You can always be learning from the news around you. See the post below about the probable bankruptcy filings of two restaurant chains catering to middle America.
Friendly’s management states in a press release that rising costs are hurting their profits. When you hear that then you know the company is not a franchise. The business has little ability to pass on costs while still retaining its customers. The effects of inflation–rising food, energy and labor costs–can devastate profitability. Too much debt would be lethal because these companies must continually invest to maintain quality to retain customers. If cash flows go to pay a large debt expense, then little is left to maintain the business. These types of businesses can only earn their cost of capital over a full business cycle if they are efficiently run.
The history of Friendly’s Restaurant Chain is here: http://www.friendlys.com/about/. The business thrived for over 50 years but it was run by two brothers, who were great entrepreneurial operators. Without the loving attention to detail from owner-managers and the leveraging up of a commodity business to juice returns by a private equity firm, decline is deadly and perhaps inevitable.
This post complements the prior post here on inflation:
There are several lessons.
- Inflation can hurt the bad business.
- Commodity-like restaurant chains have no competive advantages; therefore, debt can wipe out shareholders during a difficult business environment.
- Note that time is not on your side with non-compeititve businesses. The only way to salvage this business is to restructure the debt and bring in entrepreneurial management to better manage the assets. Or liquidate the company. Easier said than done!
Think hard about business failure.