The opportunities and challenges in investing in Indian food services

Hemendra Mathur, a managing director at Small Enterprise Assistance Funds’ India Investment Advisors, highlights the three fundamentals investors into food services businesses in the country must bear in mind.

The organised food services industry in India has seen a swift evolution since the early nineties, and it’s only accelerating. The sector carries the chance to invest in disruptive businesses, but also the risk of obsolence before an investor has even exited.

The industry started to take off in the early 90s when home-grown brands like Nirula’s and Sagar Ratna started to build their presence. It picked up momentum in the late nineties with the entry of marquee international brands like McDonald’s and Domino’s. Post-2000, café chains started to enter the market. And then the sector caught the fancy of venture capital and private equity (VCPE) investors, who have made more than 50 deals in the last 10 years.

In the last three years the momentum has accelerated – with lines blurring between food retail, packaged food, food delivery and food services. Food services and delivery is taking share from food retail.

Most food services brands are going omni-channel ­– home delivery, web-ordering, tie-up with rating or ordering aggregators – to serve the end customer and improve margins. The changes driven by new-age online delivery models are forcing even conventional, offline restaurant chains to rethink their strategy.

For investors, there are many choices and chances to invest in early-stage food services companies. But the obsolence risk is only increasing – there is a chance that what investors commit to today can become obsolete by the time they plan to exit. In such situations, how should investors decide to invest or not to invest in a brand? The answer lies in looking at fundamentals:

• Focus on back-end and developing links with supply chain: kitchen, vendor development and product development is at the heart of any food services brand. It allows the brand to scale faster and saves 15 to 20 percent of sales in costs. This will continue to remain at the core of any successful food services model.

While the pure-play front-end online ordering sites are easy to replicate, it is difficult and time-consuming to develop a business model with strong links to the agricultural supply chain. Robust back-end models have more entry barriers than front-end models.

However, there are food services companies who have integrated to farm level sourcing staples, vegetables, spices, herbs and fruits from farmer, and many farm aggregators who cater exclusively to food services.

An integrated supply chain is also the key to capturing supply chain margins. Businesses with supply chain integration can have gross margins of as much as 60 percent to 70 percent.

• Unit economics and location: Managing a chain of restaurant is no different to managing a portfolio of stocks. If 30 percent of the stocks are making a loss, there is a good chance the portfolio will make a loss. Likewise, if 30 percent of restaurants are making a loss, there is a good chance the chain will make a loss.

The ability to quickly exit loss-making locations is the key to sustainability. Online ordering channels help to hedge the risk of location choices.

• Scalability: Though most brands focus on multiplying the number of locations to build scale, the brands with long-term vision focus on building the supply chain for key ingredients. McDonald’s in India spent five years building its supply chain before opening the first restaurant.

Scalability is also determined by a brand’s ability to go multi-format, omni-channel and adapt to different locations. This, in turn, is driven by the standardisation of the menu and delivery process orientation to provide consistent experience across locations and channels. Recruiting, retaining and training manpower is also part and parcel of scalable models.

However, both investors and entrepreneurs must avoid “scalability at any cost”.

The e-commerce models in India which seem solely driven by scale (in a quest for higher valuations) have spoilt margin discipline in other industries, including food services. Many entrepreneurs justify short-term losses in pursuit of scale, which investors should evaluate with caution.

In summary, the food services sector is witnessing exciting times and despite many challenges, there is unprecedented opportunity for investors interested to invest in disruptive and innovative businesses in the food supply chain, which have the potential to become billion dollar businesses.