Case 018Commercial and market casesCore
A restaurant chain with 25 outlets wants to grow to 60. Work the outlet economics and the payback on a new outlet, and say whether the fund should back the expansion.
1The situation
Tandoorwala Kitchens runs 25 casual-dining restaurants in two cities. A mature outlet does Rs 4 crore of revenue a year. Food costs 32% of revenue, rent 12%, staff 18% and other costs (power, delivery commissions, marketing, maintenance) 16%. Central overhead is Rs 5 crore a year. Leases run 9 years.
The founders want to open 35 more outlets over three years at Rs 2.5 crore of fit-out and deposit each. A new outlet does about Rs 3 crore of revenue at a 15% margin in its first year before reaching the mature numbers. Central overhead would rise to Rs 8 crore.
2Your task
Build the outlet P&L and the company EBITDA today, work the payback on a new outlet with and without the ramp, test a weaker outlet, and give a view on backing the expansion.
Quick check
Outlet margin is 22% on Rs 4 crore. What is the simple payback on Rs 2.5 crore of capex, and what does a ramp year do to it?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
A mature outlet earns Rs 0.88 crore on Rs 4 crore, a 22% margin, so Rs 2.5 crore of capex pays back in 2.8 years at maturity and about 3.3 years with the ramp, inside a 9-year lease. Today the company makes Rs 17 crore of EBITDA; at 60 outlets about Rs 45 crore on Rs 87.5 crore of new capex. Back it in cohorts, because a site doing Rs 3.2 crore instead of Rs 4 crore earns only a 15% margin and takes 5.4 years to pay back.
Step 1What does one outlet earn, and what does the chain earn?
Begin with one restaurant, the way its owner would. Of every Rs 100 of sales, Rs 32 goes on food, Rs 12 on rent, Rs 18 on staff and Rs 16 on everything else, leaving Rs 22. On Rs 4 crore that is Rs 0.88 crore of outlet EBITDA, and 25 of them make Rs 22 crore before the Rs 5 crore head office, Rs 17 crore of company EBITDA. Note which costs move with sales and which do not: food and other costs scale with revenue, rent and staff are close to fixed, and that split is what decides how a weaker outlet behaves.
| Per outlet, Rs crore | Mature, Rs 4 crore | Ramp year, Rs 3 crore | Weak site, Rs 3.2 crore |
|---|---|---|---|
| Revenue | 4.00 | 3.00 | 3.20 |
| Food, 32% of sales | (1.28) | (1.02) | |
| Rent, fixed | (0.48) | (0.48) | |
| Staff, fixed | (0.72) | (0.72) | |
| Other, 16% of sales | (0.64) | (0.51) | |
| Outlet EBITDA | 0.88 (22%) | 0.45 (15%) | 0.46 (15%) |
| Payback on Rs 2.5 crore | 2.8 years | 3.3 years incl. ramp | 5.4 years |
Step 2How long does a new outlet take to pay back?
Rs 2.5 crore over Rs 0.88 crore is 2.8 years, which is the number the founders will quote. With a first year of Rs 0.45 crore the cumulative cash is 0.45, 1.33, 2.21 and 3.09 crore after years 1 to 4, so the capex comes back about 3.3 years in. Against a 9-year lease that leaves 5.7 years of Rs 0.88 crore a year, roughly Rs 5.0 crore of cash per outlet over the lease after recovering the fit-out. A 35% cash yield on capex is why restaurant chains expand; a 15% margin site at 5.4 years is why many of them stop.
Step 3Should the fund back the expansion?
Yes, in cohorts, with a test the founders must pass. Thirty-five outlets at Rs 2.5 crore is Rs 87.5 crore of capex for about Rs 31 crore of mature outlet EBITDA, and company EBITDA rises from Rs 17 crore to about Rs 45 crore after the larger head office; that is a strong return if the new sites match the old ones. The question to diligence is whether they will: the first 25 were the best locations in two cities, and the next 35 are by definition the sites not chosen first, or sites in a third city where the brand is unknown. Fund the first ten, require each to reach Rs 4 crore within eighteen months, and release the rest against that evidence.
The key concerns to name in the room are the ones the owner of a single restaurant worries about: location and footfall, rent as a share of sales, the chef and staff turnover, food cost inflation, and delivery platforms taking a larger share. The limit of the case is its flat numbers: rent escalates during a lease and a mature outlet's sales can fade as newer places open nearby, which is why a 3.3-year payback, not a 2.8-year one, is the figure to plan on.
Where candidates lose it
The common loss is a payback computed on mature margin from day one. A new restaurant opens slowly, and a 15% first year on Rs 3 crore adds most of a year to the payback; the founders' 2.8 years becomes 3.3.
The second miss is treating all costs as variable. Rent and staff are fixed, so a site doing Rs 3.2 crore does not earn 22%, it earns about 15%, and the whole expansion case rests on new sites matching old ones.
What the interviewer asks next
- Delivery platforms rise from 16% other costs to 20% on the half of sales that is delivered. What happens to outlet margin?
- Would you prefer the founders expand in the two existing cities or open a third?
- How would you structure the investment so the fund's money is released outlet by outlet?
Asked at General Atlantic, Generalist, Beijing, 2014 (Wall Street Oasis): If you were to open a restaurant, what are some key concerns?
Company names and figures are illustrative.