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Fri 22nd Nov 2024 - Friday Opinion |
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Subjects: Modelling the Budget’s impact, the Wonder stuff, higher inflation or price wars
Authors: Graeme Smith, Glynn Davis, Maria Vanifatova
Modelling the Budget’s impact by Graeme Smith
Pricing, staffing, opening hours, rent contracts; companies in the hospitality and leisure industries will be putting every commercial and operational lever under review in response to the Budget. Like retail, these sectors provide millions of part-time and relatively lower-paid jobs, and staffing will become more expensive when increases to the national minimum wage, national living wage and employer national insurance contributions (NICs) kick in next April.
Unlike some parts of retail, however, the hospitality and leisure sectors may have less leeway to pass on the increase in costs to consumers. Groceries are an essential expense; a meal out or a pint at the pub are not. One publican in London told the BBC that the Budget would add 30 to 40 pence to the cost of a pint – an increase his customers might not want or be able to swallow. A 1.7% cut in alcohol duty on draught products, which will lower the price of a pint of beer by a penny, will be of little consequence in this new scenario.
UKHospitality says increases to employer NICs and higher wages will add 10% to employment costs per person and £3bn to the sector’s annual tax bill (which was £54bn in 2022). Adding to cost pressures, most pubs and restaurants are facing higher business rates next year as discounts introduced during the pandemic are tapered off. Meanwhile, an overhaul of business rates, slated for 2026, is proposing increasing rates for businesses with a rateable value above £500,000, which could affect large, popular pubs in busy locations.
Higher taxes come at a delicate moment for the hospitality industry. In the second quarter of 2024, our Hospitality Market Monitor detected a nascent recovery in the number of licensed premises, equivalent to five new openings a day. However, year-on-year outlet numbers were still down by 1% – equivalent to nearly 1,000 sites – and remain almost 14% below pre-covid figures. The reality is the industry does not yet have the margin position to absorb higher tax, payroll and business rate expenditures. However, pushing extra costs on to the consumer by raising prices needs to be carefully managed. Many locations are experiencing volume declines already and broad-based price rises may depress footfall further, which could, in turn, affect the viability of certain sites.
AlixPartners’ soon-to-be-published survey of more than 2,000 UK consumers reinforces these concerns. When asked about their dining out plans for next year, a large majority of respondents said they would be spending the same or less, which in an inflationary environment means less custom for restaurants and pubs. Respondents also said they would be travelling less, and this chimes with what hotels and travel agents are telling us: that consumers in certain demographics are displaying a greater sensitivity to pricing. While the rise in minimum and living wages might lead to a short-term bounce in consumer discretionary spend that benefits restaurants and bars, our survey also showed that more than a third of consumers are more likely to save any extra income than spend it.
There is no one-size-fits-all solution for these challenges because there are so many operating models in hospitality – small, family-owned premises, leased and tenanted businesses, and large, company-owned managed sites, to name a few. As a result, businesses need to analyse the net effect of the chancellor’s Budget based on the kind of assets they own and the business models they operate.
Modelling the Budget’s impact should consider the type and size of each venue, how price increases might affect footfall and other changes to consumer behaviour. For example, customers might switch from drinking premium lager to lower priced beverages, or they might drink less on a night out.
Modelling the interplay of these different factors will help businesses understand which sites have the headroom to absorb higher costs, which can afford to increase prices, and which have no leeway and require greater attention. Some sites may simply become uneconomic under the new tax regime and may need to close permanently or enter discussions with landlords to work out a life-saving solution. Indeed, we may also see a flurry of M&A activity come to the fore, as larger operators look to acquire smaller businesses that face financing challenges.
In addition, on the cost side, reducing opening hours or trading days might help to optimise the cost of labour (while closely analysing any effect on total demand and including customer feedback by outlet type). In the longer term, fast casual concepts with lower labour intensity may begin to proliferate. Tenants and franchise holders may also have the option of renegotiating rents with landlords.
Hotel groups tend to have higher margins than a majority of bars and restaurants, so they may have more room to absorb higher tax and payroll costs. Even so, staffing will be a concern, and before the Budget, hotels and leisure operators were reporting a drop in demand for in-house food and beverage services as the post-covid spike in domestic travel ran its course. To compensate for this revenue loss, businesses should consider adjusting staffing and schedules, as well as optimising rates to maximise occupancy under a range of scenarios.
