Finding the Right Foodservice Program

With gas margins in the gutter and operating costs nearly doubling over the past five years, the 35% margin foodservice offers has been a savior of sorts for Mike Harrell, president of Jernigan Oil Co. Inc., a fourth-generation marketer in Ahoskie, N.C. that operates 25 Duck Thru convenience stores.

It doesn’t help that North Carolina, where the majority of Duck Thru stores are located, has the third highest gas tax in the country. Its neighbors to the north and the south, Virginia and South Carolina, have much lower tax rates that result in a 12-15 cent price disparity at the pumps, with Duck Thru on the losing end. That kind of hole is difficult to dig out of.

"From the beginning, we were operating with a serious disadvantage," Harrell said. "When fuel prices are high, people will drive 15 or 20 miles to save that money. Without a strong destination in the store, the obstacles we face may be too big to overcome."

As it stands, Duck Thru stores are thriving with an effective foodservice mix that consists of Hot Stuff Pizza, Sub Express and Squawkers Chicken. The decision to get into foodservice was a fairly easy one, Harrell said. Finding the right programs was the hard part. He began by examining what the community needed, rather than focusing on what he wanted.

"Our plan was to differentiate ourselves from other retailers, not just convenience stores, but drug stores and hypermarts," Harrell said. "There is a stigma associated with gas when retail goes above $3. When that happens, customers tend to scale back their spending inside the store.

"Foodservice is recession proof and makes us a destination in a way that is independent of gasoline, beer and cigarettes. We are not in food because it’s fun, we are in it for better margins. Ultimately, it’s the most profitable part of the store."

Harrell estimated that as a profit center, foodservice accounts for about 45-60% of his chain’s gross margins. By comparison, fuel is only about 1-2%. That beats industry averages. According the NACS State of the Industry (SOI) Report, food held serve as the top category for overall gross margins at 49.8%.

Other operators, including mega chains like Sheetz Inc., have had similar revelations. Louie Sheetz, vice president of marketing for the family-owned business in Altoona, Pa., explained that as the company saw shifts in the percentage of profit contributed from its three major categories—food and beverages, convenience/grocery and petroleum—it needed to change its business model, which is why it developed its convenience restaurant concept.

"In 1988, our core business—convenience and grocery items—represented 40% of our business. In 1995, that percentage dropped to 27% and today it represents 18% of our total gross profit dollars," said Sheetz. "Seeing our core business shrink was a strong indication that we needed to replace those revenue dollars and still deal with the competition that was coming from many different directions. We took that opportunity with food. In 1995, food only represented 40% of total gross profit dollars. Today it’s 58%."

For Sheetz, the decision to operate its own foodservice brand was made many years ago. The convenience restaurant, though, was its opportunity to create something truly special. So when it decided to change the direction of the company, it vowed to do it with a bang.

"Rather than being satisfied with success, this was the best time for us to stop and say, ‘What about tomorrow?’" Sheetz said. "Don’t be forced to change. Try to stay ahead and create the trends of tomorrow. If you are not constantly innovating to meet the needs of consumers, you might as well hand the business over to your competitors."

Whether considering investing in a foodservice program for the first time or retrofitting into a new brand to an existing store, retailers must consider the following:

 

Location Analysis. When determining which foodservice strategies make the most sense, operators must conduct a preliminary review of all its store locations including physical plan, size, condition and type of area. This review should look at the company’s store locations as a whole in order to identify patterns, typical store profiles, access to main roads and types of locations. The results are used to determine which foodservice segments and concepts make the most sense.

 

Segment Selection. Segment selection is a critical early step in foodservice development since it will impact operating results, investment costs, managerial requirements, suitable sites, franchise availability, revenues and all else associated with foodservice. Retailers must then weigh the advantages and disadvantages of multiple fare segments, such as burgers, pizza, sandwiches, chicken, seafood, Mexican, snacks (ice cream, frozen yogurt, bakery and cookie concepts) and other popular segments like Chinese, coffee, bakery, Italian and barbecue.

Segment characteristics to be addressed are daypart requirements, popularity, demographics, equipment requirements, investment costs, complexity and labor requirements.

Concept Selection. After selecting a segment, operators must identify the segment concepts that are most appropriate for the company. Ultimately, the correct concept will depend on a company’s specific strengths, weaknesses, opportunities and threats. Types of concepts include franchised or licensed brands, proprietary brands, manufacturer brands, unbranded foodservice, multiple brand strategies and alternative foodservice strategies.

