Financing

Fast-casual chains run into trouble

Aggressive development has hurt the companies’ same-store sales, leading to more closures.

When Snap Kitchen shut its Chicago market last week, it joined an increasingly inclusive club of fast-casual chains slowing development, closing units or shutting down altogether.

Potbelly and Zoes Kitchen have slowed their growth. Noodles & Co., Pie Five, Pollo Tropical and Taco Cabana have closed locations. ShopHouse Asian Kitchen, My Fit Foods and Baja Sol Tortilla Grill have all shut down completely.

Once the beneficiaries of nearly unfettered growth, fast-casual chains have run into problems the past two years as industry same-store sales and traffic have weakened.

Consider this: For each of the past four quarters, same-store sales at publicly traded fast-casual chains (not including Chipotle Mexican Grill) have lagged behind both full service and quick service, according to data from Technomic.

And that performance was at its worst in the third quarter of this year, when publicly traded fast-casual chains reported a 4% decline in same-store sales.

By contrast, full-service same-store sales declined 1.8%. Quick-service concepts’ same-store sales increased 0.5%.

The slowdown at fast-casual companies has been fairly dramatic. In the first quarter of 2015, the chains’ same-store sales averaged 7.2%. Sales have deteriorated ever since.

To be sure, fast-casual chains have fewer locations and the companies themselves are newer. As a result, their sales can be volatile, because they’re more vulnerable to consumer shifts and competition. The chains themselves have simpler menus that also leave them less protected when customers suddenly get an appetite for something other than burgers or burritos or customized pizza.

And these numbers don’t include Panera Bread, which was taken private earlier this year and, by the company’s own accounts, have continued to perform well this year. The company in November said that its same-store sales outperformed the restaurant industry by 800 basis points in the third quarter. That implies 5.8% growth for the 2,000-unit bakery/cafe chain.

But fast-casual chains are struggling largely because of intense competition within the sector, and outside of it.

Consider this: Fast-casual chains added nearly 4,400 locations between 2014 and 2016, according to Technomic's Top 500 Chain Restaurant Report. That’s a 19.4% growth rate.

By comparison, the number of full-service units grew by about 500 over the same period, or a 1.8% growth rate.

The number of quick-service locations grew by just more than 3,000, or 1.8%.

Theoretically, demand for fast casual should be growing by more than that, given consumer trends: The chains promote higher quality in a more simplified concept where customers don’t have to pay tips and can easily take their food with them so they can eat at their desk or on their couch.

Yet same-store sales weakness at these chains suggests that the development has been too aggressive—flooding consumers with choices.

And let’s not forget that established companies are growing more competitive themselves, and they’re frequently gunning for the business they’d been losing to fast-casual chains over the past decade.

McDonald’s, Wendy’s and Burger King have improved their offerings and their marketing and are growing as a result. Casual-dining chains that have lost a lot of business over the past 11 years, meanwhile, are finally gaining traction with takeout customers.

These are bigger, more established chains that have resources to improve their restaurants and their food and their marketing that many of the smaller fast-casual concepts do not.

What happens from here remains to be seen. Fast-casual companies are still attracting millions in investment from private-equity groups and venture capitalists that should continue to fuel expansion. That expansion is driving up lease costs that could force even more closures if sales don’t pick up.

Perhaps the slowing development could help many chains rebuild their unit economics. Or maybe whatever has been holding back restaurant sales the past two years dissipates with tax reform in 2018.

Regardless, the fast-growing sector has clearly taken a break over the past year.

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