State of the UK Restaurant Market (2017)
This has been based on the excellent piece on PwC about the restaurant sector at the end of 2017, with additional commentary from me based on developments in 2018 and my view of the market from the inside.
Food for thought
PwC: The restaurant sector has performed well in recent years with market growth underpinned by long-term demographic and consumer trends. But market conditions have become more competitive, consumers are facing pressure on their real incomes from rising inflation and cost pressures are increasing. A more cautious outlook on the sector is justified.
Me: Recent high-profile chain closures and restructuring including Toys R Us, Prezzo, Barbecoa, Jamies Italian, Strada, Byron and Maplin will have a significant impact on the high street (thousands of jobs are about to go). The ‘cautious’ outlook is justified, though I would suggest ‘concern’ is more appropriate for the chains.
The market environment is becoming more challenging
PwC: People now eat out more often and for a wider range of occasions. This fundamental structural shift, driven by demographic and consumer trends, has led to considerable market growth in the restaurant sector in recent years and underpinned significant transactional activity, particularly over the last two years.
PwC: As it has grown, the eating-out landscape has evolved significantly compared with 10 years ago. Chains have taken market share and grown the market through aggressive roll-out and by offering more choice, better quality and more consistency to customers.
Me: Restaurant Chains often adopt heavy discounting models to attract volumes of customers over-and-above their already narrower margins. Chains such as Prezzo and Pizza Express always have offers and many guests in our two restaurants comment that if Prezzo and Pizza Express didn’t run the offers they would be empty. It appears that these slim margins have been eroded as people are eating out less often in the same places, leading to closures and restructuring. I used to run the website for Fakhreldine in London (in my old web designer days) and they relied heavily on Taste cards (et al), offering 2-for-1 dining and a chance to see a celebrity at their glitzy location. But, when they paused the offers the place was empty and, eventually, they went out of business.
PwC: There is also increasing crossover between market segments. The food-to-go sector has grown and is available all day, while dine-in chains are increasingly offering takeaway options. At the same time, advances in technology have led to more visibility for smaller providers, as well as providing help to drive the growing popularity of delivery services such as Deliveroo and Uber Eats (see my last piece on this sector here).
PwC: But the level of competition created by this greater variety of propositions, rapid rollout by brands and the entry of substitutes, such as app delivery platforms, is now challenging restaurants. The extent to which the growth of delivery services is adding incremental sales or cannibalising sales and eroding margins is also unclear.
Me: There has been some consolidation here as expected with many of the smaller entrants disappearing. However, the larger players are also increasing their commission requirements, further adding to the cost burden on restaurants.
Consumers are feeling the pinch
PwC: At the same time, that competition for consumers’ restaurant spend is increasing, household discretionary spending looks set to come under pressure.
PwC: Consumer confidence held up in 2016, even improving after the Brexit vote, and consumer spending continued to grow in real terms. However, the Bank of England has forecast that inflation will rise to 2.7% by the end of 2017, which could dampen real income growth. The balance of opinion according to a PwC survey shows that household income is expected to be lower in the next 12 months than it is now.
PwC: If real income does begin to contract, sentiment may have more of an effect on consumer spending than it has done in recent times. Higher energy and commodity prices, as well as a weaker pound, have driven up the cost of non-discretionary spending categories, which could put pressure on discretionary spending. It is also uncertain if credit, which has been growing at more than 10%, the highest rate in 10 years, can continue to support consumer spending.
PwC: Should sentiment turn sour, consumers’ discretionary spending priorities are likely to change and restaurants may face lower demand. During the downturn in 2009, our PwC Consumer survey found that consumers opted to eat out less often, cook more at home and use promotions/discount codes.
