McKinsey Case: Digital & Vegan Restaurant Franchise

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If the candidate asks: prep items (mise en place) are processed final ingredients (for example, roasted onions or cut tomatoes), which are required to assemble the final dish.

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 calculating 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.

We just saw we have a problem with our cost/revenue ratio as compared to a competitor. We want to analyze how reducing the number of the prep items (i.e. simplifying the dish) would affect the gross profit for Pizza of VegDigi. We know that if we take out 1 prep item from the dish, we would decrease cost/revenue ratio by 5 percentage points, but the sales/day would also decrease by 10% (customers would find the dish less interesting and would order less of it).

If we take out 3 prep items from Pizza, how this will affect absolute gross profit of VegDigi?

• 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 potentials, with the 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.

Possible answer

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

• Full control over the 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 the 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).