Almost every company has reported earnings for the third quarter and for the most part the results have been robust, at least on the top line.
In the fast-food business, this has continued a recovery that began last year and has been steady for much of 2021.
We wonder how long it will last. Restaurants’ recovery has been entirely price-based, fueled by a historically high increase in menu prices and average check. Traffic, on which fast-food chains have typically relied upon, is simply not recovering.
In October, limited-service restaurants raised prices by a record 7.1%. That continued a trend that has taken place for much of the past 18 months. Operators have increased prices to maintain margins as labor and food costs have taken off.
These higher menu prices, coupled with consumers ordering more food at a time, has driven average check to levels never before seen.
According to Revenue Management Solutions, average check soared 27%. Traffic, on the other hand, was down 13%. And those numbers have held relatively steady all year long. In fact, there has been little, if any, clear evidence of traffic improvement in recent months. Check out the following graphic:
Historically, high prices hurt traffic and sales as consumers move onto something else. The pandemic has turned this idea on its head, for two reasons.
First, last year, fast-food restaurants were all consumers had. They also had a lot of money, thanks to stimulus payments. And so they took a break from the monotony of quarantine and went to the drive-thru. That gave operators the ability to raise prices.
More recently, consumers have not had much of a choice in the matter. Consumers will generally shift spending toward lower-cost groceries when restaurant prices increase and retail prices are steady. Yet food-at-home prices have taken off this year, too, because grocers are dealing with the same cost pressures as restaurants.
Thus, there is less concern about raising prices and, in fact, analysts have often pressured executives when it’s perceived they’re not raising them enough—as they did earlier this month with Wendy’s.
McDonald’s same-store sales last quarter were up 14.6% on a two-year basis, driven entirely by average check. Much of that came in the form of higher prices. The chain has raised prices 6% this year, executives said.
“So far, it’s been received OK by customers,” CEO Chris Kempczinski told analysts in October. It’s a sentiment many other executives have echoed.
That may be true. But customers can sometimes take their time to react to prices. At some point they realize just how much they’re spending and adjust their spending accordingly. So their reaction may not be immediately evident, but wait a few months.
What’s more, traffic should at least be improving. As the graphic above demonstrates, it has barely moved for the past year. Yet consumers are moving more than they were at the beginning of 2021.
According to federal data, 11.6% of employees worked from home in October. That was down from 13.2% in September. But it was far below February, when 22.7 percent of workers did their jobs at home, and of course, well down from last year when that was more than a third.
More people working in the office would in theory bring more people into restaurants as they go to and from work. Yet the data doesn’t suggest that is resulting in improved traffic to restaurants.
What does this all mean? It’s certainly possible, as McDonald’s CFO Kevin Ozan suggested, that consumers’ habits have changed more permanently. That they will be purchasing for larger groups, either through delivery or the drive-thru or traditional takeout, long after the pandemic is actually over. That, as we’ve said before, could be the efficiency the industry needs to get through potentially long-term labor headaches.
Yet there is a reason that the federal government historically spends so much effort fending off inflation. Eventually, high prices reduce consumption, which results in a recession. In this case, consumers could well look at these menu prices and decide to start cutting back. Restaurants’ pricing power can only last so long.