Why the restaurant industry is ripe for automation and what to expect next.
Jonathan DeVito, Managing Principal | firstname.lastname@example.org
Todd Ruddick, Principal Consultant | email@example.com
People are expensive.
The restaurant industry employs millions of Americans. According to the Bureau of Labor Statistics (BLS) over 3 million people work in Back of the House (BOH) roles and the number of individuals working in Front of the House (FOH) roles is substantially higher.
However, people are expensive and labor is one of the biggest costs associated with operating a restaurant. Furthermore, a shortage of qualified labor and developments in wage legislation are fueling increases in labor costs.
One of the implications of rising labor costs has been increased interest in removing workers from restaurants. Automated (at least partially) BOH operations have already emerged in tech hubs such as San Francisco and Boston. As for the FOH, digital ordering kiosks are almost old news at this point.
With the above in mind, a number of pressing questions remain.
Is increased automation in the restaurant industry inevitable? If so, how will developments play out and over what time period? Perhaps most importantly, what are the potential implications of automation for suppliers, operators, and employees alike? The following attempts to answer these questions by examining innovation in the restaurant industry, foodservice labor economics, and potential scenarios.
The speed of change.
Innovation in the restaurant industry has historically moved at a snail’s pace. Anyone who has read John Steinbeck’s 1939 novel The Grapes of Wrath may recall the descriptions of the hamburger stands that the Joad family encountered on their way from Oklahoma to California. What is remarkable is that over 80 years later, all across the United States, we still have cooks frying hamburgers in establishments lined along highways. The hamburger hasn’t gone anywhere and neither has the way hamburgers are cooked. Instead of moving from the Joads to the Jetsons, it seems that we have gone from hamburgers to hamburgers.
However, although changes have been few and far between, the ones that have occurred have been relatively transformative.
Most major operational shifts seem to trace their origins to the limited service (LSR) space (which includes quick service, abbreviated as QSR, and fast casual). White Castle is often credited with initially pioneering the idea of assembly-line style foodservice production in the early 1920s. By the 1940s, Richard and Maurice McDonald, were using the “Speedee Service System”, a highly efficient form of foodservice production, combined with a limited menu. This operating approach would later be brought to scale by Ray Kroc and McDonalds Corporation (McDonald’s). Today, QSR operators, like McDonald’s, can be found across the globe in disparate environments spanning airports, highway rest areas, and shopping centers.
In recent years, combinatorics, often leveraged by fast casual operators, has been the most noteworthy mode of operational innovation.
Fast casual operators have been able to take share by offering customization, speed, and quality at moderate price points. One of the key ways in which they are able to achieve this is by prepping ingredients and distributing these items across customer-facing steam tables. Guests arrive and select ingredients to be placed in some type of edible or inedible carrier, such as wraps or bowls. The benefit of this set up is that guests can produce thousands of customized combinations of items from a set roster of options. The classic example of this model is probably Chipotle.
As for equipment, the Coca Cola Freestyle machine also plays on combinatorics. The machine presents guests with a limited number of inputs that can be recombined into a large number of customized options..
While environments may be modified, most of these innovations still hinge on humans operating traditional equipment types. The Freestyle machine doesn’t rely on much employee labor (aside from maintenance), but dispensed beverages are often self-service to begin with.
A closer look at restaurant labor economics.
While necessity isn’t always the mother of invention, in the case of restaurants, it might be.
Putting the cost of foodservice labor in perspective, according the USDA food dollar series, a series that breaks down consumer expenditures across various categories, 22.4 cents of every dollar spent on food by consumers in the United States went towards foodservice worker salaries and benefits in 2017. This was up from 18.8 cents on 2007. This equates to $154bn dollars being spent by American consumers on foodservice salaries and benefits in 2017, up from nearly $87bn in 2007 (a nominal increase of 78%, compared to a nominal increase of about 50% for overall foodservice household expenditures).
