During Ed Rensi’s 14-year term as president and CEO, McDonald’s (MCD) experienced phenomenal growth. U.S. sales doubled to more than $16 billion, the number of the U.S. restaurants grew from nearly 6,600 to more than 12,000, and the number of U.S. franchisees grew from 1,600 to more than 2,700. Under Rensi’s leadership, McDonald’s became the most recognized brand in the world, the next being Coca-Cola.
Rensi has remained busy since his tenure at McDonald’s ended.
He is the first to admit that the challenges to the restaurant industry are mounting. “I was getting sick of running restaurants because the deck is so stacked,” he says. This month, Modern Trader has a candid discussion with Rensi on regulations, tax policy, minimum wage and other factors affecting investors in the global restaurant industry.
MODERN TRADER: From a macro-perspective, what is your outlook for the industry, and how should traders measure sector performance?
Ed Rensi: Restaurants need to evolve with their customers at the same pace that customers evolve. One of the things we did at McDonald’s is we believed in quiet evolution, not revolution. That’s why the company has sustained itself for 70 years, and will continue to do so as long as they maintain that culture.
When analyzing performance, you can’t look at dollar amounts; you’ve got to look at transaction counts. There’s been a steady decline in transactions at all restaurants on a comparable basis since 2007. And there are more restaurants being built every year. The newer restaurants come out of the box for three years looking really strong, but a whole bunch of other restaurants get closed down.
Closings are outstripping the openings right now. When people look at these comparisons they need to look at transaction counts, how many customers are actually born into a place, and then take a look at openings and closings and what’s happening in the marketplace.
MT: What has been the driver of closings?
ER: There’s been a massive cultural change in this country that’s been brought on by online purchasing. Look at where Amazon (AMZN) is at today, and look at where Sears (SHLD) is at today. Look at where JCPenny is at today. Go down the list. The world’s changing dramatically and the restaurant industry is belly-to-belly with American consumers three times a day, 365 days a year.
I don’t think there will be a change; it’s going to continually deteriorate. The world’s changing radically and dramatically and it’s got a lot to do with demographics. I don’t see how the capacity that we are bringing online in the restaurant industry can be absorbed. We’ve got excess supply, diminished demand, and a changing world relative to what people are going to eat, how they’re going eat it and when they’re going to eat it.
MT: The growth of Amazon has harmed retail, and many restaurants are tied to retail shopping malls. How big of an impact has that had?
ER: It’s enormous; if you look at the York Town shopping center in Illinois where I had hamburger restaurant, Tom and Eddy’s, that place has become a giant-sized outdoor food cart. The retail side at that place is diminished more and more every day. In fact, the investor that bought it wants to develop the land for multi-use [rather than] having a shopping center. How can you put 45 or 50 restaurants on a property like that and expect any of them to succeed for very long?
I don’t care how good you are. There’s only a certain amount of capacity and if you look at that strip, there are 69 chain restaurants on that road and it’s probably four miles. And there’s [more than] 300 restaurants. Everything from Capital Grille to burger joints.
I wouldn’t build a restaurant in a mall unless they guarantee there will be no other restaurants in that mall ever again.
MT: Where are the current opportunities in the restaurant sector?
ER: It’s “bun on the run.” Places that cater to people who are compressed for time and have to grab something to eat. It’s McDonald’s at breakfast. It’s McDonald’s at lunch. That’s one category that will sustain as long as you can keep the price value where it needs to be, and you don’t get your occupancy cost so high you can’t afford a place.
That’s something that scares me about the way some of these restaurants have been remodeled. You put so much money into it where you’re never going to get a return. In Europe, they have buildings that are 500 years old. In the United States after 15 years we tear them down and build a new one. That’s insane. That kind of capital input is just not sustainable.
MT: You recently created a controversy saying it’s cheaper to buy a $35,000 robotic arm then to hire an inefficient employee making $15 an hour bagging french fries. Are you surprised by the media backlash?
ER: I was inarticulate, I should have said robotics and automation.
Make no mistake, I don’t care what the media says. What makes them experts? They talk to guys like me to get the answers if they have no depth of knowledge.
The reality is automation and robotics are taking over, which is a tragedy for this reason: minimum wage jobs have always been a starting point to develop talent. You need to have a development and training program in place so that in 35 years that person could be the CEO of the company.
The whole theory behind Hamburger University is that by the time a person became a McDonald’s store manager they’ve had 2,000 hours of training if they started out as a minimum wage employee; 65% of McDonald’s managers came from hourly minimum wage jobs and 65% of managers came from store managers. And 65% of the officers of the company in restaurant operations came from store manager and supervisor positions. It’s going to be one of the big problems at McDonald’s because for the first time in history, the firm has a CEO in the United States and a CEO globally. But neither one of those guys ever worked in a McDonald’s restaurant. They were never trained in McDonald’s culture; 20 years from now that’s going to be a problem.
