Entering the Fast Food Industry

Entering the Fast Food Industry Introduction Pull open the glass door, feel the rush of cool air, walk in, get on line, study the backlit color photographs above the counter, place your order, hand over a few dollars, watch teenagers in uniforms pushing various buttons, and moments later take hold of a plastic tray full of food wrapped in colored paper and cardboard. The whole experience of buying fast food has become so routine, so thoroughly unexceptional and mundane, that it is now taken for granted, like brushing your teeth or stopping for a red light. Eric Schlosser from the book Fast Food Nation The food that people always eat or dont it was always determined by some economical and environmental forces. And the big growth of the Egyptian fast food market occurred according to some main changes in the Egyptian society. One of the main changes was the huge entering the women the workforce, which increased the request on some service which women usually do like cooking, cleaning, and child care. And now you can see the double income of the household which make an increase of the requested fast food. Socially, these fast food chains created many changes within the Egyptian behavioral patterns as well. Cleanliness and quality allowed families to feel safe and comfortable, permitting their children to go out on their own. A cheerful atmosphere and fun promotional items and gifts available at these chains attracted children and the younger generation began to frequent them more often, meeting friends and planning parties. It gave the Egyptian youth a safe acceptable place to go to. From here was born the concept of home delivery, a hugely profitable business today. Now, one can order virtually any consumer product by telephone for delivery and thousands of young people are employed in this sector. As consumers became frequent customers, the database developed into a very important asset. Promoting sales and keeping information classified was a must, not to mention boosting an already-escalating competitive environment. Entering the fast food market can be done in several ways that each one of them differs from the other. There are two main choices; first is acquiring a franchise license from an international-branded fast food chain, the second is to create a new brand that is developed locally and independently. Each one of them has their own advantages and disadvantages, and choosing an entry strategy heavily depends on several factors which will be analyzed in this paper. Before choosing an entry strategy the market has to be assessed extensively and to do so Porters Five Forces and the PEST (Political, Economical, Social Technological) analysis models represent the perfect harmony in analyzing the heavily saturated and very competitive Egyptian fast food market. Office of government commerce, (2006) Definition of alternatives Before proceeding with the market analysis we have to understand clearly what is meant by each one of the entry strategies to avoid any misunderstandings; According to (Treas, 1973) franchising can be defined simply as a business relationship between two entities; the seller (franchisor) and the license buyer (franchisee). The franchisee buys a royalty license from the franchisor to have the permission of doing business and opening fast food chains under the brand name of the franchisor. However, the franchisees are still independent and the chains are under full supervision and management by them but they have to abide to certain quality standards and regulations set by the franchisor to help them maintain and save the brand image of their trade mark. (Treas.1973) (Kaufmann Dant, 2001) On the other hand, opening an independent (locally branded) fast food chain is the total opposite of franchising. Instead of buying a franchise license from a well known established brand, the founder decides to create a new novel brand enduring all of the associated costs and taking the risk of creating a new brand image that requires time to gain the desired reputation. Some of the successful franchises in Egypt could be: McDonalds, Pizza Hut, KFC, Burger King, and Sbarro. While Successful examples of independent in Egypt could be: Cook Door, Smileys, Momen, Amo Hosny, Bon Appetite, and Prego. Porters five forces analysis Michael Porter in this analysis suggested a frame that industry influenced by five forces. These forces can determine the competitive intensity and therefore the attractiveness of a market and attractiveness means the overall industry profitability. These forces represent the micro-environment side which is more specific than the more general macro-environment one; they consist of those forces close to a market that affect its shape and stability. (Figure 1: Porters Five forces Model) (Michael E. Porter 1980: 31) Rivalry among existing competitors The first component of the five forces analysis focuses on the competitive rivalry. Competitive rivalry is one of the key areas for an industry, because in many cases it may determine the marketing strategies that will be developed and implemented. The purchasing power of the Egyptian consumers is quite strong and naturally those consumers have high expectations. That is the reason why fast food chains constantly compete for better products and more attractive promotions. For