Fast Food Chain

Type: Acquisition, Mckinsey&Co. interview type

Problem at hand:

Our client is Great Burger (GB), a fast food chain that competes head–to-head with McDonald’s, Wendy’s, Burger
King, KFC, etc. GB is the fourth largest fast food chain worldwide, measured by the number of stores in operation. As most of its competitors do, GB offers food and “combos” for the three largest meal occasions: breakfast, lunch and dinner.
Even though GB owns some of its stores, it operates under the franchising business model with 85% of its stores
owned by franchisees (individuals own & manage stores, pay franchise fee to GB, but major business decisions e.g.,
menu, look of store controlled by GB).
As part of its growth strategy GB has analyzed some potential acquisition targets including Heavenly Donuts (HD), a growing doughnut producer with both a US and international store presence. HD operates under the franchising
business model too, though a little bit differently than GB. While GB franchises restaurants, HD franchises areas or regions in which the franchisee is required to open a certain number of stores.

GB’s CEO has hired McKinsey to advise him on whether they should acquire HD or not.

Approach and Framework:

Acquire or not?

So, moving accordingly we shall look into the following in order to determine whether GB should acquire HD:

We would want to find out what the value of Heavenly Donuts would be to Great Burger.
We would have to look at the strategic fit of the companies. Do they complement each other? Can they achieve further benefits (or synergies) from combining their operations?
The cultural similarities/differences, to see if the management/employees of the companies would fit in well together
We need to have a sense of how well positioned GB is to execute a merger with another company. Have they done this before, for example.

Digging deeper we should look into the following:

Growth in market for doughnuts
HD’s past and projected future sales growth (break down into growth in number of stores, and growth in same
store sales)
Competition – are there any other major national chains that are doing better than HD in terms of growth/profit. What does this imply for future growth?
Profitability/profit margin
Investment required to fund growth (capital investment to open new stores, working capital)

So, now we shall look into the possible synergies that could be achieved if our client acquires HD. A synergy is an area where additional benefits can be captured over and above the sum of the two companies (such as cost savings or additional revenue).

- For this, we need further data regarding the no. of stores, their location, Financial of both HD and GB.

Additional data from the client

Based on the above data there appear to be opportunities in cost savings and in revenue gains.

In cost savings:

There may be an opportunity to save on General & Administrative Expenses through combining management locations/functions
There may be decreased Cost of Sales (per unit) because the companies are purchasing greater volumes together
GB appear to manage their property and equipment costs better, which means that they may be able to transfer
this skill to HD.

In revenues:

Additional sales can be achieved through selling Donuts in GB stores
Also GB have a greater global presence which HD could leverage in order to grow outside the US
Since GB has greater Sales per Store, they may have better skills in finding good locations for stores, and could transfer this skill to HD
Since GB is bigger, it probably has more investment capital available to help HD grow at a more rapid rate.

Lets say the team thinks that, with synergies, it should be possible to double HD’s US market share in the next 5 years, and that GB’s access to capital will allow it to expand number HD of stores by 2.5 times. Now we need to find out what sales per store will HD require in 5 years in order for GB to achieve these goals?

For the calculations assume:

Doughnut consumption per head in the US is $10/year today, and is projected to grow to $20/year in 5 years
For ease of calculation, assume US population is 300M
Use any data from the earlier table that you need

Solution:

Today’s market share is $700M/$3B = ~25%.(This is available from the earlier table, and you are encouraged to make sensible, round estimates in a calculation.)
Expected US market in 5 years = $20 *300M = $6B
If HD double today’s market share, the will have a market share of 50%, so their sales will be 50% x $6B = $3B
They are also expect to have 2,500 stores (= 2.5 x 1,000)
So sales per store = $3B / 2,500 = $1.2M

A very good observation to make is that this seems like a realistic growth target, because we are requiring stores sales to less than double, while we already know that per head consumption of donuts is likely to double.

Now, we have assess how selling Doughnuts in GB stores impact the overall profitability. To do this we would try to work out the incremental impact this move would have on profits. So we would:

Calculate the incremental revenues we would get from selling donuts in GB stores (how many, at what price, etc.)
Calculate the additional incremental costs that would be incurred from doing so (for example, additional staff, additional training, additional marketing, additional distribution and purchasing costs)
I would also look at the additional store investment we would have to make (for example, extra space, new equipment, etc.).

We should also investigate if the additional donut sales would mean lower sales of traditional GB products. For example, breakfast products might be affected as many people have donuts for breakfast. This is known as “cannibalization”.

Additional question from the Client:

What would be the incremental profit per store if we think we are going to sell 50,000 doughnuts per store at a price of $2 per doughnut at a 60% margin with a cannibalization rate of 10% of GB’s sales? Note that the cannibalization rate is the percentage of GB products which we think will not be sold because they have been replaced by donut sales. Here is some additional information which will help you:

Current units of GB sold per store - 300,000
Sales price per unit - $3 per unit
Margin - 50%

Solution:

- Donut sales will bring in an additional $60,000 in profit ($2 price x 50,000 x 60% margin)

- However, we will lose $45,000 in the original profit from GB sales (10% cannibalization rate x 300,000 products x $3 price x 50% margin).

There will be $15,000 incremental profit per store

HD will require a sales per store of $1.2M

So,

Therefore,

Now, to summarize our perspective to the CEO of Great Burgers(GB) on whether GB should acquire HD.

Early findings lead us to believe acquiring HD would create significant value for GB, and that GB should acquire HD
US Growth targets seem achievable given the expected growth in Donut consumption in the US
There are other opportunities to capture growth from international expansion of HD
We also believe there are other potential revenue and cost synergies that the team still needs to quantify.
We believe HD can add $15k in additional profit per GB store simply by selling donuts in GB stores. This represents a ~25% increase in store profit from this move alone
We will also provide you with recommendations on the price you should pay for HD, as well as any things you need to think about when considering integrating the two companies.