MT: Take us through the corporate conversation in 1990 and 1991 when the minimum wage was increased from 3.80 to 4.25? How does it impact the bottom line?
ER: There’s only a few ways to offset an increase in cost like that; you have to build your sales exponentially to cover it or develop new streams of profitability. I was responsible for doing all the calculations at what minimum wage would do to us and I had a fellow named Brian Gordon who sat by my side. What we discovered was we had a lot more elasticity in the pricing of our breakfast products and breakfast expansion than we did in hamburgers, because the price of hamburger was going through the roof. And we knew that there was a certain price point that you couldn’t exceed.
We sold the first hamburger for over 99¢.
When you’re a public company, the board is only interested in one thing: What is the quarterly report going to look like?
Are you going to increase sales and profits? Is the economy going to get better? Are you going to build more outlets?
So, you have a long term strategic growth plan, and everything you do all day gets in the way of that. It’s 30% food in serving costs, it’s 30% all-in labor costs, it’s 30% occupancy cost, and it’s 10% profit.
That’s the basis of most fast food restaurants. If the minimum wage is going up, that could be a 1% or 2% decline in profitability. To replace a 1% increase in labor cost you have to increase the menu board 3%.
MT: The focus on the minimum wage has centered on the replacement of cashiers with kiosks. What other automation is emerging in the sector?
ER: A lot of automation happens that people don’t think about.
All the backroom preparation is moving off site.
Why would you cut onion in the back of a restaurant if you can already have ready 500,000 million pounds of cut onions and distribute it to 50 restaurants, or 500 restaurants? Look at Panda Express. They don’t cook anything in a restaurant. That stuff is all pre-chopped, set up, ready to go, stuck in combo bins and delivered to restaurants. All they do is take scoops from the binds, throw them in a skillet and dump sauce on them. The amount of labor you need in those places is diminished dramatically.
MT: How high of a mandated minimum wage can the restaurant industry tolerate?
ER: That’s the wrong question. The question is how much of a price increase can the consumer accept?
What’s going to happen to your business if the minimum wage goes up? Because there are solutions to the increase in cost and it’s mostly price increase and becoming more efficient. And that’s why automation robotics becomes so important. But the real question is, how much inflation can the average individual accept? And if you’re in Texas there’s one answer. If you’re in Chicago it’s a different answer. That’s the reason why all discussions of minimum wage ought to be a state issue and not a Federal issue. [Even] a city issue. The Federal government mandate should never exceed the average of 50 states. It is insane.
MT: Some companies are projecting store growth rates of 500% to more than 1,000%. How realistic are the numbers that are being put into investor presentations? Particularly when firms are being brought public?
ER: I’ll just say generally, that you can let your mouth overload your butt pretty fast. And if you’re a Texas-based company, you’re probably enjoying enormous growth. And if your company’s less than three years old, you’ve probably got some pretty spectacular numbers, because it takes three years for most restaurants to settle out at what their final numbers will be. If you doubt me, take a look at Kona Grill (KONA) which built a bunch of restaurants last year and they’re in deep trouble right now. It will take them three years to absorb those restaurants. You can’t let growth outrun your ability to manage the organization. If you franchise you have to support those franchisees.
So, to have a 5,000% road is mind boggling. If somebody said that, I wouldn’t, as an investor, buy a dime of their stock. But I just don’t think those numbers are sustainable.
MT: You said that you were getting sick of running restaurants because the deck is so stacked. How have things changed in the last decade?
ER: I would say the Obama administration turned the restaurant industry as well as a bunch of other industries significantly. The change in work rules, who could or could not get overtime, [the Affordable Care Act] and what you had to do to qualify for insurance coverage [had an effect]. Then minimum wage, the single-card sign up for labor unions, sales tax going up and the myriad of regulations around the environment; those are all put on the backs of small businesses. I’ve heard people say that fast food restaurants can afford a $20 minimum wage because of “all the money” McDonald’s makes. I reply that 30% of our sales were in labor costs.
Meanwhile, a company like Apple’s (AAPL) all-in labor costs is less than 2%. And then you got the Internal Revenue Service asking question that make no sense.
For example, what is a full-time worker? How do you define it? Now there are 10 different categories of workers that you have within a business.
The employees listen to all that crap, and they get argumentative because they’re not getting what they think they’re entitled to.
MT: What about entrants like Blue Apron?
ER: I know several Blue Apron (APRN) fans. I’ve gone to their houses and they break open their box for a dinner for four. Perfectly balanced, perfect amount of calories, perfect amount of fat and all the rest of that, but, for my taste, as a foodie, I’m going to do it myself. Part of the fun of dining out is the preparation, the socialization while you’re waiting. The meat, the roast and all that kind of thing. This thing is so prepackaged the only difference is it’s never been cooked. I don’t know how it differs from Stouffer’s or microwaveable pot pie. And it’s expensive.