Food & Coffee Offers New Ideas to Drive Non Fuel Income

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1 RPS Energy is part of RPS Group, a FTSE 250 company with a turnover of $700m. RPS Energy is one of the world s leading suppliers of independent commercial advisory services, project management support, and transaction support for the energy sector. Our clients include Governments, National Oil Companies, Integrated Majors, Independents, and Financial Institutions worldwide. The Downstream practice of RPS Energy has assembled a team of more than 50 sector specialists who have 20+ years extensive practical business experience across all elements of the Downstream Value Chain. Our clients tell us that this provides a uniquely differentiated consulting service. Food & Coffee Offers New Ideas to Drive Non Fuel Income Jan 2010 This paper deals with the continued evolution of coffee and food offers on retail service station sites. While coffee and food offers at retail service stations is not a new idea we examine: The options for retailers looking to introduce new Food & Coffee (F&C) offers using an established 3rd Party brand, or developing their own brand, direct or 3rd Party operation and key success factors for great new offers We identify new ways in which retailers can innovate and improve existing F&C offers to drive increased consumer preference and sales We examine how the economic downturn is affecting the F&C market, and propose changes to existing F&C offers to respond to the current market conditions FOOD & COFFEE OFFERS AT SERVICE STATIONS THE STORY SO FAR & OPTIONS The idea of oil companies adding F&C offers as part of the non fuel offer at service station sites is not new. Across Europe, the Middle East & elsewhere over the last 10 years Oil Companies have added offers with increasing sophistication, starting from simple self service coffee machine to much more complex served food offers with fresh products prepared on site. Oil Companies have introduced F&C offers to leverage the dramatic growth and increase in coffee drinking with a café culture developing in many markets as well as capturing the wider opportunity for food on the move and differentiating their whole retail site offers from competitors. While some Oil Companies have already deployed good F&C offers, others have not developed such offers or only have basic offers. At a macro level we still see a strong opportunity and rationale for Companies implementing programmes, with the increase in coffee consumption being a key driver. Over the last few years the rise in coffee consumption has been driven by coffee drinking as a social pastime linked to increased spending on food, drink and leisure. 1

2 Kg per Head RPS DOWNSTREAM RETAIL Average coffee consumption at a global level grew by 18% from 2006 to 2007 to 1.3 kg per head p.a. and we see further growth opportunity in countries with low current consumption, as shown below in Table 1. Growth of coffee consumption in the UK is a good example, with consumption per head growing by 21% from 2003 to The UK now has an estimated 11,000 coffee shops (branded and unbranded), with Oil Retailers establishing strong coffee and food offers, lead by BP who have over 200 Wild Bean Cafés, Esso (Exxon) have over 100 On the Run Café s featuring Costa coffee, and Subway have over 20 stores on service station sites. In Europe there are 9,300 branded coffee stores (including 3,800 in the UK) with a 2009 report by Allegra Strategies (a coffee market analyst) forecasting growth to 11,000 stores by Figure 1: 2007 Coffee Consumption by Country (Kg per Head per annum) Finland Norway Germany Italy Greece Spain USA Hungary UK Poland Qatar Russia Saudi World Avg Oman Turkey South Africa In developing and deploying coffee and food offers, Oil Companies need to make two strategic and operational choices. Choice 1 is whether to operate the coffee and food offer yourself or allow a 3rd Party to operate for you. The key criteria on making the right choice is to make an accurate and realistic assessment on the capability of your site staff (Manager and all Team Members) to operate a F&C offer, as operating this type of offer entails additional complexity over and above operating other non fuel site elements (e.g. a shop or convenience store). Unless you are confident that you can invest in the right people to deliver an F&C offer on a consistent basis, then you should not consider direct operation and should look at 3rd party operation. Choice 2 is to develop and use your own brand or use a well known 3rd Party brand (often under a Licence or Franchise Agreement). While using a 3rd Party brand may well generate higher sales, you have to pay an initial Franchise Fee, plus ongoing Royalty and Marketing Contribution payments to the brand owner, and may also face restrictions on where you purchase raw materials from or minimum labour levels etc. Your decision should be based on looking at the economics. 1 Source: International Coffee Organisation 2

3 A theoretical example, but based on known metrics from a North West European market is shown on Table 2 below. The challenge is developing your own brand to a point that while it may still drive lower sales than a 3rd Party brand, but it drives higher profits. In the example below, at both sales levels the own brand delivers higher profitability, but in the higher sales scenario the gap between own brand & 3rd Party brand profitability, increases. However in developing your own brand, your model has to be based on a belief that you can build recognition and brand equity without spending significant amounts on advertising, as high advertising spending can kill profitability. The approach has to be on effectively using the location strength of your service station sites and cross selling by staff members, plus low cost web and SMS marketing to build awareness. Figure 2: Indicative P&L, Own Brand and 3rd Party Brand Operation Own Brand % of Sales 3rd Party Brand % of Sales Sales $ p.a Gross Margin 70% 65% Gross Profit Labour Cost % % Utilities % % Other % % Advertising % % Franchise Fee % Royalty % Total Costs Net Profit Higher Sales Sales $ p.a Gross Margin 70% 65% Gross Profit Labour Cost % % Utilities % % Other % % Advertising % % Franchise Fee % Royalty % Total Costs Net Profit At lower sales level, own brand marginally more profitable At higher sales level, own brand noticeably more profitable than 3rd party brand KEY SUCCESS FACTORS FOR DEVELOPING NEW FOOD & COFFEE OFFERS Assuming you have chosen to develop your own brand/offer, rather than using a 3rd Party brand, we propose the following as four key success factors: Focus on coffee As detailed above, in many markets significant opportunity exists for coffee and a food and drink offer can be centred on a coffee offer/proposition. Even adding a coffee offer to an existing strong food proposition can add significant sales. Business Week magazine quoted Michael Heinritzi, McDonald's No. 1 European franchisee, with nearly 40 stores across Germany and Austria, who suggests that when a McCafe is added to an existing McDonald s fast food restaurant, store revenues jump 20% to 25% Keep it simple An F&C offer does not need to be complex to be impactful and appealing to customers. At service stations, customers are generally in a rush, so keeping menu items 3

