In the years leading up to the pandemic, restaurant bankruptcies had become a recurrent headline. The count of U.S. restaurants and bars increased at a 2.2 and 2.5 percent compounded annual growth rate (CAGR) over the three and five years preceding 2020, respectively, according to Rabobank. Put into context, roughly 45,000 new restaurants—net of permanent closures—opened across three years, more than in any other comparable period over the last 25-plus.
It created a dynamic some believed set a course correction into motion. One expert told FSR the industry could be headed for a 15 percent reduction, or the elimination of 100,000 restaurant sites. This oversaturation was also responsible, in the view of certain pundits, for widespread traffic declines and a middle ground where restaurant operators were getting stuck between two viable splits—retail-focused and convenience-driven restaurants, and those who catered to experience.
The rate of expansion accelerated meaningfully, from growth of 1.7 to 1.8 percent in the 20 years prior to COVID. Operators raced to take advantage of decades-low unemployment levels, rising discretionary incomes, favorable demographics, and multiplying delivery and ordering options, which totaled more than a third of overall foodservice growth from 2017–2020, per Rabobank. What resulted could be described as “zero-sum” field that benefitted some over others. One concept’s growth potential came at the expense of somebody else’s. This pulsed is certain arenas. Rising rents in retail malls and high-traffic areas, such as the urban locations so many fast casuals gravitated toward when real estate prices dropped amid the financial crisis, brought the restaurant industry to an inflection. Many of these concepts were suddenly saddled with expensive leases, declining guests counts, and high costs jump-started by wage pressures. Additionally, there was an abundance of inexpensive money dipped into by restaurants, and as interest rates climbed back, those same parties had to write debt at a higher interest rate.
There’s no concrete point today on how many closures COVID ushered. In 2020, independent locations declined by 8 percent, according to The NPD Group. Or 28,399 closures. According to NPD’s Fall 2021 ReCount restaurant census, which counts restaurants opened as of September 30, 2021, the independent field expanded by 1 percent, or 2,893 units, in 2021. Using Business Employment Dynamics data compiled by the Bureau of Labor Statistics, The Washington Post pegged the 2020 total closure number at about 72,700. In March 2021, Datassential’s Firefly database shared a number of 79,438.
It’s a difficult thing to pin down but that 70,000–80,000 range appears to be the initial wave. Nick Cole, head of restaurant and hospitality finance at Mitsubishi UFJ Financial Group, says the number of restaurants per capita is at its lowest point in 25 years (which fits Rabobank’s research). And it’s coming against a backdrop of population growth. “This supply/demand imbalance bodes well for restaurant chains even in the face of potential softening demand as we head into 2023,” he says.
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But although restaurant supply is down, Cole does not expect a significant increase in new development near-term. It’s a sentiment shared by many operators in recent quarterly reports and look-ahead pieces. BTIG analyst Peter Saleh noted that although margins should recover from the several hundred basis points of contraction reported throughout 2022 by a bevy of chains, the combo-effect of commodity, higher-priced labor (even if there’s more jobs), and construction inflation will continue to weigh on franchisee economics, sentiment, and, in turn, development. Simply, 2024 is more likely to represent a serious growth target for most than 2023.
Scott Snyder, CEO of Bad Ass Coffee of Hawaii, which just opened its 28th location, has 12 additional units under construction and about 90 more sold that haven’t begun building yet. “We are starting to see a little bit of a reprieve on some of that,” he says of the construction costs and delays. “But I agree … I think by 2024, we ought to be back to where we have been; a little but more productivity in how long it takes us to open.”
He adds Bad Ass has some stores “that have been sitting on permitting for months.” In the past, it was a three- or four-week process.
Saleh pointed out restaurant growth nearly always follows the directional trend of unit economics. In a six-month period to close 2022, Saleh held conversations with franchisees across multiple concepts, and there was a clear, pessimistic tone on development. Commodity and labor inflation took their toll on margins. Saleh estimated franchisee EBITDA margins were down 300–350 basis points in the past year, and well off a recent peak of 13.5 percent. Couple that with those aforementioned construction costs (15–30 percent higher year-over-year) and cash-on-cash returns have potentially been cut by a third in the past two years. So development might have to wait for margins to recover before it accelerates.
M&A is a waiting game, too. As Cole and his team anticipated in November 2021, M&A was constrained in 2022 because of margin pressures due to rising commodity prices, workforce shortages, and the need for higher expenditures to attract labor. “The current inflationary environment and resulting margin compression has hurt business results and is therefore driving M&A activity down,” Cole says. He expects business performance in the first half of 2023 to be better than in 2022, and potentially spur a pick-up in M&A.
“Most restaurants report that they are fully staffed now, however it is costing them more to do it,” Cole says. “Ultimately, while it is still not easy to staff, pressure has been relieved across the board.”
