Friday, June 29, 2007

Applebee's & Schumpterian Dynamics

Today's Wall Street Journal features a textbook article about Schumpeterian dynamics and industrial structure.

In discussing the current troubles of Applebee's, the popular restaurant chain, it notes that the idea began as a single restaurant, loosely modeled on TGI Friday's, in 1980.

1980. Ronald Reagan was President, you didn't own a cell phone, and few of us had personal computers.

The article nicely observes three contributing factors to Applebee's demise. One is the growth in restaurants, from one for every 1,029 people thirty years ago, to one for every 664 people as of 2003. That's nearly a 100% increase in competition. So much for opportunities remaining fixed, and no change over time. This sector has become crowded, as barriers to entry remain, as always, fairly low.

A second factor is, not surprisingly, changes in American food preferences. Restaurants with meteoric growth due to style and cuisine are notoriously risky in terms of long term success. Applebee's menu formula originated almost thirty years ago.

Again, as the Journal article notes, today, your local supermarket competes with ready-to-eat delicatessen fare that is affordably priced and very acceptable. Plus, tastes have moved away from the bar-food and heavy, platter-like dishes at Applebee's. Fried and large are out, smaller and fresher are in.

Ruby Tuesday's is featuring ads touting fresher dishes in smaller portions, for lower prices, with a signature chef personally crafting their menu.

Finally, as this Yahoo-sourced chart shows (click on the chart to view a larger version), Applebee's stock price has barely outpaced the S&P500 Index over five years. And most of that has been a recent rise, at a faster rate than the Index, beginning late last year. For the early part of the period, the stock mirrored the S&P's rise, then flattened and fell as the index continued to rise, through mid-2006.

Former SEC Chairman Richard Breeden's investor group took a position in the stock, and has been agitating for changes. The restaurant chain's management is charged with essentially fiddling and compensating itself lavishly, while Rome burns. According to the Journal, the chain's management realized it had a strategic positioning problem as long ago as October, 2005.

Now, it is aping Ruby Tuesday's, by using chef Tyler Florence as its signature menu designer. Speaking personally, I have been to one of the chain's locations a few times in the last six months, as shopping with my daughters found me nearby at dinner time. I was not impressed.

The tab was higher than I expected for food that was not really all that good. "Steaks" that had gristle running throughout. Merely average salads. Somehow, for the atmosphere and menu, the total check size was somewhat shocking. A smaller, local steakhouse routinely does a much better job, for no more, and frequently less money.

I think that Applebee's is simply the latest example of the life cycle of distinctive style and menu restaurants. They catch a fashionable wave, grow like topsy, go public, and eventually mature. They add more stores, settle in as a popular favorite, and, therefore, dampen the opportunities for further, breakneck growth. Eventually, they saturate the potential markets, lure a reasonable number of patrons sufficiently frequently, and top out.

This can take a decade or more, during which consumer tastes change, early patrons' lifestyles are now radically different, and a new entry-level generation finds a new favorite restaurant chain.

Once again demonstrating that businesses which rely on capitalizing on fickle consumer behaviors simply don't have long term, consistently superior total returns. They are relatively shorter-lived, temporal plays on fortuitously hitting a sweet spot in consumer trends.

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