Growth Spurts
Where are the opportunities for 2005? Everywhere, if operators learn where to look.

By Scott Hume, Executive Managing Editor

High-end redux: Masa in the Time Warner Center.

"Think how much trouble an auto dealer would have selling a 1980 car now. It was a good car then, but without anti-lock brakes or cup holders it would be a tough sell today," says Dennis Lombardi, executive vice president of Chicago researcher Technomic Inc. “And how different is the restaurant experience now compared with 1980? Many operators are due for catching up, and I sense that they’re starting to do that.”

The foodservice industry will see 4.5% nominal and 1.4% real growth in 2005, according to Technomic’s projections. That’s better than the 0.9% inflation-adjusted real growth in 2004, and certain segments (especially full-service restaurants and college/university foodservice) are projected to post above-average gains. But in every segment, analysts say, there will be opportunities for growth.

Fast Service, Fast Response
Conventional wisdom at the beginning of 2004 was that the year would see continued evolution of the fast-casual segment, largely at the expense of quick-service restaurants (QSRs). But fast-casual growth was weaker and QSRs’ response stronger than many expected.

“Frankly, I’m amazed at the strength of the QSR segment,” says Neil Culbertson, a former marketing vice president at Red Robin Gourmet Burgers who heads Growth Partners, a Greenwood Village, Colo.-based consultancy. Far from being made obsolete by fast-casual competitors, mainline chains “are redefining what a QSR is. They’ve upgraded their product and they’re upgrading pricing,” he says.

QSRs Still Dominate Sales and Customer Counts As reported by UBS Investment Research, data from The NPD Group's CREST study show that quick-service restaurants account for the bulk of commercial sales and customer traffic. CREST also finds that while customer-satisfaction scores for QSRs showed a slight improvement in 2004, casual and midscale chains registered slight declines. Source: The NPD Group/UBS Investment Research. The QSR segment includes all restaurants where people pay before service; midscale includes table-service restaurants with no alcoholic beverages; casual includes table-service restaurants with alcoholic beverages and average checks less than $21; other category includes fine dining and upscale hotel foodservice (excluding catering).

“When fast casual offered better quality at a higher price, QSRs said, ‘OK, we’ll take some of that action.’ You can get a great salad at McDonald’s or Wendy’s.

Fast casual has its place, but QSRs took the challenge seriously, and you have to be impressed,” Culbertson adds.

Fast casual’s unit expansion slowed in 2004, although it continues to grow faster than any other segment. Its 13% rise in unit growth was below 2003’s 17%, but customer traffic rose 7% in 2004 versus 6% the previous year, according to Rosemont, Ill.-based NPD Foodworld.

It is important to remember that fast casual accounts for only 2% of industry sales, says Michele Schmal, NPD Foodworld vice president of product management. That said, it continues to have disproportionate impact on the industry. “Fast casual had the hamburger segment taking a new look at the marketplace and responding,” she says. “That response wasn’t 99-cent offers, it was new products. QSRs realized consumers are willing to pay more for quality.”

The Service Component
Schmal says that while fast casual remains a growth area, there is evidence that a shakeout among concepts may be starting. “There will be winners and losers,” she says.

Fast-casual concepts that offer food comparable in quality to casual dining but at quick-service speed will do well, says Culbertson. He cites Pei Wei, the fast-casual sibling of Scottsdale, Ariz.-based P.F. Chang’s China Bistro as an example. “If consumers just want fast, they can go to QSRs,” he says. “Fast casual without casual-dining quality is going to be vulnerable.”

Some concepts have struggled. Dublin, Ohio-based Wendy’s International says it will close 18 units of its Baja Fresh fast-casual chain, which in some markets experienced declining same-store sales during 2004, although Chairman and CEO Jack Schuessler says the concept is doing well on the East and West Coasts.

Midscale Under Pressure
Family-dining chains will continue to be squeezed by the improvements and successes of both QSRs and fast casual, analysts say. Technomic forecasts family chains to see 3% growth in 2005, the same as it projected for full-year 2004. Hamburger QSR sales are projected to gain 7.2% this year; varied-menu casual chains will do even better, with 7.5% growth.

Where the Growth Will Be Chicago-based Technomic Inc. projected 2004 nominal growth of 6.0% for the limited service segment overall, 5.2% for full-service operations. For 2005, it forecasts 5.6% nominal growth for both limited and full service. Source: Technomic Inc.

Midscale family chains were “a weak spot” among restaurants in 2004, hurt in part by lagging menu innovation, says NPD’s Schmal. But Lombardi says the category’s prospects improve if its two largest members—Spartanburg, S.C.-based Denny’s and Glendale, Calif.-based IHOP—reap rewards from their current strategies. IHOP’s efforts to increase dinner business could help not just it but the entire category.

The critical question for midscale chains, Lombardi says, is: “How much can they increase prices before [customer] traffic declines? At what point will consumers decide not to stay” and move to casual dining?

