Nick Martindale 5 Jun 2018 04:21pm

A challenging time for restaurant chains

An unhealthy combination of over-saturation, rising costs and changing eating habits mean many casual dining chains are fighting for survival. Nick Martindale reports

Caption: Image: Getty Images

For years it seemed the UK population could not get enough of eating out. According to Savills, some 1,800 restaurants opened during the 12 months to October 2015, with branded restaurants increasing by 55% in the past decade. But a series of high-profile struggles, particularly among casual dining chains, has brought the restaurant sector’s decline firmly into the spotlight.

In March, Italian chain Carluccio’s brought in KPMG to help evaluate its options, while Prezzo, Jamie’s Italian, Byron and Strada have all announced restructuring plans involving significant closures. Accounting group UHY Hacker Young estimates one in three (35%) of the top 100 restaurant groups made a loss last year, up from 20% the year before.

Accountancy firm Moore Stephens has also undertaken its own research based on figures from the Insolvency Services for the year ending September 2017. “We found insolvencies in the restaurant sector jumped 20%, to 984 in the last year, up from 825 in the year to September 2016,” says Jeremy Willmont, partner and head of restructuring and insolvency. “It’s a big jump but it’s not a surprise because we’re all aware of the pressures restaurants are under.”

The most fundamental problem is that supply has become out of kilter with demand, and this is seeing the mid-range, larger chains in particular suffer. “The ones in the middle have the most intense competition, and it’s a part of the market where if someone has a formula that works well they look to expand that over a number of sites, so it very quickly increases the number of restaurants and supply over demand,” says Willmont.

Private equity has also had an impact, as operators have looked to replicate successful models across the country. “Private equity has fuelled expansion into new markets at such a fast rate, and in such a way, that this has become unsustainable,” contends Julian Mant, a partner at UK law firm TLT. “This is one of the biggest challenges with expanding nationally; you need to balance speed to market with sustainable business growth.”

In turn, this has also had an impact on quality and the consistency of service and offering, believes Jenny Burns, CEO at brand agency KBS Albion. “When private equity owners force a restaurant chain to scale too quickly, that consistency is often compromised,” she says. “The properties start not being in quite the right places. The fit-outs start to have corners cut. The suppliers aren’t vetted quite as well. It becomes an issue when restaurant chains don’t deliver that consistency – they undermine their whole reason for being.”

There are other challenges facing the sector. “Following the Brexit vote the cost of food and wine has gone up as sterling has weakened, and that has put pressure on gross profit,” says Will Baxter, director and hospitality sector leader, corporate finance, at Grant Thornton. “Aside from the cost of goods, wage costs have increased through the Living Wage and property costs have gone up through both rent and business rates increases.” London has been particularly hard hit by these last two issues, he adds.

Diner habits have also changed, with a rising preference for staying in and having food delivered through services such as Deliveroo. “Eating out-of-home has become a popular habit and a broader offering due to the growth of multi-channels and more convenience for the consumer, such as online ordering and delivery,” says Virginie Pernin, chief analyst at IRI GIRA Foodservice. The growth of independent restaurants and food vans has also had an effect, she adds.

Such problems are not confined to the UK. In the US, mid-market national brands such as Red Lobster, Olive Garden and Chili’s are also struggling, says Danny Bendas, managing partner at Synergy Restaurant Consultants, based in California. “There are so many selections and choices that the frequency that someone may go back to the same restaurant has decreased over the years,” he says.

Other countries are protected to an extent by the ingrained culture of dining out, believes Philip Harrison, president and managing director of international hospitality consultancy Harrison. “Where social norms are strongest, there is generally a much greater penetration of good, reputation-led, independent operators,” he says. “You certainly see this in countries such as France and Italy where you do not have anything like the range of brands you see in the UK.”Rationing a good idea

Yet it would be wrong to suggest that the restaurant sector is fundamentally flawed, or that a spate of failures is inevitable. Rather, it’s a case of rationalisation, believes Willmont, requiring some cold evaluation and tough decisions. “What you can and should look at is your chains, and which outlets are making money and which aren’t,” he says. “When restaurants enter administration you often see that people at that point look at the business and come up with a survival plan where they might keep the best 50% or 35%; really people should be going through that process before problems arrive.” This involves looking to see if there are reasons why outlets are not performing, such as poor management, or whether there simply isn’t enough demand.

One strategy some restaurants are already deploying is to negotiate with landlords over rental payments, which can help absorb some of the other cost increases. “Landlords are waking up to the idea that if they push their operators to the point that they cease to exist then they will have an empty building,” says Baxter. “There is a slight re-weighting in the landlord-tenant relationship, and the premiums that have been paid for sites are starting to come down. Landlord contributions to the capital cost are also starting to increase, so there are changes that will make it a less harsh trading environment.”

