Hungry kyun?

What explains private equity investors’ growing appetite for the food service industry?

It took KN Vasudev Adiga nearly two decades to open 12 Adiga restaurants in Bengaluru. Now, in just over five months, he expects to cross 20. His restaurants, known for their South Indian fare and fast food items such as chowmein, pizzas and burgers, attracted a reported Rs.80 crore investment from Mumbai-based private equity (PE) firm New Silk Route (NSR) in April this year. And the chain has been in overdrive ever since. 

Riyaz Amlani can relate to that. His Impresario Entertainment and Hospitality (IEH) received Rs.48 crore from Beacon India Private Equity and Mirah Hospitality in August 2011. The company is using that fund infusion to double its presence by 2014, opening 22 new Mocha outlets and 11 Smoke House Delis across India.

Adiga and Impresario aren’t the only restaurant chains in expansion mode. In the past few years, especially since 2010, the Indian food service industry has been sizzling. Cafés, quick service restaurants (QSR), casual and fine dining restaurants, pubs, bars… everybody is looking to grow rapidly and several more are queueing up for a chance to serve Indian consumers. And PE investors are just as stirred up. PE funds poured $260 million into the food service segment in 2011 and had invested $60 million in five deals until October 2012, according to research firm Venture Intelligence (see: Hot deals).

They have invested in ventures as varied as Cuisine Asia (Verlinvest took a 20% stake in the holding company of Everstone’s restaurant business, which includes Blue Foods and JS Hospitality), North-based fast food chain Nirula’s (Navis Asia, which exited in July, selling to A2Z), Devyani International (ICICI Venture put in $31 million in the KFC, Pizza Hut and Costa Coffee business in India) and South Indian food chain Sagar Ratna (where India Equity Partners put in $30 million). “There are many people willing to finance you,” agrees Rahul Akerkar, MD, deGustibus Hospitality, which owns Indigo restaurant. “When we started about a decade ago, it was very difficult to get banks to even give working capital loans since they did not understand the business.”

But the foods business is still a difficult one, especially in India. Restaurants open and down shutters with dismaying regularity, and even deep pockets and an international pedigree is no guarantee of success. What, then, gives PE players the confidence to invest in this sector and which restaurant chains are getting it right?

Food for thought

Take a peek at the numbers and the increased interest in the eating-out business is easily explained. According to a report by Technopak Advisors, the Indian food service market is currently worth $13.5 billion, growing at 7%. Of this, the organised sector accounts for just $1.9 billion (14%), but is growing much faster, at 16%. By 2017, the market size of organised players is expected to double to $3.9 billion.

Currently, QSRs (such as KFC, McDonald’s and Baskin Robbins, etc.) account for the biggest chunk of the organised market, that is, $850 million, followed by casual dining restaurants (Pizza Hut, Mainland China, etc.), which are worth $430 million. This bias will continue even in 2017, predicts Technopak, by when both segments will have grown substantially, to $2.25 billion and $775 million, respectively.

It is this anticipated growth in the organised market, that is fuelling interest. “In developed markets, the share of organised F&B is far greater than the unorganised sector. In India, it is reverse. So, the scope is huge,” says Domino’s VP (marketing) Harneet Singh Rajpal. Moreover, he adds, Indian consumers are moving towards organised F&B because it offers better value for money -— “The quality is assured and the ambience and service is better,” Rajpal points out.

PE players agree that food habits are changing. “Apart from rising disposable income, nuclear families and more working women are also contributing to this transformation,” says Shantanu Nalavadi, partner, NSR. The time and convenience factor aside, eating out also has entertainment value in India. “Even at malls, people may only window shop, but they almost always eat at the food court,” Nalavadi points out. “Indians like to eat out and that is why we are very keen on the sector.”