instance, McDonalds was the first fast food chain in Egypt that offers toys and games with meals to trigger childrens interest and this was hugely successful where most of the children buy McDonalds happy meal in order to get the offered toy. Rivalry can be found in many familiar forms such as advertising campaigns, price discounting, new product introduction and service improvement. The more the degree of rivalry the more it becomes an obstacle for profitability, and the degree of rivalry is determined through the intensity of the competition and on how they compete. The intensity of rivalry is influenced by the following characteristics: Large number of competitors: The huge existing numbers of food chains makes the competition more intensified where they have to compete for the same customers and resources in order to gain more market share. The market includes two main categories of chains; local branded fast-food chains which include (Momen, Smileys Grill, Cook Door and El-Shabrawy), and international branded fast-food chains such as (KFC, McDonalds, Pizza Hut, Burger King, and many more) Slow market growth: If the market growth is slow the fast-food chains will fight more for the existing market share. On the other hand, if the market growth is fast, the fast-food chains will be able to improve revenues simply because of the expanding market. Egypt is considered the largest in both Africa and the Middle East in the fast-food service industry where it represents US $7 billion and is expected to reach US $10 billion over the next five years (Schaefer 2008: 1) and due to this the fast-food market in Egypt is very fast growing. Highly perishable products: Food products is considered highly perishable where it urges the seller to sometimes lower the prices and sell the product while it is still consumable, thus it intensifies the rivalry. Low switching costs: When a consumer can freely switch and choose from one product to another there is a greater struggle to capture consumers and since most of the fast-food chains meals prices are nearly similar the threat for competitors is high where consumers can switch to another competitor at any time and this creates a pressure on the fast-food chains to create a competitive edge. Low levels of product differentiation: The low levels of product differentiation tends to increase the levels of rivalry thats why fast-food chains tends to increase their brand identification to maintain their market share since they are all serving relatively the same target customers with relatively similar products. Industry shakeout: The growing market of the fast-food industry and the potential for high profits encourages new competitors to enter the market and the existing competitors to increase their size. A point is reached where the industry becomes crowded with competitors and demand cannot support the new entrants and the resulting increased supply creating a situation of excess capacity with too many goods chasing too few buyers. Exit barriers included the issue of asset specialization which can determine how easy a fast food chain can exit the market without having difficulties in liquidating its assets. Due to the fact that most of the fast food chains require some tailor-made equipments that serve their specific needs and helps in maintaining their brand image throughout their products, the degree of asset specialization is quite high in the fast food market which subsequently creates many exit barriers. (Edward 2010) (Yacoub 2010) (Hamza 2010) When a rival acts in a way that draws out a counter-response by other competitors, the rivalry intensifies. The intensity of rivalry is commonly based on the chains aggressiveness in attempting to gain an advantage. In pursuing an advantage over its rivals, a fast-food chain can choose from several competitive moves: Changing prices: Raising or lowering prices to gain a temporary advantage, and many chains try to offer money saving combo meals that sounds more economically to the consumer. Improving product differentiation: Providing innovative and new products and improving the production process itself. For example, Pizza Hut has recently introduced interesting new types of pizzas that helps them to build a strong product differentiation. Using new channels of distribution: McDonalds was the first fast-food chain to introduce the drive-thru chains that conveniently have suited many consumers helping them to co-op with the fast paced lifestyle. Threat of substitute products or services Porter describes substitute product as it is another product that can be chosen as a substitution of the required product. The elasticity of demand could be affected by more than one variable like the price, quality, availabilityà ¢Ã¢â€š ¬Ã‚ ¦ The consumer buying decision can be changed to substitute products according to the change of the price, this change increase the demand on the substitute products. Also the consumer behavior now increased to healthy food which will affect the fast food market negatively. The threat of substitutes is increased if: The substitute product offers more convenient price or performance rather than the fast-food industry because consumers always choose the alternative that offers him greater value. For example, many consumers could choose eat-in restaurants because it can