Strategic Logic Question

QUIZ

Let’s test our business IQ.

A restaurant owner who owns a building in New York City where he serves some of the best Spanish food (Tapas, Paella) seeks your advice. He nets about $30,000 a month. This is, apparently, an excellent income for a small individual owner.  He wants to expand to another location. Should he and how would you advise him?

Please, no more than a sentence or two.  How would you need to look at his restaurant business?

Correct answers are required to receive any more value videos (just kidding; power goes to my head.)

17 responses to “Strategic Logic Question

  1. This exercise is important in helping you become better business analysts. Thinking strategically will help you in your valuations.

  2. Doesn’t seem like a great return on assets, given he owns the building in NYC in an area that has the best Spanish food in the city (likely a high end area). Would advise him not to expand, based on the limited information (and limiting my answer to two sentences).

    More videos please!! 🙂

    • Dear Ben:

      You pretty much have the answer or your analysis focuses on the differentiation between owning the building AND running a restaurant. In fact, you could have a situation say where he owns a building in a very fashionable neighborhood, and he could sell or rent the building for $45,000 a month but he loses $5,000 or $10,000 a month on the restaurant.

      The key is not to focus on running a restaurant but to break apart the constituent activities–owning a building (being a landlord, owning a capital asset) and running a restaurant. If you didn’t have to pay rent, I bet nominally you could have a very profitable pizza joint on 250 Park Avenue in NYC.

      You will receive more videos. But what do I do about these other folks–cut ’em off or give ’em another shot? It is up to you, you are the winner.

  3. You are successful in the first restaurant because you are there. Are you ready to put in as much in the second restaurant? It is a lifestyle question. The alternative is to learn how to invest the free cash flow. You can’t for ever be running a restaurant.
    wy

  4. No. Highly competitive business in NY. Owns the building which reduces his overhead. New location will need additional investments and he may not be able to focus in the same way as the current restaurant.

  5. If the owner can maintain the current ROIC and if expansion is the best opportunity to find growth, then expansion it is. In addition, I agree that the owner needs to consider his lifestyle and how much effort he is willing to put forth.

  6. What’s his return on capital, what does he think were the factors of success in the current business, and will he be able to replicate the business elsewhere? If the quality of the food is dependent on him being the head chef, for example, then he may not be able to serve food of an adequate quality elsewhere.

    A little diversion on my part … in a former life, I worked as a trainee accountant. One of our clients was the proprietress of a delicatessen, who decided to open an additional shop, if memory serves. She couldn’t, of course, be in two places at once, and unfortunately she discovered that someone she hired was stealing money – pretty easy to do in a cash business. She hadn’t checked the amounts banked against the till roll. This episode greatly shook her confidence in other people.

    • Dear Mark:

      All good questions. His ROIC is fair–about 10%. The type of analysis I am trying to get people to do is hinted at in the answer to the Munsingwear case study.

      The first step in thinking strategically (there will be many posts/case studies on strategic analysis in the future) is to break apart activities within a business to see where advantage lies.

  7. I’m having trouble doing any original thinking about the question posed as I’m immediately hearing Greenwald telling me that growth in a commodity type of business doesn’t make sense as the returns from the new restaurant will only be enough to offset the cost of the additional assets required to run it.

  8. Well you can build on the Greenwald thinking. First, you already are skeptical that the restaurant business has barriers to entry so no supranormal profitability. Any new restaurant would only earn a fair return if run efficiently.

    So you would then be focused on the source of this restaurant’s profitability by separating out the activities of this particularr restaurant. The great real estate may be masking the poor returns of the restaurant.

    Practice in thinking strategically will help.

    Don’t be discouraged. If you ask 90% of all corporate management’s what their company’s source of competititve advantage is they would say………..them! or their people or their culture. Yes, important but not as structural competitive advantage.

  9. I would advise him to check going market rents for storefront space in his area, then subtract the market rent (the alternate use if he rented out the space) for the storefront from his $30k/month “earnings.” Next, compare his adjusted ROIC to the ROICs on other potential investments he could make.

    [Reminds me of SYMS]

  10. Dear Carvel:

    A+. Go to the head of the class. Yes, SYMS was called a “Death-watch” stock as investors waited for old man Syms to pass on so the long-held real estate could be monetized and the money losing retail clothing stores could be shuttered.

  11. Break apart the business and check each components returns on investment…key deciding factor I think

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