The Quick Service Restaurant (QSR) industry presents a stark dichotomy for investors. It is a sector that can be volatile, with a disturbingly high rate of failures, and at the same time, it is a sector that can be poised for enormous wealth creation driven by organised players. The main argument is that out of 100 new restaurants (including cafes) 60% of them fail within the first year, and 80% fail within five years. The few that survive are the ones that learn how to operate with capital intensity, standardisation of operations, and strict financial standards. The sustainable growth of this sector is not achieved by simply going on a store expansion spree but by utilising the available resources through optimisation by means of Same Store Sales Growth (SSSG). This article will provide the analysis of the situation of high-risk operations, dissect the essence of financial metrics that characterise investing ability, and outline the map of the strategic direction that supports the disciplined leaders in the industry.

The Current Landscape

The QSR industry is essentially a non-core-technology business that is highly capital-intensive with a huge level of pressure on costs. Starting a restaurant requires a huge initial investment in the form of setting up a kitchen, furniture, design, and most importantly, rent deposits, which may require a significant amount corresponding to five to six months of rent in reserve. The cost of setting up a large franchise like a McDonald’s can range between ₹3.4 crore and ₹5 crore (INR).

The operational difficulties of new entrants are harsh such with rent being the biggest challenge; cloud kitchens encounter variable cost challenges, which are mostly caused by delivery aggregators such as Zomato and Swiggy. Such platforms usually take a 30% commission cut that, in addition to marketing and packaging costs, may take as much as 50 – 55% out of the pocket of a cloud kitchen.

In addition to high capital requirements, the operation is complicated because of the inventory management, which is not an easy task because most of the inventory is perishable. In addition, understaffing is essential in a QSR environment and may lead to customer dissatisfaction, particularly when the industry players have high turnaround expectations.

Core Analysis and Argument Development

Investors should see beyond the impressive success of QSR businesses and put extreme attention on their operational efficiency and sustainable long-term growth drivers.

Global QSR leaders, including McDonald’s, have managed to be successful not only due to taste, but also due to standardisation and operational excellence. McDonald’s has been so good at Standard Operating Procedures (SOPs) that the procedures make sure that the time and experience are consistent regardless of the place where a customer is, either in Chennai or Jaipur. Their operational orientation is reflected in their fast service, and their maximum turnaround is three or four minutes.

This productivity is important since it directly impacts the important measurements of profitability, such as Gross Margins and Store-Level EBITDA. The sweet spot in the industry dictates that Gross Margins should be in the range of 65% to 70% (or the cost of goods sold is not more than a third of the selling price). The typical Store-Level EBITDA (operating profit before non-operating costs) of successful QSRs is between 15% and 20%. This amount is important, particularly when factoring in the obligatory expenditures that are inherent to the franchise model, in which royalty charges in many instances tend to vary between 4% and 5% of the net revenues and can even up to 6.2% percent in the case of Yum Brands (KFC, Pizza Hut).

The payback period, or time taken to break the first capital investment, is critical in determining the attractiveness of the investment by a QSR. Two factors directly affect this payback period, and they are store size and location. Smaller size of the store increases the turnaround time rate, as evidenced by models such as Luckin Coffee in China, which are in premium areas (as small as 20 square feet) to significantly cut down the rental spend and make a quick profit.

Nevertheless, Same Store Sales Growth (SSSG) is the most sustainable indicator of long-term creation of value. Although the growth of store count can be effective, there is a limit to the number of stores that can be opened in the future. SSSG implies that the company is sustainably increasing its revenue on the basis of its footprint, which is actually a proxy for the increase in sales volume.

Three broad strategies, such as attained by strategic pricing or the ‘barbell strategy’ where low-pricing products attract the customers and then they are offered higher-margin products (e.g. Burger King pushing the Whooper), and the ability to increase the sheer amount of customers served or unique delivery orders served (e.g. the successful Choco Lava product by Dominos in the past), motivate SSSG. The firms that are presently grappling with SSSG, such as Jubilant Food Works (Domino’s), emphasise that even the big players have to continue innovating to deliver this crucial growth measure.

The Strategic implications and The Road ahead

The QSR industry trends are leading to a trend of growing concentration of wealth in the organised industry. This migration of values is already being effected, with consumers shifting, especially in times when they need something dependable or when they have a huge group of people, towards established brands such as Domino Pizza over local brands, and where they find comfort and familiarity.

In the case of organised players, the future would be strategic placement on a number of dimensions such as Technology Investment (deeper integration of operations), Model Optimisation (latching to and capitalising on the growth differentiation) and Asset Light Strategies (small footprint and high turnover would provide highly accelerated payback periods).

This process of growing aggregation and professionalisation of the industry is likely to generate enormous wealth as consumers change their behaviour and spending habits as they shift towards regular, packaged, even frozen/ready-to-cook food solutions, searching to increase the shelf life and predictability of such food.

Conclusion

The Quick Service Restaurant sector is more of a complex, high-capital logistical game in which the playing field is extremely challenging, with a margin of error that is as thin as a hair, with a 60% failure rate in the first year. To investors, it is success in finding players with operational excellence that guarantee high standards of standardisation and efficiency, high store-level EBITDA of 15% to 20% and above, and most importantly, growth sustainability through consistent Same Store Sales Growth.

With the industry aggressively organising and technology continuing to penetrate operations, it is only the players who make their operations sound like a well-tuned machine and not a whimsical enterprise that will reap the enormous potential of wealth being shifted to the organised food industry.

Operational rigour does not exist as a luxury in a sector where merely one out of every ten restaurants survives, but it is the sole investment thesis.