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.
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.
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.
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 take away 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.
But the level of competition created by this greater variety of propositions, rapid roll out 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.
At the same time that competition for consumers’ restaurant spend is increasing, household discretionary spending looks set to come under pressure.
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.
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.
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.
Against a more competitive backdrop and a more challenging outlook for consumer spending, restaurants also face growing cost pressures.
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.
Over the last few years, aggressive roll-outs by branded restaurants have led to a skills shortage for 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.
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.
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 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.
A number of the market’s characteristics, which were created by rapid expansion now look more problematical.
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.
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.
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.
Senior Associate, PwC United Kingdom
Tel: +44 (0)20 7213 4888