This article was written by James Lanyon, EVP, Strategy & Innovation, and Sean Eidson, VP, Strategy & Innovation at Material.
Restaurant leaders and operators faced considerable obstacles over the past few years and should be commended for having navigated a once-in-a-generation business challenge. By the end of 2020 it
was estimated that approximately 110,000 U.S. restaurants closed either permanently or long-term.
From the pandemic then straight into inflation, rising interest rates, and softening consumer spending,
Material’s view is:
- The restaurant category may never normalize.
- Food delivery apps are emerging as the real winners.
- It’s time to take back your margin.
- This can only be done by owning the customer relationship.
Understanding the what and why behind current conditions is the first step in capitalizing on this change. To get there, restaurants need to embrace change as a constant and then optimize, roadmap, and even blow some things up in order to respond faster and exceed customer needs.
Material works with some of the largest and most
innovative restaurant brands. Those relationships mean we know what really took place during the pandemic
and how managers and operators are thinking about
the future.
Using that information, our focus is to provide strategies
for growth and long-term customer retention while
serving as a partner in disruption for challenger brands
looking to uncover new growth by reshaping the
restaurant category.
The restaurant category may never return to “normal”
While leaders who made it through the pandemic are to be commended for their courage, persistence, and ingenuity, there were also miscalculations along the way.
The single most impactful miscalculation was to assume that the 2023 post-COVID economy would enable them to resume “business as usual” or at least to get close to pre-2019 operations. This thinking assumed post-COVID business conditions would be favorable and also hinged on the notion the industry itself was heading in the right direction before COVID.
The go-go days
Prior to 2019, consumers were experiencing a massive boom in restaurant choice. Spending on food away from home had roughly doubled to half of all consumer spending in the food category, up from 25% in the late 1950s. But the market was peaking.
A 2019 Washington Post article reported that the boom was about to bust: “We just lived through the greatest period of restaurant growth in U.S. history. Here’s why it’s ending.” The article was a review of James Beard Award-winning food journalist Kevin Alexander’s book Burn the Ice: The American Culinary Revolution and Its End. The Post article was on the heels of articles from Restaurant Business (2018) and The New York Times (2017)—both asserting that there may be too many restaurants.
This swell in restaurant monetization typically yielded one of four planning directions for existing concepts:
- Franchise value rejuvination (relaunch the brand)
- Digital ordering enablement (modernize the brand)
- Experience innovation (differentiate the brand)
- Organizational shuffle (differentiate internal delivery)
Regardless of which direction was selected, it was almost always chosen with the sole purpose of elevating unit sales’ potential in a frothy market. Then the pandemic hit and normal stopped. Three years of “there are too many restaurants” signals were muted.
Fast forward to today
The 2023 headline is different from what operators and managers envisioned when thinking about a post-COVID world. It’s clear few, if any, envisioned the impact inflation would have on consumer behavior and commodity prices. No sooner were operators and brand leaders starting to see uptake in digital experience investments and improved hiring when consumers, nervous about inflation, brought about the great trade down and pushed sales towards fast food at the expense of the casual and fast casual sectors.
There’s no doubt that fast casual executives may be looking enviously over the fence towards their QSR peers, many of which are having banner years. But the headline of sales growth doesn’t tell the full story.
This is particularly true when you take into account the role food delivery aggregators play in today’s modern food service marketplace.
The real winners: food delivery apps
The category story in Q1, 2, and 3 has been growth for QSR brands. Restaurant Brands International reported a stellar 2022 system-wide sales growth of 13.4%. Yum! Brands CEO David Gibbs noted, “2022 was a landmark year for Yum! as we beat our own industry record for unit development, opening an incredible 4,560 gross new units.”
While that is impressive, it ignores a deeper, more fundamental reality which is that third-party delivery aggregators have become a whole new sector of the restaurant industry. This reallocation of commerce will have a direct impact on same store sales profitability.
The research service Apptopia released its list of most downloaded food apps 2022 and the results were telling. McDonald’s came in first with an estimated 40MM downloads which was not surprising given the company’s heavy investment in mobile app adoption. More telling was that DoorDash came in a close second at 34MM. When reanalyzing the list, there’s an interesting tug of war between large franchises and third-party delivery services.
McDonald’s, Starbucks, Domino’s, Taco Bell, and Chick-fil-A, all regarded as best in class, were barely able to reach parity with third-party delivery services in mobile market share growth in 2022. Third-party services represent ~52% of the downloads. That’s just one data point in an increasingly complex ecosystem, but it’s important to note that whoever controls the interaction controls the data; and whoever has the data has the relationship.
Whoever controls the interaction controls the data; and whoever has the data has the relationship.
As delivery apps continue to grow in popularity they will continue to serve as a go-between with the customer and the brand while taking a portion of the same store margin which will spell trouble for the restaurant industry over time.
