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Consider this. Yum! Brands, the owner of Pizza Hut, KFC and Taco Bell, saw same-store sales in India fall four per cent in the December 2013-ended quarter but wants to add 400 stores in Tier-II and Tier-III cities in the next two years. The company has already crossed 600 stores in India and has no plans to go slow. Ditto with Hardcastle Restaurants, franchisee of McDonald's in the south and west of India, which proposes to add 75 to 100 stores in the next two years at a time when its same-store sales also doesn't look exciting either.
Get the drift? Despite the protracted slowdown and falling same-store sales, quick service restaurant (QSR) chains are on an aggressive expansion mode in India. The reason is not far to seek: real estate has become cheaper and these players are optimistic about the long-term potential of the market. According to an October 2013 Technopak report, the QSR industry is anticipated to grow from $48 billion in 2013 to $92 billion by 2020, a CAGR of 10 per cent annually. Metros and major Indian cities form over 90 per cent of the QSR market. The same report says, with their promise of affordability and convenience, QSR chains expect growth in the range of 20 per cent-plus across India in the next five years.
What is driving their optimism in an otherwise sluggish market? Is it only cheap real estate? What about the cost of distribution in smaller cities? Will it not build margin pressure?
Look closely. The QSRs are depending heavily on smart procurement to stay competitive in a slow market. "The biggest challenge that procurement managers across the industry face today is the unprecedented inflation and volatility in commodity price," says a spokesperson of a McDonald's business partner that serves as distribution centres for its restaurants in Mumbai. "Managing the entire supply chain - right from materials management to physical distribution - is a big challenge which is complicated by the lack of infrastructure in the country," adds Manpreet Gulri, country head, Subway India. Which in effect means, organised restaurant chains in India today can't do with anything less than 100 per cent local sourcing.
Enter: local vendors, who can make or break a QSR chain's fortune, and not just fast-track its expansion plans.
It is not for nothing that one of the largest food service retailers in India, McDonald's, has developed a multi-layer supply chain network in the country with a strong integrated backend to reach out to local vendors for its procurement needs. The steps in procurement at McDonald's begin at the farm-end from where suppliers collect the produce, process and dispatch it to regional distribution centres in temperature-controlled trucks, from where the inventory reach the respective restaurants.
"Local sourcing is a significant contributor to optimising costs in India, primarily by cutting down on transportation costs. With volatile exchange rates and steep duties on imports adding to the burden, it is imperative that we have a strong local sourcing model that enables us to fulfil our brand promise of value and affordability to the customer," says Amit Jatia, vice-chairman, Westlife Development & Hardcastle Restaurants.
While substantial investment in technology is not on the mind of QSR brands in India as yet, there is an evident rush for innovations - like developing new products with 100 per cent local ingredients. Most hot beverages in Costa Coffee stores are made with 100 per cent Indian ingredients and so is the Classic Coffee Cooler, a blended cold coffee. The lettuce farming in India and the indigenous McFry are innovations that drove in cost efficiency for McDonald's.
Apart from that, investment in standard technologies like ERP (enterprise resource planning) is keeping brand managers at KFC, Pizza Hut and Costa Coffee informed about their stock and inventory movement at every restaurant and warehouse. That said, good vendor management dictates that negotiations are completed in good faith. McDonald's also has in place processes of audit and controls at every stage of its supply chain network to build a risk-free procurement cycle. Subway has moved to the early stage of e-procurement system with electronic placement of orders for all franchisees and track inventory movement.
It's not competition; it's a journey
Ensuring procurement flexibility and managing multiple supply chain configurations are imperative for Indian QSRs. But every region and vendor is unique, and so are the alarms they raise. For most brands in this category, the typical challenges come from supply side of the vendors. At KFC, for instance, there are certain raw materials that vendors are unable to deliver or manage, particularly during sudden demand surges, say after the brand goes for a TV campaign or a rock music show near a KFC restaurant. The reason: the vendor doesn't have the capacity to supply additional inventory or it is unable to plan systematically.
Such instances are not uncommon. As a possible way out, Arjun Verma, executive director and CFO, Devyani International, the franchisee for Costa Coffee, and KFC and Pizza Hut restaurant chains in India, prescribes that before going to TV or launching an event, the franchisor and franchisee should make fair estimates about how the consumer is going to behave, the possible demand surge and based on that it/they should prepare the vendors. And still there can be hiccups - say, if the franchisor estimates a 15 per cent surge in demand during and immediately after a campaign, and it turns out to be 25 per cent. The solution: go for inter-restaurant or inter-region transfer of inventory.
For Radhakrishna Foodland, precision forecasting based on past history as well as contingency supply sources is the only way to manage and reduce the impact of any interruptions in supply. For Subway, the answer is building own supply infrastructure. To tackle the existing bottlenecks, Subway has in place a network of development agents who ensure smooth movement of inventory between the supplier and the franchisees in a region.
Strategic sourcing is equally important for Cocoberry, which operates in the frozen yogurt category, where uninterrupted availability of the raw material (the premix that is the core of the product) is critical. Choosing to discontinue the import of any raw materials, Cocoberry has, over the past few months, concentrated on building a local sourcing model. Apart from lower costs, the move has reportedly assisted the brand in better collaboration on product development and faster compliance on regulatory matters by its local partners.
"Though food inflation has been high last year (exacerbated by currency depreciation), we have been able to contain our input prices with cost efficiencies driven by our local procurements. As a result we did not have to increase our prices in the past one year," shares Rahul Deans, CEO, Cocoberry.
"At the procurement end, working with lettuce farmers and training them on modern irrigation practices and emphasising on cold chain integrity from farm to fork has led to reduced waste," says Jatia of Hardcastle Restaurants.
