Lean Times for Restaurants

A shaky economy and higher food and labor costs are squeezing eateries. How can chains raise prices and hold on to their customers?

www.chipotle.com

by Ben Steverman

Americans love to eat out, but the weak economy could be testing their appetite for restaurant food.

Rather than just an infrequent treat, a restaurant meal has become a daily ritual for many people. Almost half the money spent on food in the U.S. is spent at restaurants, a number that's been rising steadily for decades, says the National Restaurant Assn. And on any given day, almost one in two Americans patronizes a restaurant, the group says.

The dining landscape in the U.S. is increasingly varied and complex, ranging from independent restaurants of all stripes to fast-food chains such as McDonald's (MCD) and Burger King (BKC); newer "fast casual" restaurants including Chipotle Mexican Grill (CMG) and Panera Bread (PNRA); inexpensive casual dining chains such as Applebee's, recently acquired by IHOP (IHP); and more expensive options like the Cheesecake Factory (CAKE).

A competitive environment for restaurants is getting tougher as hungry consumers spend more time cooking at home. The economy is the main culprit in the shift, analysts say. As the unemployment rate rises and home prices fall, Americans feel both less wealthy and more insecure about their future income. Also, high gas prices leave less money in the weekly budget for an evening out.

Price Hikes

Even if customers do decide to eat out or order in, they're increasingly likely to experience sticker shock when the bill arrives. Prices of many food commodities have skyrocketed, meaning restaurants are paying more and more for their raw materials, especially corn and wheat but also meat and dairy products.

With labor costs also rising—the result of minimum wage increases—many restaurant operators feel squeezed. Do they increase prices and potentially drive away cash-strapped customers, or suffer with narrow profit margins? Restaurants are "trying to strike that balance between raising prices and also maintaining a value proposition that can attract consumers in a tough economic environment," says Robert W. Baird analyst David Tarantino.

On Mar. 31, New York-area Chipotle restaurants hiked prices almost 10%. A spokesman for the chain, which offers Mexican fare, said the price rise, the first in more than three years in that region, was due to higher food costs. "Even with the new prices in New York, Chipotle remains a great value," he said in a statement.

Mickey D's vs. Home

At first glance, a 10% menu hike seems likely to scare away customers, forcing them to get lunch and dinner at cheaper fast-food restaurants or buy food at the supermarket instead. But cause-and-effect in the restaurant industry isn't so simple. For one thing, nearly all chains are increasing prices, giving consumers fewer cheap options.

Because of their low prices, fast-food restaurants are expected to hold up well in a weak economy. McDonald's, with its "Dollar Menu," and its rivals offer cheap food to customers who can't afford fancier sustenance. Rather than a luxury item, fast food has become a staple to many Americans, says Morningstar (MORN) analyst Jim Owens. "It's very hard for consumers to prepare food on their own for a cheaper price than that," he says.

It's still cheaper for Americans to cook most food at home, but the costs of food at the supermarket are actually rising faster than menu prices at restaurants—3.9% in the past year at restaurants, vs. 7.6% food price inflation in the past year, says Hudson Riehle of the National Restaurant Assn.