He isn’t alone. Most PE firms admit to having high expectations. “We believe that restaurants are a high growth area when backed by cuisine innovation and strong execution,” says Gopal Srinivasan, CMD, TVS Capital, which has invested in celebrity chef Sanjeev Kapoor’s company, Indian Cookery, as well as Om Pizza, which runs the Papa John’s franchise in India. The core idea is to help the brands scale up aggressively. “We have been associated with Impresario from the time they had only a dozen outlets,” says Deepak Shahdadpuri, MD, Beacon India. “We’re glad to participate in their second round of funding as well, given their tremendous growth.”

But can the Indian market deliver the aggressive growth and profits that PE firms are lusting for? Remember, for every McDonald’s, there’s a Wimpy languishing away and for every Pizza Hut, there’s a Pizza Express that exited India. If the going is as exciting as it is made out to be, why are some players losing their appetite?

Past imperfect 

There are a few common themes running through failures in the Indian foods business. In a nutshell, they are: wrong pricing, inadequate supply chain, lack of standard operating procedures (SOPs) to ensure consistent quality and a dearth of trained staff. Consider American ice cream brand Baskin Robbins, which entered India in 1993. By 1997, it was closing many of its 50-odd outlets, having gotten its strategy wrong on multiple counts: it priced its offerings at Rs.40 when the going rate for an ice cream was about Rs.8. And unlike many rivals, it didn’t add vegetable fat to its products, sticking with more expensive milk.

“So, we couldn’t price products as cheap as rivals,” recalls Subroto Mukherjee, who served as the COO of Baskin Robbins till 2011 and is currently the CEO of his own F&B consulting outfit, Carnevale Hospitality. Meanwhile, lack of dedicated vendors and a cold chain was impacting cost as well as quality and taste. “How were we to ensure that the ice cream tasted the same in Gangtok and Gurgaon?” asks Mukherjee. In 2000, the brand centralised its ice cream production and established a stable franchisee system. Tying up with local vendors for cold chain facilities helped reduce wastage and improve production efficiencies. By 2007, Baskin Robbins had opened 100 outlets and currently has over 500 outlets across India. 

 Then there’s Yo! China. Delhi-based Mood’s Hospitality received Rs.27 crore from Matrix India in November 2006 and planned to use that to grow the Chinese fast food chain from its 20-odd outlets to over 200. Four years later, though, Ashish Kapur, CEO, was busy closing unprofitable outlets. “We started opening restaurants all over India but soon found that the cost of serving another restaurant in Delhi from Gurgaon was completely different from servicing one in, say, Assam,” he says. Now, Kapur is following a cluster approach, focusing on one geography at a time to service and manage the outlets better. He has also set up a central commissary in Gurgaon that makes the basic sauces for all restaurants, ensuring economies of scale as well as standard taste. The plan is to hit the 100-restaurant mark by 2015, up from about 50 currently.

Certainly, the gestation period isn’t as short as restaurateurs and investors would like. For instance, Kaati Zone owner Kiran Nadkarni could scale up and turn profitable only this year, despite an investment from Accel Partners in 2007. “Understanding customers, getting the food and pricing right takes time,” he says. There’s also the location conundrum: “A place where people can see you, visit repeatedly and can try your food easily is worth its weight in gold,” says Mad Over Donuts (MOD) COO Tarak Bhattacharya. Trouble is, it does cost about that much to get such a place. The rule of thumb is that rental costs shouldn’t account for more than 20% of sales; in India, it’s usually 25%. Akerkar is trying to move to a sharing model where the rent is tied to the revenue generated. This way, the landlord shoulders some risk.  

Other headaches abound — the lack of a proper supply chain and high taxes, for instance. Add to this the slow pace of getting licences, multiple-level clearances and a perennial shortage of trained staff. With attrition levels as high as 25%, opening and running a restaurant is an exercise in endurance. “You incur training costs again and again,” points out Impresario’s Amlani. 

Not surprisingly, companies that have got the mix right are much sought after. Aditya Birla Capital Advisors CEO Bharat Banka points out how his fund looked at about 20 companies before zeroing in on AD Singh’s Olive restaurants in October 2012. A good contender for investment, he says, is a brand with a proven track record of profits, and one that can be easily scaled up. “Olive is one of very few brands in this sector that has stood the test of time,” he adds. With so many hurdles, how are some brands getting it right?

