State of the Restaurant Industry 2022: Franchisees’ view

Franchisees have been hit hard in 2022 by food price inflation, equipment and supplies delays, increased labor costs, a continuing shortage of workers and difficult decisions about balancing menu prices and profit margins with customer traffic counts. All while paying an increasing dollar royalty to the franchisor.

“The beginning of the year was so difficult, and we were hopeful that we were seeing glimmers of positivity. But most of our franchise operators have not had a good second or third quarter,” says restaurant group head for Bank of America, Cristin O’Hara.

Operators who own franchises of several different brands are stressed. Each of their entities is getting smacked, in one way or another.

Senior relationship manager for Bank of America, James Short, agrees. “After rebounding last year, a quarter into 2022 people were shocked by where we were.” A big problem, of course, is the cost of goods sold. In large part, restaurant operators don’t have a lot of control over those costs. They are at the mercy of the commodities markets and food suppliers.

One especially stressful part of the equation is how much of the food price inflation to pass on to customers. “Many operators have been groping in the dark about how much price increase they can and should take,” says vice chairman of investment banking for BofA Securities, Roger Matthews. “The issue is both relative and absolute pricing.  Relatively, you care about what your competitors are doing. If you’re taking a 10% menu price increase and they’re taking 5%, you’re out on a limb. Then there’s the issue of absolute pricing. At some point, price increases can become so aggressive that the customer says, ‘I’m not paying that for this anymore. It’s not worth it.’”

Menu prices are up significantly overall. In August, the price of food away from home was up 8% compared to August 2021, according to data from the Bureau of Labor Statistics. This represented the largest 12-month price increase since 1981.¹ Concerns are, of course, that after raising prices aggressively this year, the industry is facing another cycle of discounting and promotions, which no one likes.

Labor costs have also risen, and most restaurants remain understaffed, but Short says most operators feel they have figured out how to manage their workforce. Although supply chain issues remain, with some unpredictable item shortages, the industry is not as affected as many businesses.

For most multi-unit operators, investment — both internal development and mergers and acquisitions — has stalled. M&A activity has slowed dramatically, partly because it’s so difficult for buyer and seller to align on future margins.

“Activity in M&A is not great. It’s impossible when you don’t know what your EBITDA will be in the next few years,” O’Hara says. And that’s across brands. Short says there’s a large gap between the seller’s asking price and the buyer’s bid. With the current economic volatility, it’s hard to calculate costs, sales and margins for a full 12 months. “This is the first time in my career where buyers are negotiating the purchase price more on varying EBITDA than the price multiple,” he says. For buyers right now, figuring out future EBITDA is more important.

“That depends on how well the brand was able to weather the environment — if they could take price increases, how their particular cost of goods has been affected, how materially their cash flow was impacted. In addition, larger operators have greater access to capital. Larger systems with larger cash flow tend to have credit that is more flexible, and they may still be developing and remodeling,” says Short.

Many operators have become more conservative in the face of the current economy and needing to focus on the state of their current house. But operators who are using debt to grow may not have access to capital.

The overall outlook for the franchisee community for the rest of the year is a mixed bag, largely depending on the brand. For example, which brands have new and innovative products coming out, and which have a better mix of commodities?  Most operators feel good about the fact that they’ve figured out how to manage labor. That’s a definite improvement over the past 12 months. Short says, “For the most part, restaurants are staffed up, dining rooms are open, and operators are extending hours back out. The cost of goods sold, that’s where everyone is uncomfortable — figuring out where the cost of goods is headed, and how to manage menu prices.”

Sources:

¹ https://restaurant.org/research-and-media/research/economists-notebook/economic-indicators/menu-prices/