Thinking ahead
Where does this all leave operators in 2023? The decline in restaurant capacity due to COVID explains why restaurants have been able to pass on higher operating costs and rising inflation to the customer in the form of price increases, Cole says. This even as diners themselves endure the financial pressures of inflation with greater household expenses. Yet there’s some potential friction ahead.
“Throughout much of the year, we have seen consistently higher sales figures due to rising menu prices and stable foot traffic. However, in the last month or two there are signs that foot traffic might be slowing,” Cole says. “If foot traffic continues to decline significantly, even an offset in prices might not be able to sustain revenue.”
He adds demand generally slows when the impact on household budgets makes customers reevaluate their spending patterns. Cole expects that to continue into 2023 as customers absorb the significant hike in the cost of living.
Something disruptive about this reality, however, is how digital has segmented spending patterns through COVID and where it’s left the definition of “value.” Put differently, how will guests define the “affordable luxuries” that have historically shielded foodservice in light of economic downturns?
In a survey from global scale-up company Deliverect, customers said they were ordering delivery, costs and all, more than before. Forty-two percent of people in the U.S. said they were getting up to three deliveries a week—2 percent above pre-inflation habits. When it came to reasons they weren’t doing so, “overpriced menu items” didn’t crack the top five (long delivery times was No. 1). The two factors most at play, in terms of ordering delivery, were quality ingredients (90 percent) and convenience (84 percent).
Customers appear willing to spend on food, but it has to satisfy value from one of two angles—convenience or experience. History is repeating itself as the stakes raise. Only now it’s tied to higher prices and discretionary income instead of choice in the marketplace. Yet the same points of differentiation remain in focus—consistency in quality or consistency in convenience. There’s little room in the middle.
According to the National Restaurant Association, nearly three years removed from COVID’s onset, 16 percent fewer people are dining on-premises than before. But the Association claims the gap has been entirely covered by off-premises business. Delivery is 5 percent higher than 2019 and carryout 3 percent lower. Drive-thru, however, sits 13 percent above pre-COVID marks and today accounts for 39 percent of all restaurant traffic, per an article in The Washington Post.
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Data from Revenue Management Solutions showed, among revenue channels, drive-thru turned in the worst year-over-year performance at negative 10.2 percent in November, lower than the year-ago period. In fact, month-over-month drive-thru trends have held stable since May 2022. Meanwhile, dine-in climbed 29.6 percent in the month after growing 37.1 percent in October. Takeout was 20.6 percent higher and delivery 11.5 percent, although that, too, has declined versus previous months.
It illuminates a post-COVID landscape: Higher drive-thru usage than 2019, but with an arrow that’s leveled out; sustained preference and interest in off-premises streams; yet with clear evidence the dining room is far from dead.
Hudson Riehle, senior vice president of Research for the Association, said in a statement Thursday the industry was ending 2022 “in an environment that’s the most typical since 2019.” Just as RMS showed, baselines are forming. “Moderate but positive employment growth across the economy and elevated consumer spending in restaurants will allow the restaurant industry to kick off 2023 on a more optimistic note than the last few years, but operators remain braced for potential challenges in the new year,” Riehle said.
This past calendar, just like the two before it, was rife with external pressures. The story of 2022 was unequivocally inflation and how it forced supply costs up. Borrowing capital become more difficult and, broadly, operators had to raise menu prices to cover for all of it.
The Association’s Business Conditions survey of 3,000 operators, released Thursday, showed the trifecta of higher food costs, labor costs, and energy/utility costs continue to present a sizable challenge for a majority of restaurants.
Percent of operators who say the following items are a significant challenge for their restaurant:
All restaurants
- Food costs: 92 percent
- Labor costs: 89 percent
- Energy and utility costs: 63 percent
- Full-service segment
- Food costs: 92 percent
- Labor costs: 90 percent
- Energy and utility costs: 67 percent
- Limited-service segment
- Food costs: 93 percent
- Labor costs: 87 percent
- Energy and utility costs: 58 percent
And here’s how restaurants are responding to higher costs:
- 87 percent of restaurants increased menu prices, while 59 percent changed the food and beverage items that it offered on the menu
- 48 percent of restaurants reduced hours of operation on days that it is open, while 32 percent closed on days that it would normally be open
- 38 percent of operators say they postponed plans for expansion
- 35 percent of operators say they stopped operating at full capacity
- 32 percent of restaurants cut staffing levels, while 19% postponed plans for new hiring
- 21 percent of operators say they incorporated more technology into their restaurant
- 13 percent of operators say they eliminated third-party delivery
The Producer Price Index for All Foods (the change in average prices paid to domestic producers for their output) rose in November for the 18th time in the last 23 months, with 15 of those increases topping 1 percent. While menu prices also increased 8.5 percent between November 2021 and November 2022, these jumps were lower than grocery store prices, which lifted 12 percent over the same period.
“In this kind of economic environment, typical operators don’t have much margin for error. With major input costs escalating, they can make changes to align with local consumer demand while realigning operations for longer term growth,” Riehle said.