Me: Even though, statistically, real income is higher, the competition from the endless stream of new entrants, concepts and pop-ups in the market coupled with the fickle nature of many consumers wanting to jump on the latest trend (backed and fuelled by social media) dilutes the available market share available to established and existing restaurants. Many of my colleagues in the industry have commented that 2017 has been a ‘slow year’ by comparison, and this is echoed by many suppliers to the restaurant business. Suppliers have commented that a number of their clients are struggling and a few have already closed. This is also, in part, attributable to increasing cost pressures …
Cost pressures are increasing
PwC: Against a more competitive backdrop and a more challenging outlook for consumer spending, restaurants also face growing cost pressures.
PwC: The restaurant sector is labour intensive and faces significant challenges on the cost, availability and quality of its workforce. The National Living Wage introduced an upward step change to the cost structures of restaurants in 2016, with further annual increases of c.6% expected until 2020. Restaurants have had to absorb this step change and may not have been able to recoup the entire cost increase through price rises.
PwC: Over the last few years, aggressive roll-outs by branded restaurants have led to a skills shortage of chefs. As a result, a supply shortfall exists and the cost of finding good chefs is rising. In addition to this skills gap, UK unemployment has fallen to 4.7% in March 2017 and foreign labour supply is reducing, partly driven by the sharp depreciation in sterling since the Brexit vote. All these factors are likely to contribute to upward pressure on wages in the sector.
Me: See Hospitality industry’s rapid growth under threat without Government support. Recruitment of hospitality staff, in general, has become harder. Fewer applicants come forward for every job. They also want more money or have zero experience as they are coming from other sectors where there are fewer jobs. If this trajectory continues, there will also be a lot of them out of work.
PwC: The c.18% depreciation of sterling has also increased import costs, impacting many food categories. The full impact of the pound’s weakness is expected to come through in Q2 2017 as fixed price supplier contracts and hedging instruments for larger groups begin to fall away. For companies that import ingredients, rising input costs will be difficult to recover through price increases and may drive restaurants to review the supply of goods and price points.
Me: As a Lebanese restaurant operator, many of our ingredients come in from overseas and some have doubled or tripled in price as a result of these economic changes. There are only so many price rises you can absorb.
PwC: Other cost pressures are mounting too, particularly business rates. Non-domestic properties have been revalued nationally for the first time in seven years and these re-valuations will form the basis of business rate liability for the next five years, starting in April 2017. London-centric portfolios will experience significant rises in business rates, although national portfolios will be protected partially by rates refunds for most properties outside London.
Me: See The “Affordable Restaurant” Apocalypse. Business rates across both our restaurants went up a little under 35%. We are looking to challenge these rises where applicable and also have applied for rate relief where available. However, contesting business rates is now harder than before and requires more hoops to jump through which will deter the smaller operators. Further, applications for rate relief take time to process and it is now nearly one year after the rates went up and we are still waiting to hear back about any potential offset that may be available. In the meantime, we are paying the new, higher rates.
Me: Let’s also not forget that commercial rents are going up and some commercial landlords can be quite unforgiving when it comes to setting the new rent unless you are very lucky. Independent landlords often offer more flexibility, but if they have a portfolio of properties you may find yourself faced with a difficult decision.
PwC: A number of the market’s characteristics, which were created by rapid expansion now look more problematical.
PwC: Fast, large-scale restaurant brand roll-outs have driven sector growth in recent years. They are now causing some concern that chains have focused on numbers of restaurants rather than the quality of individual sites, opting for scale before introducing the right infrastructure and rolling out their offering before appropriate processes are in place to cope with the expansion.
PwC: International expansion, too, rather than a sign of strength can often act as a distraction from the core UK business and also comes with a big cash requirement.
PwC: The winners in this tougher environment will need clarity in strategic decision-making. Delivering a relevant and differentiated proposition to consumers will be critical, while cost and operational efficiencies will be another key focus for most restaurant groups. Those that lack strategic positioning may find it difficult to recover cost increases through price rises and could be vulnerable to financial distress, which in turn may drive further consolidation through M&A.
Me: I see PwC switched to using ‘concern’ for the chains. Good call! Numbers have been the driver in this sector, and recent openings like Cote in Weybridge have underperformed (we can see this as we are their neighbour and they aren’t as busy as we have seen other branches in the past).