Franchised or Licensed Brands. The potential advantages of choosing a major quick service restaurant (QSR) brand includes higher sales volumes, national marketing campaigns, instant credibility, the halo effect (lending credibility to a secondary or proprietary brand), a well-honed operational system, sophisticated facility designs and refined training and development systems. Potential drawbacks that should be taken into account, according to NACS, are possible encroachment, higher investment costs, re-imaging costs, management training requirements, royalties, lack of franchisor support and limited menus.

Proprietary Brands. Developing a convenience store company brand generally requires organizational commitment starting at the very top, a tight geographical concentration of stores and ongoing research and development. Sheetz, Wawa, QuikTrip and Quick Chek Food Stores are among the industry leaders in this area. The advantages include the ability to implement foodservice wherever the company chooses, the ability to fine-tune and continuously adjust the brand, no royalties, uniform offerings and no franchisor. As with any proprietary program, one of the negative aspects is the need for substantial and ongoing financial and managerial resources. These programs require 24/7 attention with all the adjustments and research and development done internally.

Sheetz Made-to-Order (MTO) foodservice program is successful for many reasons, but perhaps none more important that its variety. MTO features dozens of entrées, hot and cold sandwiches, wraps, fresh salads and fresh-cut fruit.

Manufacturer Brands. Numerous companies offer "brand packages" to c-stores wherein the operator receives a menu, products and the look and feel of a national brand, without the franchise. Advantages are numerous such as site selection flexibility, reduced foodservice entry costs, training materials, an operating system, brand name familiarity, no royalties and limited commitment. Red flags range from a possible lack of consistency, ties to only one supplier and no external marketing to limited assistance and lower revenues, NACS said.

However, as the foodservice industry becomes more competitive, food manufactures have stepped up, Harrell said. Duck Thru store, for example, choose Hot Stuff Pizza (Hot Stuff Foods), Squawkers (Brakebush Brothers) and Sub Express (Omni Food Concepts) because they only requiring distribution agreements, no monthly licensing or franchise fees.

"Our support has been excellent on all levels," Harrell said. "A Hot Stuff rep is in our stores about once a month monitoring our consistency, offering suggestions and elevating our entire platform. They have exceeded my initial expectations."

Unbranded Foodservice. Unbranded foodservice lacks an identity separate from the convenience store company and runs the gamut from extremely simple (pre-wrapped sandwiches and hot dogs) to fairly sophisticated delis. The benefits of this type of program includes devotion of resources to developing a store brand, no royalties, no outside company interference and the ability to build the company’s foodservice identity. Issues to consider are lack of recognition and credibility, lower revenues, loss of a brand’s look and feel and a lack of foodservice operating expertise.

Multiple Brand Strategies. Having two or more brands at one site has several obvious advantages including more items to attract customers during different dayparts, avoidance of brand burnout, a complementary effect on the company’s core brands and the ability to share the building, staff and equipment. When deciding on a multiple brand strategy, operators need to consider local competition, site characteristics, managerial capabilities and development costs versus projected revenues.

A multiple brand offer has proven effective for Duck Thru without a hefty upfront investment. From the outset, Harrell was determined to avoid monthly franchisee fees because his stores don’t generate the volume required to be profitable with a national brand, but he didn’t want to sacrifice quality or variety.

"We operate in rural towns so we’re fortunate not to have a lot of foodservice competition at some of our stores. This gives us an advantage, but also comes with a lot of responsibility," Harrell said. "We can’t just offer a simple variety. It has to be fresh, innovative and affordable enough to attract the customers day after day."

Alternative Foodservice Strategies. While some convenience store companies may not wish to operate their own foodservice, they do want the benefits of increased customer traffic and incremental sales that foodservice typically brings. Two ways to achieve this goal are leasing and co-development. Leasing space to a QSR offers several advantages: the foodservice operation is left to an expert, a guaranteed income stream and reduced capital and human resources requirements. Retailers are cautioned that these agreements can create conflicts, customer confusion and a capped revenue stream, especially if a store gives up its coffee or fountain program.

McDonald’s, when it entered began testing its Small Town Oil program in the late 1990s, demanded control of the coffee program. After costly site investments to co-brand with McDonald’s, in what was perceived as a great foodservice investments, chains like Waring Oil in Jackson, Miss., couldn’t wait to rip the concept out because it lost control of too much of its convenience stores.

Co-development is another effective strategy for operators that that helps offset real estate and operations costs. Typically, the QSR erects a full-size unit and runs the foodservice operation. The upside to this strategy is that it allows multiple use of land that may be too expensive for freestanding units, could reduce the initial investment required on a new site and creates a food destination run by a foodservice specialist.