Below is a snapshot of the 2017 food dollar as well as table highlighting retail and foodservice changes.
The increasing amount of money spent on foodservice benefits and salaries is interconnected with a number of other factors. The American economy has been on an extended bull run and unemployment is skirting along historic lows. Demand for labor has made finding, and retaining, employees increasingly challenging. The situation for restaurants is especially serious given that industry employee turnover is notoriously high. According to the National Restaurant Association, restaurant industry turnover hit a post-recession high of nearly 80% in 2018. Some operators, especially in LSR, can experience rates well over 100%.
Further fueling cost-of-labor headwinds is wage legislation. Many major cities are being affected by major increases in minimum wage levels. In Chicago, where the authors reside, the minimum wage for non-tipped employees is currently $13 per hour, or nearly 80% higher than the federal minimum hourly wage. And while this may be stating the obvious, wage legislation has real effects on labor costs. One survey across 173 operators representing 4,000 locations found that 83% of respondents affected by minimum wage hikes experienced increased labor costs of 3% or more.
All of these factors are making a tangible impact on restaurant industry employment and profitability. The following section dives into our predictions regarding how things will play out and where automation fits into the picture.
Assessing the future: how will things play out?
While the pace may be slow, we believe that the aforementioned macro trends will make automation increasingly attractive to operators. Here are some specific topics that we think suppliers and operators should keep in mind:
→ LSR will change first: Limited service (LSR) operators are typified by a number of factors that make them a prime target for automation. The assembly-line mentality has already rendered many tasks to be so rote that automation remains the next logical step. This is similar to other disruption scenarios, like robo-advisers absorbing the role of financial advisors for low net worth clients with simplistic needs. In some ways, changes occurring first in LSR is somewhat ironic. LSR tends to have higher margins than FSR and has taken market share from FSR during recent years. The operators facing the fewest headwinds may be the first to benefit from emerging automation technologies.
→ Sympathy for the unemployed may be short lived: Automation will take jobs. And many of them won’t come back. Some may say that automation will allow operators to retrain and reposition staff, but the ultimate angle of automation is to reduce costs by removing people. It may not sound nice, but it is the reality.
Perhaps the bigger question is how will consumers respond to the eerie replacement of people with machines? Our thought is that sympathy will be short-lived. Data does show that demonstrating a meaningful difference, like socially conscious branding, can provide a lift in pricing ability. This type of branding is beneficial for firms because it helps to garner consumer trust. However, there are three key points relative to restaurant automation that readers should keep in mind:
1) Purpose-driven branding helps consumers feel like firms care about the consumer. Whether or not they are seeking brands that care about the employee is a different question. This topic has emerged, albeit somewhat indirectly, before. One study showed that 70% of Americans cite that a product being made in the United States as being very or somewhat important. However, only 21% said they would pay 10% more for American made goods and only 7% said they would pay 50% more. As a result, many consumers may care more about a product’s price than preserving American industry.
2) Restaurants can choose to maintain a “meaningful” difference in ways other than employing people, like offering clean label ingredients, while containing costs (or even reducing prices while boosting profits) via automation. Consumers may wind up feeling like they are getting the best of both worlds: attractive prices and meaningfully different products.
3) Pricing dynamics in absolute terms are different in retail vs. foodservice. In retail, a basket is typically strewn across a large number of low-priced items. In foodservice, purchases are consolidated into small numbers of higher priced items.
For example, if a consumer chooses a $1.30 socially conscious yogurt brand over a $1.00 traditional yogurt brand, the consumer paid a 30% premium (or 30 cents). If that same consumer were to pay $13 for food from a human-operated restaurant versus $10 from a traditional restaurant, the consumer would end up paying a $3 premium.
30 cents may be acceptable to a socially conscious consumer, but a $3 premium (which is 900% more than 30 cents) may be unpalatable, even if paying this amount helps to keep people employed.