Responses broken down:
All restaurants
- Increase menu prices: 87 percent
- Change menu items: 59 percent
- Reduce hours of operation on days that it is open: 48 percent
- Postpone plans for expansion: 38 percent
- Not operate at full capacity: 35 percent
- Reduce the number of employees: 32 percent
- Close on days that it would normally be open: 32 percent
- Incorporate more technology: 21 percent
- Postpone plans for new hiring: 19 percent
- Eliminate third-party delivery: 13 percent
Full-service segment
- Increase menu prices: 89 percent
- Change menu items: 70 percent
- Reduce hours of operation on days that it is open: 49 percent
- Postpone plans for expansion: 34 percent
- Not operate at full capacity: 36 percent
- Reduce the number of employees: 29 percent
- Close on days that it would normally be open: 36 percent
- Incorporate more technology: 21 percent
- Postpone plans for new hiring: 18 percent
- Eliminate third-party delivery: 16 percent
Limited-service segment
- Increase menu prices: 86 percent
- Change menu items: 48 percent
- Reduce hours of operation on days that it is open: 46 percent
- Postpone plans for expansion: 43 percent
- Not operate at full capacity: 34 percent
- Reduce the number of employees: 35 percent
- Close on days that it would normally be open: 27 percent
- Incorporate more technology: 21 percent
- Postpone plans for new hiring: 21 percent
- Eliminate third-party delivery: 10 percent
Fifteen percent of restaurants said they were adding fees or surcharges to checks as a result of higher costs. It was pretty even across lines—17 percent of full-serves said they were alongside 14 percent of limited-service operators.
Among those who are doing so, 81 percent said they believe it will be necessary for more than a year. Eight percent expect to continue adding feeds or surcharges for another seven to 12 months, while only 11 percent expect this practice to sustain for less than six months.
Duration that restaurant operators expect the fees or surcharges will be necessary:
All restaurants
- Less than three months: 3 percent
- Four to six months: 8 percent
- Seven to 12 months: 8 percent
- More than a year: 81 percent
Full-service segment
- Less than three months: 2 percent
- Four to six months: 5 percent
- Seven to 12 months: 7 percent
- More than a year: 86 percent
Limited-service segment
- Less than three months: 4 percent
- Four to six months: 12 percent
- Seven to 12 months: 9 percent
- More than a year: 75 percent
And despite these efforts, restaurants still expect profitability to be challenged in 2023; only 16 percent of operators said they predict being more profitable this year than last. Half feel they’ll be less profitable and 34 percent expect similar results.
The supply chain remains a pressure point, too. Ninety-six percent of operators noted their restaurant experienced supply delays or shortages of key food or beverage items in the past six months. Among those, 76 percent said they made changes to their menu offerings as a result (82 percent in full service and 70 percent in quick).
Seventy-eight percent of operators added they’ve experienced supply delays or shortages of equipment or service items in recent months.
Turning to the ever-present labor topic, 62 percent of operators claimed their restaurant currently did not have enough employees to support existing customer demand (63 and 61 percent for full and limited service, respectively).
The climate might be improving, but operators feel there’s still room to climb—restaurants added roughly 62,100 jobs in November to bring the total to 11.9 million, or 460,000 or so short of February 2020 figures.
In the last 23 months, restaurants added nearly 2.2 million jobs. That’s 400,000 more than the next closest industry (professional and business services).
Among those restaurants who claimed to be understaffed, 66 percent said their restaurant was more than 10 percent below necessary staffing levels; 27 percent claimed to be more than 20 percent under.
Operator reports of how understaffed their restaurant was:
All restaurants
- 1–5 percent below necessary levels: 7 percent
- 6–10 percent below necessary levels: 27 percent
- 11–15 percent below necessary levels: 21 percent
- 16–20 percent below necessary levels: 18 percent
- More than 20 percent below necessary levels: 27 percent
Full-service segment
- 1–5 percent below necessary levels: 7 percent
- 6–10 percent below necessary levels: 26 percent
- 11–15 percent below necessary levels: 21 percent
- 16–20 percent below necessary levels: 20 percent
- More than 20 percent below necessary levels: 26 percent
Limited-service segment
- 1–5 percent below necessary levels: 7 percent
- 6–10 percent below necessary levels: 27 percent
- 11–15 percent below necessary levels: 21 percent
- 16–20 percent below necessary levels: 16 percent
- More than 20 percent below necessary levels: 28 percent
Close to 80 percent of operators (79 percent) said their restaurant currently boasted job openings that were difficult to fill. Most added they’ll be actively looking to boost staffing levels in 2023. Eighty-seven percent would likely hire additional employees during the next six to 12 months, if there were qualified applicants available.
At the same time, they’ll need to balance staffing needs with external forces—57 percent said they’d likely lay off employees in the next six to 12 months of business conditions deteriorate and the economy enters a recession.
