McKinsey Case: Digital & Vegan Restaurant Franchise

Problem Definition

Our client is a European venture capital firm. They are potentially interested in investing into a new restaurant franchise player from Austria, called “VegDigi”. VegDigi has just 3 corporate restaurants in Vienna and no franchisees, yet, but their business model is considered innovative for a restaurant industry, and is based on 3 pillars:

• Proprietary IT system – VegDigi’s team has developed their own IT system (which manages all restaurant processes – from cashier desk and employee schedules to inventory management and delivery).
• Innovative vegan menu – VegDigi offers fresh, whole-foods vegan menu, which differentiates itself from the rest of the fast food offering in taste and quality. VegDigi puts a lot of focus on its foods being healthy.
• Transparent business practices and processes – VegDigi prouds itself to be a transparent business, meaning they publish all their data and talk about their success and failures openly online.

Our client has engaged us to help them to determine whether or not to make an investment into the VegDigi.

Comments

This is a typical McKinsey case and consists of 3 types of questions + a short summary:

1. Structuring – a candidate is expected to put together an issue tree / hypothesis tree
2. Exhibit ­– a candidate is expected to look at the exhibit and to draw some insights from it / formulate hypotheses
3. Math – a candidate is expected to calculate something and to formulate a hypothesis based on the calculation

All McKinsey cases are interviewer-led cases, so the interviewer should guide the candidate through the interview.

Short Solution

Solution

Example of an excellent structure:

Consumers

• Preferences – is vegan trend here to stay? Hypothesis: very probably, because of environmental and health concerns connected to animal farming as well as due to animal rights activism
• Geography – is VegDigi able to focus on the right geography, where the vegan trend is the strongest? Hypothesis: yes, it is probably going to be Europe)
• Marketing – will VegDigi be able to deploy efficient marketing to appeal to the key customer groups? Hypothesis: yes, if focused on middle class, educated, environment- and health-conscious

Price

• Price Sustainability – will VegDigi be able to charge a good price (maybe even price premium?), due to its business model and focus on veganism? Hypothesis: yes, VegDigi's values are easy to communicate and to understand, therefore price premium is possible

Franchisees

• Acquisition of franchisees – will VegDigi manage to acquire franchisees? Hypothesis: interesting value proposition for franchisees, because 1) vegan is very popular 2) potential ease of management through IT 3) VegDigi’s core business value is transparency
• Retention and work with franchisees – more difficult to say how this will go. Hypothesis: depends on the future contractual and business relationships, for example in terms of kitchen: 1) will VegDigi be selling something to franchisees as franchisor (e.g. ingredients) or 2) will just mediate between franchisees and a supplier – first option might create mistrust and conflict of interest in a long-term

Competitors

• Vegan – development of other vegan offerings can have double effect: a) negative: create more fierce competition but also b) positive: create an atmosphere in which vegan food is more acceptable. Hypothesis: market is not saturated yet, so positive effect shall outweight the negative
• Franchisors – VegDigi is competing with other franchisors for franchisees, the question is whether VegDigi’s offering for franchisees will have a competitive advantage? Hypothesis: yes, due to its IT system

Costs

• Fixed
  • IT costs – since VegDigi is IT-focused company, it will need to acquire IT talent in the future, so price development in this area will affect VegDigi. Hypothesis: costs for IT will definitely rise, it will be difficult for VegDigi to attract IT talent, because it's a restaurant company (not as cool as working for other type of start-up)
  • Rent – Development in real estate market will affect VegDigi, since they have corporate brick & mortar locations. Hypothesis: due to current economic situation (post-corona), the prices for real estate will go down
• Variable
  • Cost of ingredients – Hypothesis: it is the most important variable costs component, since it will affect both VegDigi corporate locations and its franchisees

Out-of-the-box opportunities

• Comprehensive vegan brand – vegan market is growing rapidly day after day. Hypothesis: if VegDigi is able to branch out into other consumer products (vegan clothing, vegan cosmetics), it might be able to build a comprehensive vegan brand

Main hypothesis: Out of all the factors 1) strong appeal to trendy consumer preferences (vegan) and 2) strong value proposition for franchisee acquisition (digital management) are the biggest factors which play in favour of DigiVeg for its future development (Candidate can also formulate any other main hypothesis, as long as there is a hypothesis)

Example of an excellent exhibit analysis:

• Outlier: Cost-structure of VegDigi is worse than this of the competitor (cost/revenue ratios are higher for all positions), it seems like the cost structure is also correlated with the number of prep items within each player (i.e. more prep items -> higher cost / revenue %) Hypothesis: VegDigi has potential to improve cost /revenue ratios, maybe by a) reducing number of prep items; or b) by increasing prices? Price premium vs competitor could be a reasonable thing to do, since VegDigi has more focus on quality and health (bowls & soups vs hotdog & French fries).
• Outlier: Vegan Pizza is definitely a best-seller, it is the highest selling dish not only at VegDigi – but also if compared to the competitor’s bestseller (burger). Vegan pizza sells 50% more per day vs burger (300 / 200 – 1 = 50%). Hypothesis: definitely keep and develop further the dish, regardless of its high cost/revenue ratio.

Optional: candidate suggests to calculate the gross profit – interviewer agrees​ (table below is not shareable with the candidate!)

• Outlier: Absolute gross profits are almost the same (EUR 3,300 per day) for both VegDigi and the competitor. Hypothesis: VegDigi is definitely an interesting investment target, because it’s already now matching gross profit of the competitor, but could further improve it.

• New cost/revenue ratio = 45% – ( 3 * 5%) = 30%
• New gross profit % = 1-30% = 70%
• New sales/day = 300 * (1-30%) = 210
• New revenue = 210 * 9 = ~ 1.900 EUR
• New absolute gross profit for Pizza = ~ 1.300 EUR (vs old one of 1.500 EUR)

Hypothesis: Reducing number of prep items for dishes for VegDigi doesn't make sense, because it's clearly driving sales and gross profit down –> if we would want to increase the gross profit for the VegDigi, it's worth to think about increasing prices for their dishes.

• As regards the overall trends for the next 5 years, VegDigi has a lot of potential, with biggest being 1) strong appeal to trendy consumer preferences (vegan) and 2) strong value proposition for franchisees (digital management)
• We looked at some internal economics of the one restaurant of VegDigi as compared to the competitor and we found out that VegDigi has worse cost/revenue ratios for all the dishes – this can be however fixed through pricing. Hypothesis: price premium vs competitor is possible, because of higher quality.
• Overall, VegDigi seems like an interesting target. We are not able to give a final recommendation on investment yet, but definitely something to look into further.

Difficult Questions

Possible answer

Benefits of a "factory kitchen" and selling to franchisees:

• Full control over quality of ingredients
• Easier to produce to should-cost (due to full transparency of cost structure)
• Faster reaction to price increases in the food market (swap of ingredients)

Drawbacks

• Potential conflict of interest – selling to franchisees creates an impression of not being "in the same boat" / not playing for the same team
• In case of the problems it would be the easiest lever to pull ("just increase prices on the ingredients, which we are selling to the franchisees") and that is why it's dangerous

Hypothesis: Due to the fact that VegDigi wants to establish itself as a franchisor, the best way would be not to assume role of a seller, but rather to assume a role of an intermediary (i.e. negotiate framework contracts with the individual suppliers on behalf of the whole franchise network).