Chains gain edge as food costs rise: independents forced to raise prices

Nation's Restaurant News, May 8, 1989 by Peter Romeo

Chains gain edge as food costs rise

Runaway commodity costs are handing chain restaurants an advantage over independent rivals in the firefight for an increasingly price-sensitive clientele.

Protected by fixed-cost volume purchasing agreements, multi-unit operators say they have held the line on menu prices despite the heftiest increases in wholesale food costs since 1980. But many independents lament that the pressure on their margins has been too intense to withstand.

"Food costs were going over the roof. We had to raise [menu prices], and food costs keep going up," said Ron Gustafson, owner of 70-seat Biff's Seafood Restaurant in Portland, Ore.

"They're desperate," commented Malcolm Knapp, a New York researcher who monitors restaurant sales. "There's a real advantage there for chains."

But that edge could be temporary. Many chains' long-term purchasing agreements are set to expire in June. Although a number of operators say they expect only moderate cost increases, commodity experts are more guarded. They foresee a decrease in beef costs, but warn that continued dry weather could hoist the price of vegetables, some fruits, and grainbased products.

What's more, chains may discover that their low prices and frequent discounts have conditioned consumers to expect a bargain.

"Price has become such a sales hook for them that now it's working to their disadvantage," said Ron Paul, president of Technomics Inc., a research firm in Chicago. "Operators have spoiled it for themselves. They'll talk about raising their menu prices, but they'll be reluctant to do it because they know they'll meet resistance from consumers."

"It remains to be seen what the effect will be on their bottom lines," commented Carl DeBiase, whose New Jersey-based Restaurant Trends monitors the sales performance of chain restaurants.

In the meantime, many chains are enjoying the added business they have garnered by freezing or even rolling back menu prices.

"Taco Bell went from raising its menu prices by a couple of percentage points last year, to lowering its prices by a couple of percentage points this year," said DeBiase. "From what we've seen, it's having double-digit sales gains."

Chili's, the 165-unit dinner-house chain, said it held price increases to less than a percentage point during the first quarter of 1989. The dinner-house operator reported a 67-percent year-over-year leap in net profits on a 19.5-percent rise in revenues for that period.

"We are extremely cautious about increasing our prices because value is an essential part of our concept," said chief financial officer Jim Parish. The chain estimates that 85-percent of its segment consists of independent operations.

McDonald's said it held prices during the first quarter.

Rax, a Midwestern rival, is striving to snap a downturn in sales and profits in part by slashing the cost of its all-you-can-eat food bar, which generates more a fourth of sales.

"We went from highs of $3.59 at lunch and $3.99 at dinner to $2.49 at lunch and $2.99 at dinner," said Rax president Larry Ritter. "We also took some moderate increases on sandwiches and soft drinks."

"We will be very cautious about price increases," he said, adding "we don't expect big increases in costs when we renegotiate our contracts."

Independents harbor different expectations.

"We will be raising prices primarily to meet rising food costs," said Alberto Salazar, the former world-class runner who now operates the Oregon Electric Station, a 190-seat dinner house near Eugene. "We've put in twice the effort we ever have in keeping them down by conventional methods, but we've not been able to."

Salazar said his food costs have risen by two percentage points in the last six months, to 38 percent of sales.

"Independents' margins have always been smaller than chains'," said Knapp. "They can't buy as well because they don't have the volume, so they have a higher cost structure."

That disadvantage has been damaging in light of a mounting unwillingness by consumers to accept higher prices. Economists cite stubborness as the reason why the U.S. Labor Department's Producer Price Index has been rising more quickly than the Consumer Price Index. In March, according to the bureau, retailers charged only 5 percent more than they did a year ago for goods they bought for 5.6 percent more.

The discrepancy was much wider for food-service operators. Although wholesale food costs rose in March at a year-to-year rate of 7.5 percent, the price of restaurant meals rose only 4.6 percent, according to the Labor Department. In contrast, grocery stores hiked prices by 7.7 percent.

Using a data base comprising 150 restaurant chains operating in 75 markets, DeBiase pegs the increases in menu prices for the whole first quarter at 3.2 percent.

The Labor Department indicates that food costs rose during that period by almost 6.4 percent.

The National Restaurant Association has predicted that menu prices will rise throughout 1989 at a rate of 4.6 percent. But the group based its projection on the anticipation that food costs would rise by only 3.2 percent.