It's not a contract; it's a relationship
Effective vendor management presupposes long-term relationships over short-term gains and marginal cost savings. Constantly changing vendors in order to save a penny will cost more money in the long run and will impact quality. Not surprisingly, long-term loyalty and predictable order flows form the cornerstone of business-to-business relationships. It would not be wrong to say the success of global QSR brands in India rests on their ability to leverage local vendors.
To this end, McDonald's shares its long-term plans with vendors and engages with them for training on an ongoing basis. In return, McDonald's suppliers adopt a 'system first' attitude, giving the brand a priority customer status.
Costa Coffee, the coffee shop chain owned by the UK-based multinational company Whitbread, emphasises that such relationships thrive on clarity. "In dealing with suppliers we have introduced an open-book costing policy," shares Santosh Unni, CEO, Costa Coffee India. "Transparency is of paramount importance in our relationship," Unni elaborates. "For example, our largest vendors are the food vendors - airline catering companies like Lufthansa flight catering etc. Based on open-book costing, we agree on the margin or mark-up to offer the vendor and leave no space for ambiguities. If the cost of a sandwich is Rs 50, we tell the vendor: let's consider the cost of raw material components of a sandwich, say it is Rs 30. Then we offer the vendor, say, Rs 15 mark-up over that. So everybody is clear about how the costing is done."
Take the case of Costa Coffee's take-away cups. The company probably uses up a few lakhs of cups in a year. So, even a small change, say Rs 2 difference per cup translates to a big number. This is precisely the logic that drove the company to manufacture the red take-away cups of Costa Coffee in India. Four years ago, this product was imported from the UK. Two years ago Costa transferred the procurement source to China. And a year back, the company transferred it to the Indian suppliers. "So we pick and choose products that are big. Typically we use the principal of 80-20 - what is 20 per cent of your procurement which has 80 per cent value," says Unni.
To streamline franchisee-vendor transactions, restaurant chain Subway helps its franchisees set up IPCs (international purchasing cooperatives) in each region. Besides assuring steady supply and collaborations across regions, these cooperatives help to reduce supply chain costs and improve product quality. The regional supply chain advisory groups guide the IPC on local issues and develop regional specifications for all products to ensure that any requirements arising from local laws, customs or religions are addressed.
Yet in dealing with perishable commodities, short-term demand-supply fluctuations, seasonal rise and fall of prices may play havoc with any relationship. "Hedge long term but flexible contract with vendors," says Arjun Verma of Devyani International. Unni of Costa Coffee supports Verma adding that at Costa Coffee, contracts with vendors last for three years and raw material price is revised every six months. This way the coffee chain claims to reduce risk involved in commodity price fluctuations.
To ensure steady supply, Devyani International has tied up with two vendors for every significant food item like chicken, oil, cheese etc. "The idea is, you should not keep all your eggs in one basket - if one vendor fails to deliver or face problem at production end, you have another to fall back on," says Verma.
In sum, the return on the investment made in nurturing a positive vendor relationship cannot be measured directly against the company's bottom line. But as the brands discussed here have found, a well-managed vendor relationship can help in reducing costs and improving the quality of their offering to the customer.
Negotiating commodity price volatility: Five tips for QSRs
Tarun Jain
Vice-president, food services, Technopak Advisors
The double-digit inflation rate during most of 2013 made it difficult for QSRs to maintain their food costs. At the same time, a low market sentiment and heavy tax burden put pressure on their top line, making balancing the revenues and costs a veritable tightrope walk. While increasing prices might sound like a natural response to high inflation, it is not the wisest tool; QSRs must look at achieving internal efficiencies before resorting to a price increase.
Here are some tips for keeping food costs in check in such volatile times:
> Understand your product portfolio thoroughly through a Pareto analysis: Identifying those 20 per cent of your products that contribute to 80 per cent of your revenues, and costs are important in order to understand which commodities can have a harder impact than others. For a chicken chain, chicken, oil, flour, and seasonings may be the key commodities, while for a pizza chain, they might be cheese, tomato sauce and flour. There is a need to have different strategies for different commodities, based on their importance within the system.
> Re-examine your procurement strategy: While a rise in a commodity price generally leads to an increase in procurement costs, there are other costs that also influence the price you pay. These include the cost of packaging, transportation, taxation (including octroi, customs duties etc), and the company's reputation and credit rating in the market. Such actions as changing the minimum ordering quantity, lowering supply frequency, taking larger pack sizes, accepting supplies in centralised stores and renegotiating credit terms are all levers, which can provide some respite in these tough times. Encouraging the use of convenience products can also provide savings in the short- to medium-term. Say, if the price of tomatoes goes up, the use of tomato puree can provide some insulation.
> Source directly: As far as possible, and if reach and volumes justify, a direct sourcing strategy is preferable. This will not only reduce the overheads arising from a long value chain, but will also reduce the risk of artificial inflation presented by wholesalers.
> Opt for contract manufacturing: It is necessary to look beyond established manufacturers and/or suppliers as they may have lower inclination to negotiate. Encouraging new manufacturers and/or suppliers and providing them start-up support can help negotiate a transparent, long-term deal on a cost-plus basis, and significantly reduce costs.
> Realign the product portfolio: An in-depth analysis of the menu can reveal the correlation between commodities and their impact on specific menu items. If certain commodities are expected to rise beyond reasonable limits, it may be time to rework the product portfolio and thereby minimise their impact. This can be done by developing substitute products and refocusing marketing efforts on these.
> Keep a keen eye on the market: Doing this can help Indian quick service restaurants forecast the movement of commodities. Both rising and falling ones are equally important and can help achieve a balance in terms of overall costs. For example, while the price of flour may be going up, that of coffee and tea might be going down, and, as a result a cappuccino and muffin combo can still continue to be lucrative.