provide them with more food quality rather than the fast-food chains but eating in a restaurant can be more expensive. The switching cost is low and minimal, the threat of substitution becomes higher and the consumer has the ability to switch between alternatives easily with no extra charge and this is the case in the fast-food market Bargaining power of buyers There are several types of buyer power. The first is related to the customers price sensitivity. If each brand of the fast-food chains is similar to all the others, then the consumer will base the purchase decision mainly on price which will increase the competitive rivalry, resulting in lower prices and lower profitability. For example, some consumers would choose McDonalds rather than Burger King for being cheaper. Also the more number of substitutes is available for the buyer, the more powerful he becomes. The other type of buyer power which is not strongly relevant to our market analysis is the negotiating power where larger buyers tend to have more leverage to negotiate prices. Bargaining power of suppliers The fourth part of the five forces analysis focuses on the power of the suppliers and how is it easy for them to drive up prices. This is driven by the number of suppliers available for each key input. The uniqueness of their product or service and the cost of switching from one to another determine how powerful they are. Powerful suppliers can squeeze profitability out of an industry that is unable to pass on cost increases in its own prices. The supply power in our case is represented through the people who provide materials used for the fast-food production such as bakery, poultry, vegetables and packaging. To determine how much the suppliers are powerful we have to asses several aspects; The supplier will become less powerful if he depends heavily on a certain buyer for revenues. For example, Farm Frites-Egypt supply McDonalds for their French Fries, and McDonalds represent a major revenue resource for them where they cannot afford to lose such a strong customer, and this is the case for most of the fast-food chains in Egypt where the suppliers for the materials depend heavily on fast-food chains willing to offer convenient prices for them to become his exclusive supplier for a certain material. (Aly 2010) (Eslam 2010) Changing suppliers for fast-food chains have relatively high switching costs because choosing a supplier comes after several quality tests and approvals by the fast-food chain. Also most of the fast-food chains require exclusive materials and products to be made especially for them like for instance the packaging. (Edward 2010) The supplier will become more powerful if there are no substitutes for him, but in the fast food market in Egypt each key entry has several substitutes that a fast-food chain can choose from. As mentioned before, McDonalds depends on Farm Frites-Egypt to supply them with French Fries, but at the same time McDonalds has the option to choose another supplier with the same standards of Farm Frites such as UniFood. (Aly 2010) Barriers to entry/ Threat of entry It is not only the existing rivals that represent a threat for competitors in the fast-food industry; the possibility that new firms may enter the industry also affects competition. In theory, any competitor should be able to enter and exit a market. In reality, however, there are several aspects that can represent an obstacle for entry and these are called entry barriers. Entry barriers are unique industry characteristics that define the industry; it can reduce the rate of entry new rivals, thus maintaining a level of profits for those already in the industry. These barriers arise from several sources: Government creates barriers Present days, the procedures a fast food chain under-go to open a new outlet is very excruciating, time wasting and requires lots of paper work. This includes; safety regulations, health inspections and taxation procedures. And due to the high levels of bureaucracy in Egypt, the task is never easy. (Aly 2010) (Edward 2010) (Eslam 2010) In the past, the regulatory authority of the government in restricting competition is evident in Egypt during the era of Gamal Abdel Nasser in the sixties, most of the consumer products where locally produced by governmental companies. For example, consumer durables where locally produced by the Ideal national company. Anwar El-Sadats shift of alliance from the Soviet Union to the western world in the early seventies was followed by the Open door policy, or privatization at the expense of the public sector state monopolized large scale industries. The shift from Nassers State capitalist era to full integration into the world capitalist system went hand in hand with encouraging consumerism and franchising activities in Egypt.