Margin matters now more than ever
A handful of restaurant category brands invested early in proprietary customer engagement platforms
and were rewarded with enduring positions of strength, while other brands struggled to pivot. Starbucks with its mobile app, Pizza Hut with its top-rated loyalty program, Panera with its brand-defining digital customer experience, and Chick-fil-A with its outstanding omnichannel platform were some of the early leaders who have seen sustained success.
But for every one of these successes (several of which Material helped deliver) there are many more instances of brands that chose to defer or delay investments in customer transformation. Delivery is
an often-repeated rationale for deferring some or most of the customer engagement responsibility to
third-party services.
It’s hard to fault restaurant brands for wanting to cozy up to delivery apps. Restaurant companies that
did not have robust digital customer engagement platforms when COVID hit, scrambled to direct available funds to bridge their digital divide through delivery. The prospect of offsetting the cost of deploying delivery personnel to meet customer expectations made sense. Why add even more labor
cost into an unpredictable economic environment?
Understanding the hidden cost
There is a hidden cost in this short term calculus: the loss of franchise value. Franchise value doesn’t just influence the brand’s short term revenue prospects, it heavily influences mid- and long-term recurring revenue. Chick-fil-A is perhaps one of the most admired QSR franchises. It has a middle-of-industry cost to open, but an eye popping 15% royalty and 50% profit share. This is in comparison to Wendy’s 4% royalty fee. Yet Chick-fil-A operators are more than happy to pay it. It’s hard to underscore the franchise value concept enough.
McKinsey and Co. recently released an analysis of what drives overall restaurant brand value, reviewing data from 2016-2021 for 55 restaurant chain brands. It came to two conclusions:
- Same store growth drove shareholder returns (not a huge insight, but statistically important)
- Same store margin drove franchise valuation
Because margin drives franchise valuation, restaurant brands with an over-reliance on third-party delivery services are putting their margin at unsustainable risk. In a separate analysis, McKinsey noted: “Realistically, restaurants’ traditional profit margins of 7 to 22 percent make covering the platforms’ delivery commissions, roughly 15 to 30 percent, unsustainable as delivery orders become a larger part of a restaurant’s business.”
How restaurants can respond
They pass the cost onto the customer as a function of doing business according to Paytronix. The study reports that restaurants have raised prices by almost 24% to cover margin erosion. While this may be a short-term solution under the cover of broader inflation, there is a limit on how many times a restaurant brand can hike prices.
Pricing increases also have a downside and leave a giant opening for competitive brands that can find ways to serve the customer’s need for gratification and immediacy with greater balance.
An industry executive we interviewed for this research indicated that restaurant brands can successfully engage third party services, as long as the ratio is correct. “I would acknowledge or call out that the third parties, when the ratios are right, ARE a good and necessary part of the core business—assume 15 to 20%.” But this is a far cry from the current almost complete dependence on third party applications to deliver a quality digital ordering and fulfillment experience.
The math couldn’t be more plain. Short term decision-making during a time of crisis can rob restaurants of their ability to grow and flourish long-term. This reality becomes even more sobering when you look more closely at the financial performance of the companies driving this issue.
DoorDash—the largest and fastest-growing portion of the market with ~65% of sales is a great case in point.
Not surprisingly, like many category disruptors, DoorDash earned this growth at the cost of financial performance with a -15.37 price to earnings ratio at the time of this report.
DoorDash has recently signaled that it anticipates profitability of ~$100 million in the next fiscal quarter but that’s on sales of around $15 billion. Long-term, it’s hard to see how DoorDash continues to simultaneously grow and achieve profitability while reducing margin demand on the restaurants it serves. Similarly, it’s hard to see how it would serve DoorDash’s interest to share real customer data with the restaurants it serves. True, it does provide restaurant data views through its Merchant Portal and Business Manager features. But those aren’t the same as restaurants owning the actual customer data which they could leverage for their own use. And why would DoorDash share this data? Those are DoorDash’s customers. The food is just the product.
How to reclaim productive growth
It’s not rational or reasonable to assume restaurant brands will move away from third-party services entirely and this is not what Material recommends. This is particularly true for mid-market or emerging concepts that lack the budget capability of larger competitors. However, it is rational to envision an advanced approach to restaurant growth planning that de-emphasizes such heavy reliance on third party providers while prioritizing direct ownership of the customer relationship.
Material has developed a six-point approach for restaurants that simultaneously informs direct customer relationships while lessening the need to rely heavily on outside services for business:
6 steps to delivering a more competitive QSR offering
Brands should work in all six areas optimally in this order, however the priorities and starting point may differ based on a restaurant’s business and maturity of operations, technology, and marketing.
1. Rigorous truth-seeking for breakthrough insights
All too often restaurant brands stumble because they believe customer relationships can be solved primarily through technology. That’s not the case. Technology is a means, not an end. Insight and data must work together to fuel technology investments. Breakthrough insights are delivered through market sizing, occasion mapping, attitudinal and consumption segmentation, opportunity framing, and awareness modeling. Material is uniquely structured to understand customers at deeper levels and get new ideas into market faster. We use tools that bring real real-time customer, market, and competitive insights into our first meetings. Speed-to-market is fulfilled by agile teams in technology, data science, brand, digital customer experience, CRM, and go-to-market campaigns across all channels.