Without a doubt, the hospitality and leisure sectors are entering a period of heightened uncertainty. Their cost base has been dealt a sizeable price shock at a time when many businesses were just beginning to leave the lingering effects of the pandemic behind. They remain vulnerable to changes in consumer sentiment and the economic climate in general. This makes future performance hard to predict. Nevertheless, businesses can chart a way ahead by dynamically modelling the interplay of the factors that most affect them, defining the key actions they need to take – and where – in order to mitigate all of the additional costs from the Budget.
Graeme Smith leads the hospitality and leisure corporate finance team at financial advisory firm AlixPartners. This article first appeared in Propel Premium, which is sent to Premium subscribers every Friday. Companies can now have an unlimited number of people receive access to Propel Premium for a year for £995 plus VAT – whether they are an operator or a supplier. The single subscription rate is £495 plus VAT for operators and £595 plus VAT for suppliers. Email kai.kirkman@propelinfo.com to upgrade your subscription.
The Wonder stuff by Glynn DavisFew of you will likely have heard of Tony Hoggett, who last month announced his departure from the role of head of grocery stores at Amazon. To retail commentators, it was a surprise and suggested the digital behemoth had not really been having the predicted impact on physical food retail, and so Hoggett needed another challenge.
The bigger surprise was that he was moving to New York-based Wonder to run its real estate and store operations. I’ll admit I’d never heard of Wonder, a delivery-focused restaurant brand. So what, you might ask. Such businesses are two-a-penny or even two-a-cent.
But this one is different. It has devised an interesting model that is having an increasing impact on the New York area, where it is in the process of pursuing blanket coverage. From ten outlets earlier in the year, it will hit 35 by the end of the 2024, and 90 are planned by the end of next year. Connecticut and Pennsylvania are in the roll-out schedule.
Wonder was founded in 2018, when it had an odd model of food delivery, where the dishes were completed in transit to the diner’s house. That was junked 18 months back and it adopted a new multi-channel model – with in-restaurant dining in clean-looking spaces now accounting for 50% of orders, with the rest coming from digital, notably via its app.
What’s most interesting is that these home and in-store diners can choose from a wide variety of cuisines – from 25 to 30 restaurants. These are a mix of in-house branded concepts and menus from recognised and renowned restaurants from across the US such as Tejas Barbeque from Texas and Walnut Lane by Jonathan Waxman (me neither). Wonder has bought the rights to produce dishes from these existing restaurants.
To produce such a vast range from what are pretty small physical units – measuring around 3,000 square feet in total – is some going. This is achieved by using an unusual model that is akin to the supermarkets using the “bake-off” technique for their in-store bakeries. A central kitchen partially prepares ingredients for all the dishes before blast-chilling them and sending it all out daily for final cooking at the Wonder restaurants.
This latter step simply involves all-electric kitchens housing quick-cooking ovens, water baths and fryers, and the task can be undertaken by non-chefs. We are talking about an arrangement enabling food to be created at a significantly reduced cost base than with more traditional operations.
The precisely controlled vertically integrated nature of the Wonder set up extends to the delivery element, which is undertaken predominantly by an in-house network that operates within a tight radius with a six-minute delivery in city centres, and ten minutes in more suburban locations. This arrangement was bolstered this week with the acquisition of Grubhub from JustEat Takeaway for £510m.
But haven’t we heard all this wacky stuff before? Ghost kitchens, dark kitchens and various other kitchen-sharing models sprang up before and during the pandemic. Deliveroo’s Edition kitchens were due to be operating 200 kitchens in 30 sites by now. It is some way off that aspiration. In the US, Uber founder Travis Kalanick has found significantly less success with his CloudKitchens business, which has failed spectacularly to deliver on its plans. Over time, many of the brands that were using such services have retreated, and the explosion of virtual brands has also largely flamed out.
So, what’s the chances of Wonder succeeding with its interesting approach? It certainly has the resources, having raised a further $700m earlier this year, although CloudKitchens is proof that money is no determinant of success. Wonder’s secret weapon is, no doubt, its founder Marc Lore. He previously ran the online division at Walmart, having sold his website, Jet, to the retailer for $3.3bn. Prior to that, he sold a batch of online businesses to Amazon for $545m.
He’s clearly got form, and high-profile reviews of the food from the Wonder sites has revealed some hits in the mix. And the fact he has recruited Hoggett – who I’m informed was in the frame for running Tesco before moving on to Amazon – along with the Grubhub deal suggests it’s a serious push. If it continues to gain traction, then there will undoubtedly be learnings to be taken by operators in the UK.