Acquired tastes

Above all, restaurants must ensure they remain relevant to customers, and resist any temptation to scale back on quality, says Caroline Jameson, divisional director, food and drinks, at research consultancy Morar HPI. “It would be instinctive for them to look at smaller portions or reduced quality control,” she says. “However, chains that stay on top of their game will be able to ride out the turmoil. What’s key is to constantly evolve the offer and stay relevant.” Examples of businesses successfully doing this include Pizza Express launching its Seedlip range of non-alcoholic gin to meet the trend for alcohol-free drinks, and Flat Iron Steak’s emphasis on a shorter menu that allows it to maintain quality without over-pricing.

There are other examples of restaurants thriving, even in the current turbulent conditions. Those that have high gross-profit margins are better placed to absorb rising costs, says Baxter, citing low-protein foods such as pizzas, while others have altered their service model to keep staff costs under control. “Companies like Nando’s have a partial service model, where you don’t get full service but you speak to someone at a counter, and that helps them keep their labour costs lower,” he says. “If you have high costs of goods, high labour costs and high property costs it’s very difficult to make a net profit.” The exceptions are the very top-end, fine dining operators, he adds, where customers are less resistant to price increases.

Burns, meanwhile, gives two examples of chains that have managed to retain a more independent feel in their various outlets, despite starting from very different propositions. “Wahaca is a relatively small chain of 25 branches, mostly in London. Their secret is that they don’t think of themselves as a chain, but a collection of individual restaurants,” she says.

The second is The Ivy Collection, a series of casual restaurants across the UK, spun off from the original Ivy in Covent Garden. “Who would have thought the high-end, West End celebrity haunt of the 1960s would ever become a branded chain?” she asks. “They’ve nailed the consistency from an experience, price and quality perspective. But they’ve managed to do that with some flair by understanding the needs of local customers. For example, one of their newest restaurants in the heart of the City offers a ‘speedy lunch’ menu, ensuring the needs of the time-constrained high-flyers are met.”

But in the current climate such success stories are rare, and it’s likely there are more company voluntary arrangements and insolvencies to come. Willmont comes back to that most basic of economic theories: the law of supply and demand. “Currently we’re at a point where there are too many restaurants and not enough people to fill them,” he says. “It doesn’t really feel as if demand has fallen; it’s just that supply has expanded ahead of demand so there needs to be a readjustment.

“That will be happening on the high street for a year or two, and that’s assuming everything else stays the same. If the economy takes a downward turn and consumers have less spare cash available, it will get much tougher.”

Impact of IFRS 16

Changes to the leases standard under IFRS 16, which comes into force in January 2019, will have a significant impact on restaurant businesses by requiring all leases to go on the balance sheet.

Under the new accounting treatment, rent will no longer go through the profit and loss (P&L), but a depreciation charge will apply over the life of the lease, which is likely to be the same amount as the rent it replaces.

As a result, EBITDA numbers will be flattered by the amount of rent not going through the P&L, although in practice EBITDA is likely to be adjusted for rent in any analyses.

At EBIT level there will be no difference as the depreciation charge will have been applied.
Information courtesy of Grant Thornton

Something a bit different

When the opportunity arose to buy the Bottle & Glass Inn in Henley-on-Thames, David Holliday, a former general manager at the Harwood Arms in Fulham, and his business partner Alex Sergeant jumped at it.

Their aim was to replicate the success they’d seen at the Harwood Arms, using local food and beer to create a quality experience in a pub environment. “We like being a pub that just so happens to sell really tasty food,” he says. “We have five starters, five mains, five desserts in the restaurant, with a specials board, and we also run a pub menu.” Dishes cost around £8 for a starter and £20 for a main course, but people can also buy homemade Scotch eggs for £4 if they want a light bite.

The business is about to hit its first-year anniversary and Holliday says he’s happy with the finances so far. “For Mother’s Day we did 170 covers, and we’ve already booked up half of Christmas Day,” he says. “We also now run a lunch menu with two courses for £20 and three for £25.”

Holliday believes gastro-pubs appeal to people who are frustrated with the ubiquity on offer in many mid-market restaurants. “People don’t want to have something that comes from the same source for the same money when they can go up the road and have something from people who are actually getting in raw ingredients and cooking them.”

There are concerns; Holliday says the increase in beer duty has forced him to raise prices, while the impact Brexit will have on staffing is also a worry. He’s taken steps to ensure he can remain competitive, including investing £14,000 in an outside wood-fired oven to allow the sale of pizzas in the summer, and is moving into outside catering for events.

“Another downturn would be a worry too, because the first things people stop doing are going on holiday and going out to eat,” he says.