pav stall easier and making it easier for him to signal hygiene, value and flavour. It's a rare positive moment of democratization on the internet (instead of bubble chambers of fake news and demagoguery).
High Quality Customer Service will differentiate the winners. Shit happens. Dealing with it positively creates lasting loyalty. Swiggy and Zomatos of the world are treating customers in a far too cavalier fashion and restaurants are increasingly getting sick of it because they (S and Z) don't own their mistakes, instead resorting to any number of tactics to pass on the blame and hence costs to the restaurants. These disruptors are ripe for disruption.
As before, would love to hear thoughts and views. Pls feel free to comment below or write to me.
Source - Annual Reports of Jubilant Foodworks, Dominos and McDonalds Corp.
DELivery / Carry Out.