Okay, some background information. Before I started managing money, I managed restaurants—Olive Gardens for Darden Restaurants. Delighting customers while controlling costs were the critical drivers for long-term operational success.
If every restaurant unit ended each day just one click off productivity, hundreds of thousands were lost to inefficiency. However, even running a single unit at or under corporate productivity goals isn’t easy: staff has to be cut quickly when traffic slows and then management has to get them off the clock as efficiently as possible without disrupting customer experience. Having the optimal staffing levels when customer traffic can be sporadic, at best, isn’t easy.
Doubtless, having the right amount of line cooks for the order volume so cook times don’t get too long or just the right amount of wait staff for the most effective guest experience or having the right amount of host staff to get the guests seated efficiently has to be managed with an unrelenting and devoted management team night and day, hourly and minutely—throughout the entire system-wide chain. And even then, getting it right on any given day company-wide, within a click or so, is a rare occurrence. One productivity click down and million up in smoke—Poof!
Managing cost of goods sold is an equally rigorous job. Guests generally love Olive Garden salads. It was an excoriating decision on something as simple as how many olives were necessary per salad to maintain guest satisfaction while still providing the largest economic benefit.
A few extra olives per salad could add up to hundreds of thousands in lost cash flow. Once two olives per salad were decided as optimal, wait staff still had to be managed relentlessly because they are constantly making their own rules up or, worse, grazing on them in the kitchen alley while no one is looking.
Ditto the after-meal Andes Mints that are delivered with the bill. The servers invariably wanted to give more than the one per-person rule as they constantly hope for better tips. And getting them to make sure they didn’t go home with handfuls of them in their aprons out of shear habit or munching on them in the side alley or kitchen had to be monitored excessively, too. Each wasted mint collectively could represent huge out of control costs—millions. What seems trivial to many when seen in a vacuum is actually gigantic when viewed collectively.
I have barely begun to scratch the surface on how important controlling operational costs are—while still maintaining exceptionally high guest satisfaction results. What about bread stick waste? Waste in the prep area where you generally have 3-7 prep cooks pre-prepping the food all day? The dishwashers, who are notorious for trying to “milk” the clock? Or the vendors who always seem to want to stick it to you? Waste, ineffective clock management, input costs, poor inventory checks and counts, and everything else under the kitchen sink that has to be accounted for is critical for success.
The Olive Garden has a strong system to help control costs. And the system has produced generous rewards for shareholders over time. Even with excess capital decisions being squandered on futile start-up projects such as the China Grill, Smokey Bones, Bahama Breeze, and other ill-fated concepts shareholders still would have made out well over the long-term relatively and absolutely by investing in Darden (DRI). Over the last 15 years, Darden Restaurants has outperformed the broader markets and stalwarts such as Mc Donald’s and Yum! Brands.
Naturally, the restaurant business will never have the huge returns on capital a software company like Microsoft has or the search economics of a Google but it can be a very good long-term business and even a stellar investment when run well and bought at value prices.
For the business and the investor to do well long-term in the restaurant industry, either a niche has to be carved out or the said company must become a low cost producer. But once a brand has been established, it’s hard to kill it in this space—much harder than killing the vast majority of all technology companies.
Reflecting back on Darden for a moment, I often wonder how the stock would have performed if Darden simply re-invested the cash flows into better risk-adjusted alternatives than start-up ventures like China Grill or Smokey Bones, all of which destroyed shareholder value and was risky to say the least. What if Darden’s management simply re-invested the excess free cash flow systematically into, say, Berkshire Hathaway stock? Indeed, what if management not only had a good grasp on how to run the business—they did—but also knew how to allocate the cash optimally?
The capital allocation decisions at The Olive Garden so bothered me I decided to get into the investment business instead—10+ years ago now.
In any case, how many retailers pump money into their next promising concept once their core brand hits a saturation point? How many restaurants do the same? The records for success are dismal in these start-up ventures and the risk-adjusted returns, well, have stunk in aggregate. So, it’s good to know, companies that have good capital allocation records.
After all, as investors, we have re-investment needs.