Cautious Casual
Every category’s performance is deeply influenced by the success—or lack of it—of its leader, and Overland Park, Kan.-based Applebee’s Neighborhood Bar & Grill has been strong. Its same-store sales in November were up 4.1%, Dallas-based Brinker International’s Chili’s Grill & Bar—the No. 2 casual chain—was down 0.7%.

Like QSRs and fast-casual concepts, casual-dining chains (especially at the lower end of the price scale) need to be cautious about price/value disconnects with consumers. Maryville, Tenn.-based Ruby Tuesday reported that same-store sales were off at least 8% in each of the three months (September through November 2004) of its fiscal second quarter. Chairman and CEO Sandy Beall told Wall Street the chain “had an issue with some portion sizes and value resulting from decisions we made in conjunction with our menu released last spring.” That menu was heavy on low-carb and lighter options.

A winter menu with larger portions and backed by increased ad spending should reverse the slide, Beall predicts.

Bites of the Sandwich Category
Dwayne Chambers, marketing vice president for Greenwood Village, Colo.-based casual chain Red Robin, believes the concept ultimately can quadruple its 250 domestic locations. Its success is tied in part to the enduring popularity of hamburgers, which are its core menu item, he says.

That endurance is one of the lessons of 2004, analysts say. Through October, customer traffic at burger QSRs was up 5% versus the previous year, while overall industry traffic was only 1% ahead, according to NPD. “The industry generated 750 million additional [restaurant] visits in 2004, and a very healthy share of that was in the hamburger segment.”

McDonald’s continuing rebound—20 consecutive months of U.S. same-store sales gains, including a 7.1% jump in November 2004—deserves much of the credit, of course, even though its sales include nonburger items as well.

Among the burger alternatives McDonald’s has been testing is its line of Oven Selects hot sub sandwiches. If the chain “decides to roll out those items to its 16,000 drive-thrus it will have a huge impact on the sandwich category,” says Lombardi. Forecast by Technomic to grow 8% in 2005, the same as in 2004, the QSR sandwich segment is one of the few with higher growth potential than burgers.

If Oven Selects are introduced, Burger King and Wendy’s would be pressured to follow suit, making competition much tougher for Milford, Conn.-based Subway, Denver-based Quiznos Sub and others in the category.

Nontraditional and Non-Western
Opportunities for site expansion also are varied this year, with nontraditional, noncommercial and overseas locations in operators’ plans.

The new generation of fast-casual restaurants, such as Mediterranean Grill in Frederick, Md., combines counter service, modest pricing and upscale, adult-oriented design.

Subway’s growth strategy is a strong indication of the role nontraditional/noncommercial locations play in unit development. Of the 216 units it opened during October 2004, 83 were in airports, college campuses, hospitals, military bases, convenience stores or mass-merchandise stores. Warren, Mich.-based Big Boy opened a restaurant at the University of Michigan’s football stadium in Ann Arbor. White Plains, N.Y.-based pizza chain Famous Famiglia is going into the University of Massachusetts’ Blue Wall Eatery food court and Gaithersburg, Md.-based contractor Sodexho USA opened its Jazzman’s Cafe in Dallas’ DFW International Airport.

After a lull, international expansion is again a growth strategy for major chains, with Asia high on wish lists. Ruby Tuesday in April will open its first unit in South Korea, but most eyes are on China. David Palmer, analyst with UBS in New York City, notes that China has a restaurant-ready middle class of 40 million to 50 million, and that number may grow 10% to 15% annually. “The ultimate target market for QSRs could already be as high as 400 million,” Palmer wrote in a November 2004 report.

“China is our number-one growth opportunity in the world,” McDonald’s Global Marketing Chief Larry Light said recently. “We think the market has huge potential.”

In addition to McDonald’s, Starbucks and Dallas-based Yum! Brands (Pizza Hut, KFC and Taco Bell) already have built presences in China. Miami-based Burger King and Applebee’s reportedly are making plans to go in.

Opportunities for growth always are present, no matter how fickle the economy or consumers’ tastes, analysts say. The success stories, though, will be written by operators who put what they learned in 2004 to work this year.

A Builder's Point of View

The battle between quick-service and fast-casual concepts has overshadowed renewed strength at the high end.

“Upscale is making a comeback,” says Brian Stys, vice president of the restaurant group for Boston-based Shawmut Design and Construction. The type of restaurants it is being contracted to build is moving uptown in style and investment.

“High-end restaurants took a beating after Sept. 11, 2001, but that’s reversing,” says Stys. The action now is in steakhouses, not only at chains such as Morton’s and Fleming’s but independents, and high-ticket Asian concepts (such as Masa—with tasting-menu prices from $300 up—which Shawmut built in New York City’s Time Warner Center) and toney “urban nightclub bars” that put equal emphasis on food and beverages. New restaurant design specs call for larger bar areas, incorporating counter seating for meals as well as socializing.

Business expense accounts are rebuilding as companies decide they need to get back in the field, Stys says, and that fuels growth of the upscale market.

“Chanel and Luis Vuitton are back,” says Stys. “People want to spoil themselves a little.”