Glynn Davis is a leading commentator on retail trends
Higher inflation or price wars by Maria VanifatovaWe’ve started to feel more at ease about inflation as it has steadily slowed down each month since the start of the year. In September, the Office for National Statistics reported that food and beverage prices rose by only 1.8% compared with the previous year. However, in foodservice, inflation remains higher – around 5% in fast food and 3% in casual dining, according to Meaningful Vision’s monthly price tracking across more than 100 UK brands.
However, with the UK government’s recent Budget announcement, inflation could once again become a pressing issue as foodservice labour costs are set to rise significantly. UKHospitality estimates that labour costs could increase by 10%. Given the varying impact of labour costs across segments, we’re likely to see a cost increase of 1% to 4% across retail, fast food and casual dining, with foodservice bearing the brunt as labour constitutes a larger share of costs compared with retail.
For an industry that heavily relies on a large workforce, this hike in costs is too substantial for restaurants to absorb on their own, particularly small and independent establishments that already operate on thin margins. Much has already been done to improve operational efficiency since the covid period, but there’s a limit to how much can be squeezed. Can these cost increases be fully passed on to consumers?
Not likely, as the market remains challenging. Even in fast food, traditionally the most affordable segment, traffic has been stagnant over the last nine months, at 0.2% from January to September, and a notable decline of 4% like-for-like. Meaningful Vision’s insight demonstrates that in fast food, the pocket of growth in traffic that we may see this year comes with new openings, while existing stores experience a decline.
We anticipate that out-of-home dining prices will rise faster next year, making it a less attractive option for many. In a worst-case scenario, where most of the costs are passed on to consumers through price increases, inflation in the foodservice sector could rise to as much as 7%. Families and individuals who might have previously enjoyed regular meals out may now find it more economical to eat at home. Who will benefit from this growth, and who will lose?
Market share or profit margin – a stress test
According to Meaningful Vision’s data, the UK market is already quite concentrated, with the top 100 brands making up 60% of the fast-food market and an even greater share of consumer spend. Fast food and casual dining brands are better equipped to weather a price competition, as many of them are still in expansion mode. Over the past nine months, the top brands have increased their store counts by 3%, suggesting market share is more critical to them than immediate profitability.
They can endure longer with slimmer margins and may already enjoy better margins due to economies of scale or stronger bargaining power with suppliers and landlords. Even with low margins, larger fast-food brands could safely operate benefiting from more substantial volumes. Independent players, however, lack this buffer, raising the question of whether the foodservice market will become even more brand dominated.
Playing with prices and promotions
The US press has recently covered fast-food price wars, spurred by the introduction of new value meals from McDonald’s ($5 meal deal) this summer, followed by other major players (Burger King’s $5 deal and Starbucks’ $6 combo), along with Wendy’s considering experimenting with dynamic pricing. In my view, dynamic or variable pricing is unlikely to be a practical solution in the current UK market, as it is complex to implement across all restaurants run by different franchises. Only digital aggregator platforms could manage it effectively.
Budget-friendly fast-food offers have now become commonplace in the UK. In April this year, McDonald's introduced its first £2.79 breakfast deal, followed by another budget offer in the summer of any three items for £3. Additionally, KFC launched a £5.49 meal deal, and Domino’s followed with a £5-£6 lunch offer. The £5 price point has become a popular niche, with many major players offering deals aimed at attracting price-conscious consumers.
We’re seeing a new trend emerging in promotions and meal deals. Traditionally, combo deals were designed to give customers a complete meal experience while encouraging them to spend a bit more than they might on a single item, targeting regular customers and heavy users. Today, many meal deals are positioned as budget-friendly options, not to push customers to spend more but to retain them at any price point.
What to expect for Christmas prices
Will Christmas menu items be priced above the inflation rate this year? While the full picture isn’t clear yet, we’ve already noticed Christmas coffee varieties in coffee shops priced around 6% higher as well as sweet treats, and more meal deals being offered compared with a year ago. Whether these deals will be more expensive or offer greater value remains to be seen; we’ll know more in a couple of weeks.
Maria Vanifatova is a chief executive and founder of Meaningful Vision – provider of pricing, promotion, location and traffic data to the UK foodservice industry. This article first appeared in Propel Premium.
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