→ Deflation and commoditization: As food spending share migrates towards food away from home (FAFH), there may be an eventual period of FAFH deflation. When this will happen is uncertain, but it is a possibility. Today, only 20% of Americans’ calories are derived from foodservice. But what if the situation flipped and 80% of our calories came from foodservice? It’s hard to imagine that most Americans would be able to afford getting 80% of their calories from foodservice without prices falling.
The rise of automation is well-aligned with potential long-term pricing pressures in foodservice. If pricing ability declines, operators will need to find new ways to boost margins.
→ Experiential factors and risks: Although the short-term implication of automating labor may be the reduction of costs, experiential questions remain. A smile, a suggestion, or familiarity between staff and regular customers can have a tremendous influence on customer purchases. Without these social aspects, getting food at a restaurant can become similar to buying food at retail, where ability to differentiate is notoriously low. An analogous scenario, outside of the food industry, is Uber and Lyft. Both firms ultimately have minimal control over customer experiences since they rely on large networks of independent contractors. The result has been two very similar services competing against one another, resulting in price compression. It’s not uncommon to see people with both Uber and Lyft apps so that they can cross-check prices.
As regards experiential risks, the Dutch automat may be an interesting case. In the Netherlands, automats, which are essentially foodservice vending machines, are common place.
As the name implies, automat experiences are very… automated. They are also very cheap and many items are pre-manufactured and simply dropped in a deep fryer. It’s also difficult to discern major differences from one automat to the next. The result is highly commoditized experiences with products that struggle to reach €3.00. Generally speaking, automats are even cheaper than major QSRs. But the question is, even if labor is saved, can operators automate to the point where they lose any form of differentiation or the ability to leverage customer experience to elevate margins?
→ Consolidation & New Entrants: Automation R&D may be both expensive and fraught with unpredictability. On the one hand, this may mean that only the largest foodservice operators may be able to shoulder the costs of creating new technologies. In this scenario, large firms may be at a distinct advantage since they will be able to introduce labor saving solutions while small firms are left with high-cost human labor.
On the other hand, established enterprises may shy away from risky investments that may, in the short term, deplete cash flows and profits. In this scenario, new automation-focused entrants may see a long-term opportunity to steal share from entrenched players. We may have seen some of this activity already. For example, Zume, an automated pizza chain, recently raised capital at a $4bn valuation and received a $375m investment from SoftBank. As a side note, Zume has experienced some headwinds and recently reduced 80% of its staff. However, it isn’t clear if the reason for these developments is market-based or as a result of some other factor.
Technological advancements combined with the high cost of labor may be tilting the needle in favor of automation. However, the situation is nuanced.
First, the pace of operational innovation in the industry is slow due to a combination of hard assets designed for use by humans (ovens, ranges, grills, etc.) and culture or mentality. The shift towards automation won’t happen overnight. However, as the situation evolves, we believe that LSR will be the first to undergo a transformation and that despite concerns to the contrary, consumer sympathy for displaced employees will be limited.
As automation takes hold, we also believe that there is the possibility of either consolidation or disruption, depending on whether large firms or small firms are the first to take the plunge. However, regardless of size, operators would be well-advised not to over-automate to the point where service devolves into an undifferentiated commodity.
Despite the risks, we believe that operators and suppliers should begin seriously evaluating automation technologies. With well over $150bn in foodservice salaries spent each year and LSR continuing to take share, we are confident that there will be plenty of labor to automate over the upcoming decades.
About the authors:
Jonathan DeVito: Jonathan is the Founder Managing Principal at PIVITAS, a food industry market research and strategy consulting firm. As a believer that there is no substitute for hands-on experience, he maintains tactical food industry expertise by picking up restaurant shifts in the Chicago area.
Todd Ruddick: Todd is a Principal Consultant and growth strategist at PIVITAS. He is also an active restaurant industry investor and operator. Trained as an aeronautical engineer, Todd received his MBA and MS degrees from MIT.