4 limited and focusing on speed of service and consistency is key. A less complex offer means that while site staff will need training on how to operate the offer, all site staff can be trained and at less busy times staff can man the main sales till but also serve food and coffee Be Bold In the design and colour scheme for a F&C insert in a service station, focus on drawing customers attention to food/coffee part of the store, otherwise customers are often blind and miss this part of your site offer Focus on fresh Customers in most markets increasingly want products that are freshly prepared on site. This does not mean all products have to be made to order, as this can be highly labour intensive and reduce profitability, but made today, freshly baked labels on products can be powerful sales drivers HOW RETAILERS CAN INNOVATE & IMPROVE EXISTING FOOD & COFFEE OFFERS As with fuel retailing generally, innovating, updating and improving the site offer over time is important. Innovation on F&C offers and helping differentiate your offer from competitors will help drive increased returns. We offer the following four innovation ideas: Drive Thru Customers like the convenience of not getting out of their cars and fast food chains like McDonalds have successfully used drive thru over the last 20 years. We see drive thru coffee and bakery lead food offers as an opportunity on service station sites. In the USA Starbucks have 2,000 drive thru locations and one drive thru in the UK. In 2010 Starbucks plan to open their first drive thru on a service station in the UK Car Hop Linked to speed and the drive thru idea, a lower cost and complexity way to deliver F&C offers to customers in their cars is a car hop, having a runner on the forecourt who takes orders while the car is filled up with fuel, then delivers the order to the customer and takes payment. The runner communicates with staff members in the store using a radio headset Electronic Menu boards As the cost of LCD and plasma screens has decreased significantly over the last 5 years, using electronic menu boards that are much more visual than traditional printed boards and can be targeted at specific parts of the day (separate menu for breakfast and lunch) are now economically feasible Targeted marketing Linked to the development of more sophisticated CRM (Customer Relationship Management) programmes, retailers who use CRM and customer databases can use data to target high value customers to get them to trial or improve frequency of use for F&C offers. For example, fuel card customers could be sent an SMS or e mail offering them a half price coffee CHANGES YOU CAN MAKE TO EXISTING FOOD & COFFEE OFFERS IN RESPONSE TO THE ECONOMIC DOWNTURN The current economic downturn has impacted fuel demand in many markets and this has also had a consequent effect on non fuel sales. However the wider evidence looking at the F&C market as a whole across Europe, the Middle East and elsewhere is that the food & coffee is not declining, merely that the strong growth in the market is slowing. Consumers have not cut back on purchasing a cup of coffee or food item that only costs a few dollars, with this being a small treat they are not prepared to give up. Fast food and other limited service offers seem to have benefitted from consumers trading down from more expensive full service offerings. 4

5 We offer the following data as evidence of a decline in growth rates, rather than an actual decline in sales: UK coffee market Research from analyst Allegra Strategies suggests that in 2009 the coffee shop sales grew by 6.2% to 1.63 bn. vs This growth was lower than in the previous year (2008 vs. 2007) when the market grew by 15% Eastern Europe coffee market Coffeeheaven operate 90 coffee shops in Poland, Czech Republic, Latvia, Bulgaria and Hungary. For the 6 months to 30th September 2009, Coffeeheaven s like for like sales grew by 5% vs. 16% for the same period in 2008 McDonald s Results for the first 9 months of 2009 showed like for like sales growth of 6.4% for Europe, 2.2% for Middle East, Africa & Asia Pacific and 2.5% in the USA In the light of this sales slow down, retailers need to adapt their offers and respond to the changing market conditions. We propose the following as four initiatives to help grow sales: Bundling Offering a breakfast or meal deal of two or three items, one being a coffee or other drink at a special price that is cheaper than the combined individual prices of the items, can help improve value for money perception and increase average spend Loyalty Introducing a loyalty scheme, however inexpensive can help drive repeat purchase and customer satisfaction. A credit card sized paper card where you offer one free coffee for every 10th coffee purchase can be a simple way to reward customers Entry point pricing Introducing a food or drink product promotional product that is at a new lower price point then existing items, can help drive sales and improve value for money perception. The price of an existing core menu item should not be reduced, but a new product created that still delivers reasonable gross margin, for example a new sandwich or bakery product with a low cost filling, or a drink with a new smaller cup size Upselling Getting your staff focused on asking customers if they want a croissant with their coffee or want a large coffee or other drink rather than a regular one, can help increase sales. Offering your staff members a bonus scheme for the staff member who sells the highest number of large coffees in a week, is a simple way to reinforce upselling WHAT ARE OUR KEY CONCLUSIONS? We see continued opportunity for F&C offers at service stations. While using established 3rd Party brands remains an option, developing your own brand may generate higher returns For retailers with existing F&C offers there is an opportunity to innovate. For retailers introducing new F&C offers, we propose a number of key success factors While the economic downturn has slowed growth in F&C sales, the market is still growing and retailers can make changes to their offer to respond to market conditions We have experience of designing new and updating existing F&C offers and would be happy to look at how we can advise your business For further information, or to arrange an exploratory conversation with our senior specialists, please contact: Martin Alford M E martin.alford@rpsgroup.com W 5