Chicken chains hatch plans to battle the effects of margin-busting gas, commodity and labor costs

Nation's Restaurant News,  June 25, 2007  by Paul Frumkin

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Even as quick-service chicken chains work to stay aloft through stepped-up unit expansion, newproduct rollouts and a focus on value positioning, the runaway escalation of some fundamental costs threatens to scratch away at many brands' bottom lines.

Experts and chain executives agree that menu price increases are almost inevitable as operators attempt to offset an inflationary cost environment fueled by higher commodity, labor, construction and energy rates. At the same time, legislation in the form of trans-fat bans and mandated menu labeling also could set the stage for cost increases in the near future.

"This feels like 2002 to me all over again," says Stephen Carley, president and chief executive of El Pollo Loco in Irvine, Calif. "We're seeing a dramatic escalation in many key costs, and I also think we're seeing the end of a bull run from the consumer side. They're tapped out and stressed. They're tired. I think we're all going to be earning our pay this year."

Operators cite record-high gas prices as being major contributors to consumer distress. However, some experts downplay that aspect of the economic equation as it impacts the restaurant industry, and instead point to increased commodity costs as being the central problem.

"Gas prices have had less impact [on quick-service restaurant sales] than one would think because people instead have cut back their spending on other things--durable goods like cars, homes, flat-screen TVs," says Malcolm Knapp, president of Malcolm M. Knapp Inc., a New York-based foodservice consulting firm.

And while some consumers at the low end of the earning spectrum may have decreased their quick-service dining-out frequency, at least some of that fall-off has been counteracted as higher-income people trade down to quick service from casual dining.

The real dilemma, Knapp and others insist, is escalating commodity costs--food inflation--driven by unprecedented increases in the price of corn and, consequently, chicken, beef and dairy products.

"Cost is a much bigger issue," Knapp says. "Chains will have to implement menu price hikes to offset it."

Much of the food price inflation the country is experiencing is based on corn, which is suddenly in demand as a component in the production of alternative energy sources like ethanol.

"Farmers are making money growing corn to the exclusion of other stores," said John Barone, president of Fairfield, N.J.-based Market Vision Inc., a company that provides commodities analysis and purchasing support services for restaurant chains.

Corn, the primary feed for chicken, has experienced a precipitous rise in prices over the past several years as the demand for alternative fuels rises. Barone says corn prices were about $2.08 a bushel in 2005. But in 2006 that figure had risen to $2.59 a bushel, and in 2007 the price has climbed nearly $1.50 to $4 a bushel.

"The joke in the market is that chicken is corn with feathers," Barone says.

But while chicken prices are way up over last year, he says, 2006 actually hit a record low. Wholesale prices for boneless, skinless chicken breasts for the 2006 period of January through May were $1.11 per pound wholesale. For the same period in 2007, the price had risen to $1.58, Barone says.

Barone projects that prices will likely hit their peak in the $1.75 range toward the end of June. Then they will likely come down to the $1.50 mark by the end of the summer, he says.

Despite the increases, Barone says that chicken remains a good value when compared to other proteins.

"The average chicken customer is not going anywhere," he says.

Other costs hikes, however, are worrying foodservice executives in the quick-service chicken segment. E1 Pollo Loco's Carley maintains that accelerating construction costs are complicating the economic picture for expansion-minded chains.

"Developing nations are sucking raw materials out of the supply chain at a surprising rate," he says. "Hikes in the prices of cement, lumber, petroleum and copper are driving higher construction costs by as much as 20 percent plus."

Labor is another cost element that is rising, particularly now that the federal government is raising the hourly minimum wage from its current $5.15 to $7.25 over a two-year period.

"On the cost side, it's a pretty messy environment that will cause operators to raise prices," Knapp says.

In addition, several chicken chains are facing potential cost increases for cooking oil as lawmakers and consumer advocate groups pressure them to stop using partially hydrogenated oils and switch to trans-fat-free products instead. The Washington, D.C.-based Center for Science in the Public Interest filed a lawsuit against Yum! Brands' KFC division for the use of oils containing trans fats, and threatened to sue other foodservice operators as well in 2006.

CSPI withdrew from the lawsuit, however, when KFC eliminated trans fats from fried foods in its 5,500 domestic units. Meanwhile, New York City passed a trans-fat ban, forcing all restaurant chains to change their oils before the law takes effect next month. Philadelphia followed suit soon after New York's action.