A recession is a major economic event that has far-reaching effects on businesses and individuals alike. With the global economy in a state of uncertainty, many are wondering if a recession is on the horizon. As a restaurant manager, it's important to be aware of the potential impact that a recession can have on your business. This guide provides an inclusive insight at the indicators of a recession and offers practical strategies for navigating uncertain economic times. Get ahead of the game and start preparing for a recession today.
Recession: is it coming?
As the world continues to experience economic downturns, the question on many minds is whether or not we are headed for a recession. The National Bureau of Economic Research (NBER) has a comprehensive definition of a recession, which includes a significant decline in economic activity that is spread across the economy and lasts more than a few months. By this definition, we have not yet officially entered a recession, but global indicators such as unemployment rate along with production and spending rates should be closely watched.
As a restaurant manager, it's important to stay informed about the potential impact of global economic changes on your business. While it's unclear if a recession is imminent, it's always wise to be prepared for potential economic downturns. By taking proactive measures and preparing for potential challenges, you can ensure that your business is better equipped to navigate any economic volatility. Don't wait for an official announcement, start taking actions now to secure your business future.
In this guide, we'll take a closer look at the indicators of a recession and provide strategies for navigating uncertain economic times. Given the abundance of data, research papers, and articles that have studied previous recessions and their impact on the US restaurant industry, we'll also look at the specific impacts on the restaurant industry, assuming that the market and consumer behavior could have a lot of similarities in how to behave during the downturn periods, and those behaviors are not limited to the US market.
“A plethora of institutions including regional Fed banks and Wall Street firms have poured money and time into developing GDP forecasting models. (The Bloomberg Economics model puts the chances of a recession in 2023 at 100%, though US economist Anna Wong says it’s likely closer to 80% given that consumers are still doing comparatively well.)” bloomberg. Sahm Rule Recession Indicator
The Impact of Recessions on the Restaurant Industry: Understanding Market and Consumer Behavior
When it comes to the impact of a recession on the restaurant industry, it's important to note that not all restaurants are affected equally. Quick-service and fast-casual restaurants may fare better than sit-down restaurants because they offer lower prices and more convenience. Independents and upstart chains have also been known to outperform chains during recessionary periods.
During a recession, economic indicators such as GDP and workers' earnings tend to decline, leading to a reduction in consumer spending and ultimately, a decrease in business profits. In the first 18 months of the last recession, GDP shrank by about 5.1 percent. Stock prices in general also fell by 50% during this period, with losses much larger than those associated with earlier recessions. The restaurant industry, in particular, has lower profit margins than other industries, averaging between 2% and 6%.
When consumer confidence drops, consumers tend to cut back on discretionary spending, and this can have a significant impact on the restaurant industry. In the last recession, eating and drinking establishments posted five consecutive months of job losses for the first time since 1958. This decline in consumer spending also had an impact on restaurant stock prices, with the Dow Jones U.S. Restaurant Index (DJRI) dropping by 13% in 2008 alone. Recent research has shown that recessions have negative impacts on stock prices in general, and that restaurant stocks are particularly affected by the recession.
During a recession, consumers may opt to dine out less frequently in order to save money. They may also choose to dine out only for special occasions or events. They may also opt for cheaper dining options such as fast food or home cooking, rather than dining at more expensive restaurants. They may also be more likely to take advantage of discounts, deals, and promotions offered by restaurants in order to save money. Consumers may also be more likely to look for more value for their money and may opt for restaurants that offer a good price-to-quality ratio. They may also be more likely to order food for delivery or take-out, in order to save money on things like beverages.
Reduced frequency of dining out: Consumers may opt to dine out less frequently in order to save money. They may also choose to dine out only on special occasions or for special events.
Seeking out cheaper options: Consumers may opt for cheaper dining options, such as fast food or home cooking, rather than dining out at more expensive restaurants. Or even or home cooking
Discounts and deals: Consumers may be more likely to take advantage of discounts, deals and promotions offered by restaurants in order to save money.
Value for money: Consumers may also be more likely to look for more value for their money and may opt for restaurants that offer a good price-to-quality ratio.
Take-out: Consumers may be more likely to order food for delivery or take-out rather than dining in, in order to save money on things like beverages.
The Impact of Recessions on the Restaurant Industry
The impact of recessions on the restaurant industry is studied by dividing restaurants into limited and full-service subcategories and franchise and non-franchise sub-categories. Limited-service restaurants are less volatile during recessions compared to full-service restaurants, which are more emotionally oriented. Meanwhile, franchise restaurants tend to have more stable financial performance during recessions due to steady cash flows from royalties and franchise fees. Non-franchise restaurants, on the other hand, may yield better results from recession turnaround strategies due to their higher sensitivity to economic downturns.
While recessions can have a significant impact on the restaurant industry, not all restaurants are equally affected. Limited-service restaurants, such as fast-food restaurants, tend to weather recessions better than full-service restaurants, due to factors such as the type of sales they generate and their financing strategies. However, aggressive counter-recession strategies and effective adaptation to changing economic conditions can help restaurants of all types overcome the challenges posed by recessions and achieve success.
The restaurant industry is a diverse and dynamic sector, with different types of restaurants serving different types of customers and offering different styles of operation. As a result, different restaurant segments tend to react differently to changes in economic conditions. In general, limited-service restaurants (LSRs), such as fast-food restaurants, appear to be less vulnerable to the effects of recessions than full-service restaurants (FSRs).
