Happy New Year from all of us at APT’s Food for Thought. 2011 promises to be an eventful year in the restaurant space and we’ve heard a number of bets, top 10s, and guesses for what the year, and the strengthening economic recovery, will hold.

We’ve synthesized these ideas into a special series, in three parts, that we are launching below. Stay tuned over the next two weeks for more.

Part One: Menus, Value Meals & New Offerings

Emergence of Next-Generation Value Offers in a World of Rising Commodity Prices

In 2010, the value offer theme resounded.  Some have been both compelling to customers and profitable – think Taco Bell or Olive Garden.  Others have taken restaurant companies (and franchisees) off the rails.  As value offers reached their peak in mid-2010, many analysts and researchers started to discuss “weaning” customers from the deals.  Worse yet, commodity costs are now rising, putting more pressure on the already strained economics of value offers.  How restaurateurs navigate this situation will drive their 2011 profitability and could help strengthen restaurants competitive positioning against grocers.  We see three keys:

o   Stop fretting about weaning customers from value offers, because it isn’t going to happen, at least for large-scale chain players. Yes, the outlook for traffic looks good, especially for the hard-hit casual dining segment, but that doesn’t mean customers won’t be looking for a deal, as recent consumer polling confirmed. Focus on how the next-generation of value offers can become a profitable core for your business for 2011 and 2012. The best players will test multiple ideas early in 2011, rolling out only the best.

o   Go high-low:  Already, restaurants have been quietly taking price outside the core value offerings.  If done well, with full knowledge of the attributable impact on guest count, sales, mix, and margin, this should help restaurant economics.  But it will also accelerate mix shift to value offers, further increasing the importance of good value offer economics.

o   High-risk, high-reward input cost reduction:  The unit margin of value offers must improve for industry to succeed in 2011.  Work with suppliers to find targeted but valuable cuts to food costs. Re-evaluate hedging contracts, as Starbucks did, to ensure that additional commodity price increases doesn’t increase risk for your business. Focus your operations leaders on process improvements to squeeze out labor costs.  Then test, to ensure customers respond well to cost-reduction efforts and that you aren’t just trading higher margin for much lower volume.

Beware the Burgeoning Burger and Breakfast Bubbles

As we discussed in 2010, when too much investment chases a market without enough demand, what happens?  Well, at first there’s a lot of excitement in the industry and in the media.  More and more players chase the market. Then, the reality sets in.  Prices drop.  Losers shake out. Will this play out in the breakfast space? Things are getting crowded: Dunkin introduced Pancake Bites, while Chick-fil-A is betting on its new Spicy Chicken Biscuit, and Burger King is looking to encroach on the golden arches with its Ultimate Breakfast Platter and a Seattle’s Best Coffee, which it gave away to customers for free in November. After testing breakfast sandwiches in 45 company owned stores, Caribou Coffee is rolling the offering out more broadly across its network. Additionally, 2011 will see broad rollout of Taco Bell’s breakfast offering and Wendy’s oatmeal bars and Panini sandwiches. Much ink has been spilled hypothesizing the changes in store from Starbucks given its recent logo change, moving its brand away just coffee. Even Dominos has entered the fray with a breakfast pizza offering at its one 24 hour location in Dayton. While breakfast has fueled strong growth over the past two years, it’s unclear as to how this emerging daypart will play out with increased competition. Similar bubbling seems to be coming to the surface in the burger arena. Will 2011 be the year these bubbles burst?

Evolution in The Testing of Products in the Pipeline

Traditional restaurant new product testing has, at best, driven go/no-go decisions. (At worst, product testing has been a crutch to support executives’ gut feel as they launch a product regardless of the in-market test results.) We are seeing the emergence of a better form of product testing- evolutionary testing- where restaurants understand which components of a product concept (including specific item formulations and marketing vehicles) are truly successful through several rounds of rapid testing before rollout. Caribou Coffee recently tested new breakfast sandwiches and adjusted its plan for national rollout based on test results. Cold Stone similarly announced a test of a self-serve yogurt line in Arizona and California and a few East Coast locations, though national rollout seems a foregone conclusion.

For years, APT has seen value in using test insights to improve returns from restaurant remodels. Done right, early remodel results show which components of the remodel are successful/unsuccessful and which locations would benefit most from remodeling. Acting on these learnings drives major improvements to remodel returns.  In 2011, analytically-minded restaurant chains will embrace evolutionary testing of new products, to their lasting competitive advantage.

Re-Focus the Menu In A Sea of New Offerings

Most restaurants believe that keeping customers’ attention requires a constant stream of new offerings.  During the past year notable introductions included KFC’s Double Down, Burger King’s Ribs, and McDonald’s Smoothies.  While menu innovation is frequently successful at driving interest, the vast majority of offerings are quickly relegated to the far reaches of the brand’s menu.   Domino’s Pizza experienced great success in 2010 with its “new-and-improved” pizza recipe, winning many more accolades than with its mac-n-cheese-breadbowl-pasta offering.  Look for other restaurants to follow suit by improving their core products and streamlining their menus in 2011.

Continue to Part Two: Expansion, Investments & Operations