 

Strong Financial Management Required

There’s an old foodservice joke that goes, "How do you end up with $1 million in the food business?" You start with a $2 million investment.

That’s not so funny when it’s your money. The process of determining where foodservice is feasible and what form it should take is one of the most critical steps in profitably implementing foodservice. According to NACS, an effective foodservice feasibility study will help operators determine whether a given foodservice concept will be profitable at a particular location. The study should include five steps: site analysis; demographic and psychographic analysis; competitive environment analysis; segment and brand selection; and a financial viability analysis.

 

Site Analysis

The site analysis process evaluates the capacity of an existing convenience store or a potential store site to accommodate foodservice. It includes physical criteria, as well as making a determination of whether the store’s volume levels indicate it is a promising foodservice candidate.

Some of the key site analysis criteria to consider includes customer counts (POS data will reveal when customers enter the store by hour and day), inside sales and gallons of motor fuel sold. While motor fuel sold is a useful indicator, it is not a predictor of foodservice success. Some store operators have found that high-volume motor fuel locations do not translate into good foodservice sites. In some cases, if a store has extremely high motor fuel sales, congestion at the pump and on the lot may prohibit foodservice.

Additional items to consider are traffic counts, the site’s current foodservice sales, the size of lot and parking spaces, room for bathrooms, seating and storage and access to and from local roads.

 

Demographic Analysis

In this step, companies need to decide if the area’s population has the right characteristics to support the foodservice concept. A QSR trade area is usually defined as the area from which 80% of customers are drawn, according to NACS. Trade areas vary dramatically based on whether the location is urban, suburban or rural and access roads.

Customer profiles provide a clear picture of the potential foodservice customer, such as age, income, educational level, occupation, reason for going to a restaurant and frequency and occasion of visits. Psychographic characteristics combine demographic information with lifestyle traits. For example, research may indicate that dual income, childless couples who are college educated and have a household income over $50,000 tend to eat out more than three times per week

A company can either use the convenience store location’s existing customers to determine the foodservice profile or complete profiles for foodservice customers.

Demographics are also vital because it will help address the labor issue. Finding trainable foodservice employees will make or break a foodservice investment, not just on safety, but also on how well they follow instructions.

"There’s no question that finding and training employees is among the most difficult things we’ve had to do since investing in food," Harrell said. "But there are other things to consider like portion control and waste that will eat up your profits if they’re not monitored. We fouwnd that our night crew would sometimes cook a little extra because they thought we would just throw it away and instead they would be able to take it home. You can’t have that and still run a successful operation."

 

Competitive Environment Analysis

Chains will want to evaluate competitive restaurants in the trade area. The competitive analysis determines whether the area has the ability to support the foodservice concept.

Steps operators need to complete must incorporate visits to all of the competitive restaurants, several times and at peak periods, to assess whether they are busy, slow or somewhere in between. Foodservice consulting group Technomic Inc. advises counting customers in the dining room and cars in the lot, estimating revenue and customer counts, talking to QSR managers in the area to help determine volumes and testing estimates for reasonableness. For example, if you estimate that a QSR annually generates $3 million in an area with 2,000 residents, assumptions need to be reconsidered.

 

Segment and Brand Selection

This step helps identify potential concepts that may work at the proposed site. Segment selection is dependent on the company’s foodservice goals and objectives as well as its customer base, competitive environment and trade area characteristics.

Questions to ask include: "What are the company’s financial goals and objectives? How do existing customer demographics match up with the QSR segment profile? How saturated is the particular niche the company is considering?" And, "Does the trade area have a sufficient number of potential customers (and employees) with the right demographic profile to support a foodservice concept?"

 

Financial Viability Analysis

Financial analysis is the linchpin of a successful foodservice strategy. This step requires estimating how much potential demand exists for the proposed QSR in the trade area. Total potential demand is a combination of incremental sales from the store’s historic customer base and new sales from QSR customers.

A number of methods exist to project financial results such as analyzing costs from similar concepts, historical results of other franchises, labor projections and operations costs. NACS urges retailers to be conservative when making estimates and always project at the high end of the range, especially if a company is new to foodservice.

When all these steps are taken, chains can be assured they are prepared for the challenges that lie ahead. Consider Duck Thru. It began its foodservice program in earnest and in about five years changed the entire course of the company.

"We will only open new stores in an area where it makes sense from a food perspective," Harrell said. "In our market, gas has evolved into a loss leader. We began this process as a fuel retailer that sold food. Today, we are very much a foodservice operator that sells fuel."

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