Key Actions for Connecting Insights:
- Market Sizing
- Occasions Mapping
- Attitude & Segment Mapping
- Opportunity Framing
- Awareness Modeling
2. Value proposition and brand strategy to frame growth outcomes
Customers have more restaurant choice than ever. This puts pressure on restaurants with diluted or outdated value propositions, impersonal customer relationships, and stale rewards programs. A strong brand reputation can be an effective gateway for supporting value proposition elements—many are highly competitive to third-party applications. This is a way to give brand credit back where it belongs. Part of this process is identifying signature moments and equities that are unique to a brand, like the craze-worthy aroma of Auntie Anne’s pretzels, and connecting those brand moments to customer behavior.
Key Actions for Brand Strategy:
- Value Proposition
- Signature Moment Articulation
- Brand Positioning + Planning
3. Shape growth investments with confidence through advanced planning
Restaurants should develop an agile process and focus resources on customer experience with roadmaps to understand how hidden customer needs can be met through data, technology, experiences, service design, and team training. This means adopting an “imagineering” mindset to create new value in new ways. The goal is to know more about customers faster than competitors and have agile systems to accelerate bringing value-driving ideas into the market. Adopt the mindset of prototypes over decks.
Key Actions for Customer Experience Visioning & Roadmapping:
- Data + Technology Enablement
- Experience Strategy + Delivery
- Service Design + Training Plan
4. Bring ideas to market with physical/digital service design
In our view, service design is more effective later in the process, although brands often want to do it earlier. Why later? The more deeply a brand understands customer needs and motivations, the better its opportunity to use service design to deliver differentiated, integrated in-store and digital experiences. The restaurant industry is not alone in having disconnects between today’s customer needs and how a company operates. Customers feel that choppiness. They gravitate toward restaurant brands that make everything simpler and more personalized. Know the customer better, then apply service design at a time where it will be more relevant to those customers and pay dividends in the form of reduced scope of delivery.
Key Actions for Design + Build:
- In-store Experiences
- Customer Data Enablement
- Digital Experience
5. Find and engage new customers in new channels
As direct customer engagement begins to yield real customer data, restaurant brands gain the position to make two important moves: 1) Test and update insight assumptions generated in earlier work phases; and 2) Update channel planning, optimize media investments, creative, and content at both performance and brand levels. In our view, now is the time to capitalize on trends reflecting the fact that people pick up their phones 344 times a day, as SMS becomes a preferred notification channel, and growth of mobile ordering and takeout become norms.
Key Actions for Integrated Marketing:
- Audience Segmentation
- Channel Planning
- Media Planning
- Creative Development
6. Identify, engage, and reward best customers
Owning the customer relationship enables the most important aspect of long-term, margin-rich growth—clearly identifying the customers and segments that are most in tune with what a concept offers. When brands own the direct customer relationship and the ensuing insights, they are in the position of being able to strategically drive high value customers to locations with reduced costs over time.
Key Actions for Loyalty + CRM:
- Program Design
- Platform Consulting + Implementation
- CRM Creative + Execution
- Measurement Plan + Dashboard
Closing note: There is a fast path to deliver growth and margin
While it made sense for restaurant brands to offload the cost and level of effort to accelerate digital transformation during the pandemic, it makes less sense now. As one restaurant client aptly put it, “We love the revenue, but hate the margin.”
In our experience, we know it is possible to have both. To get there, restaurant brands must be willing to revisit long-term planning and make a top goal of regaining ownership of the customer relationship. When restaurant brands make this shift, they are better positioned to have balanced reliance on third-party services. They are also better equipped to reverse margin erosion that could reduce franchise value over time. Above all, they can create stronger, more personalized connections between their customers and their brand.
We’re happy to talk through your restaurant growth challenge. Please email us at restaurant@materialplus.io to arrange a free growth consultation.
About James Lanyon, EVP, Strategy & Innovation | James’ restaurant and food background includes marketing and loyalty work for Pizza Hut, Chuck E. Cheese, FOCUS Brands, Whataburger, 7-Eleven, Keurig, Dr. Pepper, and other brands. james.lanyon@materialplus.io
About Sean Eidson, VP, Strategy & Innovation | With 20 years of loyalty experience, Sean’s restaurant and food work includes Pizza Hut, Whataburger, McAlister’s Deli, Krispy Kreme, KFC, Taco Bell, Southeastern Grocers, Chili’s, and dozens of specialty retail brands. sean.eidson@materialplus.io
About Material | Material is a global strategy, insights, design, and technology partner to companies striving for ture customer centricity and ongoing relevance in a digital first, customer-led world. Material has an extensive restaurant growth practice with experience and expertise outlined in this POV. You see our work every day for brands like Starbucks, Pizza Hut, Chuck E. Cheese, Church’s Chicken, Jamba, Auntie Anne’s, and others. materialplus.io