The following is my theory about the operational cycle that many companies in the restaurant industry tend to go through. Typically, when a concept gets in trouble, the management team’s decision-making process has followed a certain pattern:
- Overconfidence — The concept loses its value proposition when management raises prices too aggressively or lowers the quality of food.
- Stage 1 Denial — Consumers catch on and begin to frequent the concept less often. Traffic begins to decline and management usually begins to blame the weather or another external event.
- Stage 2 Denial — In an effort to avoid the inevitable and appease the street, management begins to accelerate growth through the form of new unit acceleration or the acquisition of new brands. Normally, the core business continues to deteriorate alongside a decline in ROIIC (return on incremental invested capital).
- Stage 1 Panic — Analysts begin to catch on and management responds by slowing new unit growth, although often not by enough. The core business continues to decline, as senior management begins to replace the operating team. Simultaneously, the search for a new advertising agency begins.
- Stage 2 Panic — Now it really begins to get ugly, as management sacrifices margins to increase customer counts by implementing a deep discounting strategy. It then becomes clear that major changes need to be made across the enterprise.
- The Healing Process — Management decides to stop growth/discounting and attack the middle of the P&L to improve profitability.
Starbucks, Brinker, and McDonald’s are all companies that have successfully worked their way through this cycle, as management from their respective companies aggressively cut CapEx and began to focus on doing one thing right.
By slowing growth and attacking the middle of the P&L, EBITDA began to consistently increase in each situation. In our view, SBUX and EAT are currently two of the best managed companies in the restaurant space. DRI, on the other hand, is a company which is unwilling to address the issues the company faces. As a result, management is faced with a agitated shareholders.
When will they learn?