last updated 23/09/2019
Banking On Hospitality
last updated 23/09/2019
René Artz from Westpac looks at challenges and opportunities in the hospitality industry
If you love food and drink, or the operational adrenaline and atmosphere of a busy café or restaurant, a hospitality business may appeal. But statistics show that equal numbers enter and exit the hospitality industry every year, so you shouldn’t just follow a dream blindly. This is where buying into a well-developed franchise system can be a good idea – you’ll have a proven brand and business model behind you, detailed operating procedures and systems to follow, and benchmarks and KPIs to help you measure and improve your performance. In a competitive industry, all these advantages add up.
Making it work
Whether buying an existing franchise or starting new, there are plenty of things to consider. Financially, there are three key pillars
All three require you to conduct proper due diligence prior to committing yourself. Due diligence is like getting a pre-purchase inspection on a house or car, but rather more complicated.
Is the franchise growing and is it on-trend? Cross-check against average store sales and margins for the sector. It can be easier to grow a well-performing franchise within a growth sector.
Does the franchise provide regular benchmark monitoring? This may include comparisons of store financial performance and regular mapping of the guest journey for a consistent customer experience. Both are key to doing well in hospitality.
Great hospitality businesses focus on getting accurate data from point of sale, purchase orders and stock takes to enable regular monitoring of profit after controllable or prime costs. In business, a broad score is income and expenses, with the difference between them relying on your ability to control them for maximum profit.
A key point here is that 90 percent of controllable costs will usually lie in just three areas: food; beverage; and payroll.
Failure to monitor and control these prime costs can lead an otherwise busy, well-located hospitality business to close. A bustling café operating with insufficient margin will go out of business just as quickly as a café with few customers. So how should we view prime costs? While food, beverage and payroll are benchmarked and reviewed individually against the franchise yardsticks, monitoring the combined controllable costs against sales is a key to making hospitality work.
Rules of thumb suggest that quick service restaurants should keep prime costs within 60 percent of sales, and full-service restaurants within 65 percent of sales. Why? Because non-controllable costs from rent to franchise fees, merchant to utilities can take 25–30 percent of sales. Combined, a hospitality going concern may swallow up 90 cents for every dollar of sales before finance costs or shareholder return are allowed for.
To see why prime costs are pivotal, let’s look at how a 5 percent reduction in prime costs would impact upon a café or restaurant owner. They might achieve this through matching staff levels to a forward calendar of events, recipe costing, matching purchase orders against signed and checked delivery invoice (checking for under-delivery or theft), or reducing kitchen waste through portion control, to name just a few ideas.
Here are some numbers to illustrate the outcome:
Without one additional dollar of sales, a 5 percent reduction in prime costs raised net income for this business by 100%. Now imagine the opposite; without regular monitoring and management. In all probability prime costs are likely to rise. What do you think would happen to store profitability if prime costs rose by 5 percent? That’s why good franchises provide good systems to help franchisees manage their businesses better.
Another factor which may significantly influence profit is location. When conducting your due diligence, be wary of franchise averages, as these can hide the fact that one hospitality concept may thrive as a drive-through, whereas another may require a large kitchen to produce fresh product on-site. These factors can influence both cost control and sales success for a given location: for example, they may rule out a mall location without drive-through, or the cost of a large kitchen within a high-rent CBD site. When reviewing any franchise, try to note concept sales, margin and overhead expenses across a variety of locations, not just broad averages. Some brands may have differing business models for different types of location, so compare like with like.
A good hospitality franchise should have a clear target market, from demographics to psychographics and targeted break-even customer count. Any location should be evaluated against these targets.
It can also help to look at the rent-to-sales ratio for determining whether any particular location is feasible. Rent-to-sales benchmarks will be dependent on the franchise system and can typically range from 6-11 percent of turnover (or more) depending on location and concept. Locking in a lease above the system benchmark can eat into shareholder returns.
Check whether available lease terms match the franchise period – you don’t want a site with no franchise, or vice versa. Also, note that many franchise concepts require refurbishment every 5-7 years. If you’re buying an existing outlet, how soon will refurbishment of fit-out or plant and equipment be required?
Be careful of a hospitality concept that has failed in a given location – it may turn out to be because of a poor operator, but it could also be a location error.
When a new franchise outlet is established or a going concern is purchased, the owner soon comes face-to-face with the reality of running a complex business. A focus on sales, location and prime costs can help avoid issues, although without access to suitable capital a business may still not stand the test of time. This is something that needs to be planned for from the very start, with the aid of a franchise-experienced accountant and a specialist banker.
If you leverage all your cash and bank funding with nothing to spare from day one, you put everything you are working toward at risk. A forecast cash-flow may not build up as planned thanks to adverse weather or on-going road works. In these situations a positive cash-flow can quickly reverse for a period and a location may rapidly become untenable. Being well capitalised is key to staying the course.
If you’re going to bank on hospitality for your business future, you need to choose the right concept, in the right location and with an acceptable level of shareholder capitalisation. Following the above steps will help you minimise risk and maximise your chance of long-term success.
The information contained in this article is intended as a guide only and is not intended as an exhaustive list of matters to be considered. Persons entering into franchise agreements should seek their own professional legal, accounting and other advice.
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