The reason for this difference in performance can be attributed to several factors. For example, full-service restaurants rely heavily on high profit margins, and their sales are mainly derived from customers’ discretionary expenditures. When the economy is in a recession, customer sentiment and household income tend to be lower, which can result in a decline in revenue for full-service restaurants. In fact, a study found that the market cap of FSRs decreased by 28.3% during a recent eighteen-month recession.
On the other hand, fast-food restaurants rely on large sales volume to compensate for their lower profit margins. Their sales are primarily necessity expenditures, which are less likely to be affected by economic recessions. As a result, the market cap of LSRs only shrunk by 18.1% during the same eighteen-month recession. This suggests that fast-food restaurants were able to maintain a more stable stream of revenue during the recession, which allowed them to weather the economic downturn with greater ease.
Despite this difference in performance, it's worth noting that some studies have found that aggressive counter-recession strategies, such as increasing advertisements and operating profit margins, can be beneficial to revenue and profitability for restaurants of all types. This suggests that there may be ways for full-service restaurants to overcome the challenges posed by recessions.
Additionally, the way that restaurants finance their operations can also impact their ability to weather recessions. For example, the study found that by the end of the recession, about 56% of the assets in full-service restaurants were financed with debt, and approximately 80% of their operating and financing activities were funded through debt. This suggests that full-service restaurants may have had difficulty generating enough income to cover their expenses and had to rely more on borrowing money to stay afloat during the recession. In contrast, the debt ratios of limited-service restaurants did not show any significant changes during the recession.
Despite the challenges posed by recessions, there is still reason for optimism in the restaurant industry. For example, the study found that four of the twenty limited-service restaurant firms had losses in the year before the recession, but only two had losses in the year after the recession. Two of the four restaurants even started to have earnings during the recession. This suggests that there are opportunities for restaurants to adapt and succeed, even in the face of economic challenges.
How can restaurants thrive through downturns?
When it comes to overcoming economic challenges, various strategies can be implemented by restaurants to improve their performance. Research has shown that increasing advertising, profit margins, and optimizing asset utilization can be effective.
Asset Turnover Strategy (Cost Cutting Strategies)
The asset turnover strategy focuses on maximizing the use of assets, including inventory and working capital. Reducing long-term and short-term assets can lead to improved efficiency, according to Soliman (2008) and Bibeault (1982). Palepu and Healy (2008) emphasized that firms that adopt low-cost strategies and maintain tight controls often have high asset turnover and low profit margins. Studies by Fairfield and Yohn (2001) also showed a connection between changes in asset turnover and returns on assets.
However, there is a debate over the efficacy of cutting costs or assets during a recession, with some researchers recommending a moderate approach. McLaughlin (1990) found that companies that made moderate cost cuts during recessions not only survived but also grew faster in market-share than competitors that made extreme cuts. Srinivasan et al. (2005) found no effect on firm performance from cost-cutting strategies implemented in recessions.
It's important to note that cost-cutting strategies can have adverse effects both during and after a recession. Affiliated businesses may become disloyal, demand may not pick up as quickly as expected, and decreased marketing during recessions can have long-term impacts (Pearce and Michael, 2006; Barrett et al., 2009). The asset turnover strategy resulted in lower revenue for all restaurants, with non-franchise restaurants being particularly affected. Stock returns were higher in the following year for non-franchise restaurants that implemented turnover strategies.
Aggressive Advertising Strategy
Studies have found that aggressive advertising strategies can be beneficial to revenue and profitability, but it's crucial to approach them with caution (Clark, 2008; Little et al., 2011; Park and Jang, 2015; Pearce and Michael, 2006). The results showed that only limited-service and franchise restaurants had a positive change in revenue when implementing aggressive advertising, with no significant improvements in profitability. However, non-franchise restaurants that used the strategy experienced lower revenue and greater losses than those that did not. Additionally, there was no positive effect on stock returns for either franchise or non-franchise restaurants.
Increasing Operating Profit Margins Strategy
Food costs are a major source of operating income in the restaurant industry, and increasing margins can be achieved by offering higher-priced, high-quality menus. However, a significant increase in prices can negatively impact demand (Min & Min, 2011). Introducing new menu items or changing the pricing structure can help restaurants increase operating profit margins while balancing demand. The results showed positive effects on profitability and stock returns for all segments when the operating profit margins strategy was implemented.
In conclusion, the restaurant industry is an important part of our economy and society. It is constantly adapting and changing to meet the needs of customers and the current market conditions. The impact of recessions on the industry can be significant, but with the right strategies, restaurants can not only survive, but thrive. By understanding the differences between limited and full-service restaurants, franchise and non-franchise establishments, and focusing on maximizing assets and maintaining tight controls, the industry has the potential to bounce back stronger than ever. As we move forward, we can have hope for a bright future for the restaurant industry, with new innovations and continued growth.
References:
Forbes, Q. (2022, December 13). Recession Fears: Are We (Unofficially) In A Recession Now? Retrieved from https://www.forbes.com/sites/qai/2022/12/13/recession-fears-are-we-unofficially-in-a-recession-now/?sh=296c808432ef
Bloomberg. (2023, January 25). US recession is still a matter up for raging debate. Retrieved from https://www.bloomberg.com/news/newsletters/2023-01-25/what-s-happening-in-the-world-economy-us-recession-still-up-for-debate
Forbes Advisor. (n.d.). Are We In A Recession Yet? Retrieved from https://www.forbes.com/advisor/investing/are-we-in-a-recession/
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USDA Economic Research Service. (2015, March). The recession had greater impact on visits to sit-down restaurants than fast food places. Retrieved from https://www.ers.usda.gov/amber-waves/2015/march/recession-had-greater-impact-on-visits-to-sit-down-restaurants-than-fast-food-places/