Winning formula

The recipe for success calls for two main ingredients — standardisation and centralisation. “The more chef-centric your food is, the greater the chances of not being able to replicate it perfectly,” says Akerkar. Indeed, that’s the reason fine dining restaurants such as Indigo, Wasabi and Hakkasan aren’t able to expand rapidly — even if the restaurants could tap in to an endless source of high-calibre chefs, different styles of cooking may make the same food taste different. “A McDonald’s may not make the best burgers in the world, but it does have the best processes. That is what has made the brand so successful worldwide,” concurs Carnevale’s Mukherjee. 

Centralisation not only helps in ensuring standard flavours but also helps companies negotiate better prices and manage inventory to avoid wastage. Like Yo! China for its sauces, Domino’s too has central kitchens in Delhi, Mumbai, Bengaluru and Chandigarh, where pizza dough is made in bulk and shipped to the outlets. “There are extensive SOPs on how much cheese to add, how many minutes in the oven, the quantity and type of vegetables, etc.,” says Singh. Add-on products such as dips and starters, too, are prepared as much in advance as possible. 

MOD follows a similar hub-and-spoke execution model. Ingredients are imported but there’s a mother kitchen that supplies donuts to stores in the vicinity. The other stores, then, can be much smaller spaces, saving on rentals. Adiga, too, is exploring that idea. “We are trying to make the idli-dosa batter centrally. Then we can take a place with a smaller kitchen and increase the seating,” he says.

Increasingly, investors are looking at chains that offer foods that lend themselves to SOPs and centralisation — among Indian cuisine, that usually means South Indian, Punjabi and Indian-Chinese. “The cuisine needs to be scalable, else there is no point in having a chain,” agrees NSR’s Nalavadi, offering Barbeque Nation as a perfect example. “You get more or less similar food at a Barbeque Nation outlet. This is because the kebabs are marinated at a central kitchen, even half-grilled, to be finished at the outlet. For an Indian restaurant, if you can make basic gravies and dal makhani at a central location, you are sorted,” he says. 

 It also pays to do your research before you expand. MOD spent over 18 months studying the market before it entered India in 2008. “We deliberately went slow to understand what works,” explains Bhattacharya. “For instance, we discovered that people in India want savoury as well as sweet donuts and, unlike anywhere else in the world, Indians eat donuts warm.” Using those insights to tweak MOD’s product offerings has helped tremendously — 90% of the clientele comprises repeat customers. 

Knowing the market also helps in deciding what not to do. Adiga’s, for instance, is concentrating on growing in Bengaluru, rather than creating a pan-India footprint. “Finding vendors for ingredients is a challenge, as will adapting dishes to local tastes,” explains Adiga. Impresario’s Amlani agrees that it may not pay for fine dining restaurants to venture out of the main metros just yet. “We are ingredients-driven, unlike QSRs.” he says. 

As with most things in India, price is an issue when it comes to eating out as well. And it’s a double-edged sword. Adiga’s, for instance, is trying to expand into the casual dining format, which will fetch higher returns than the QSRs. “The trick is that at some Adiga outlets that have two levels, the lower floor is the QSR and has food at cheaper prices, whereas the upper floor does casual dining where one can sit and enjoy food at slightly higher prices,” says Nalavadi. Lower pricing can sometimes send the wrong signals. Yo! China’s Kapur says one reason some outlets were unprofitable was because the proposition of cheap food made customers doubt the quality. “The message of best food at cheap prices was lost but the ‘cheap’ tag stuck,” he rues. Now, he plans to open premium outlets where prices will be 20% higher, but agrees it will be a long haul before customers perceive the brand differently. 

Clearly, the hurdles that felled key players still exist and have to be overcome — ensuring quality and managing costs, while establishing the brand. But if the challenges are persistent, so are the F&B players. After all, at stake is a multi-crore opportunity.