(Oweiss1988:73-76) b. Patent rights Ideas and knowledge that provide competitive advantages are treated as private property when patented, preventing others from using the knowledge and thus creating a barrier to entry. KFC has their own patent rights for the chicken recipe which positions them aside from other competitors as the leading fast-food chain serving chicken making it hard for competitors to compete in the same market. (Hamza 2010) c. Customer switching costs It becomes harder for new entrants to enter the market if the switching costs are high because it makes it harder for the consumer to switch their decision, and since switching costs between different brands of fast-food chains is low, then it is easy for consumers to switch their decision, thus, making it easy for new entrants to enter the market and gain market share. d. Capital requirement. Since entering the market requires huge financial capital requirement therefore the new entrants will decrease. Capital may be necessary not only for fixed facilities but also to extend customer credit, build inventories and fund start-up losses. There can be two types of start-up costs in our case; the first one is the cost of starting a locally branded fast-food chain, the other one is the cost of franchising an existing internationally branded fast-food chain which sounds easier than starting a locally branded one but can be more costly. Further details will be discussed when comparing between the two market entries alternatives. PEST Analysis. While starting the franchising or broadly speaking starting an international business the new market that the company wants to start business in should be analyzed to make sure that the company operations would work effectively in this market. One of the important tools that companies uses in the analysis process is the PEST analysis which analyze the market considering four factors Political, Economical, Social and Technological factors. In the coming words the four factors will be discussed. Office of government commerce, (2006) (Figure 2: PEST Analysis Model) The Times100 (2008) PEST Analysis of Egypt. 3.1. Political factors Examining the political factors is a very important task any company should do before entering a new market while focusing on the Egyptian case we can find that Egypt is politically stable compared to many countries, however sometimes companies faces some political issues there are many incidents that we can find people trying boycotting specific company because of the home country of the brand as for example USA, In many times there are people boycotting American restaurants therefore we can find many companies as for example McDonalds building on the local identity of the brand by producing a product locally as for example McArabia, McFalafel, etc and that helps in building the feeling that it is a local brand. Waguih (2002) 3.2. Economical factors As mentioned previously the change in the economy in the period of Sadat to his open door policy and globalization helps franchisors to work in Egypt because it is a healthy economy. While starting the business franchisors were used to import every ingredient, but after several years of success, they began in building food factories licensed by the international brands. Consequently, factories became so efficient in the production of quality goods that after fulfilling the local demand, they began exporting their products to countries throughout the Middle East and Europe. Aboul Fath, (2008) In the past few years there were a growth in the Egyptian economy the figure 3 below shows the increase in the GDP per capita which shows that economically the market is attractive for investments. Ministry of Finance Macro Fiscal Policy Unit (2008) (Figure 3: Annual Percent Change %) Ministry of Finance Macro Fiscal Policy Unit (2008) The Egyptian government has identified foreign investments as a critical component to sustained economic growth. As a result, investors are given special exemptions and incentives. However, several barriers to investment remain including a high level of bureaucracy, complex tax systems and customs procedures. To overcome these obstacles, the Egyptian government is currently directing its effort to increase privatization and fiscal transparency, and to improve tax regulations thus encouraging foreign investments and easing the path for franchising. Aboul Fath, (2008) 3.3. Social factors Demographics The group of consumers in Egypt consist of low income families, middle and high income this may secure the success in Egyptian fast food market. In addition to that there is about 50% of Egyptian population young consumer which presented in figure 4. That may make an opportunity for the fast food chains as their young group becomes more targets to the American and European chains. There is also the percentage of the working age where they representing the purchasing power are nearly 62% showed in figure 4 below. The middle aged is seeking fast food as a solution for a ready meal. Awad, Zohry (2005) Shaefer(2008) (figure.4: Egyptian Population by Broad Age groups 1950-2010) Awad and Zohry (2005) Fast food expenditure and consumption patterns: In a study conducted by Fabiosa and Soliman (2008) they focused on explaining the impact of income changes on the expenditure behavior for the households, . Another study by Fabiosa (2008) shows the household food-away-from-home (FAFH) expenditure pattern in Egypt. When reviewing the life style of Egyptians, we can find that Egyptians eats three main meals, traditional Egyptians meals is made of rice or pasta and vegetables. Meat is also included depending on whether they can afford its cost or not. However in the past decade there were rapid increases in the interest of the Egyptians in the fast food especially in the American and European food. However, high class families usually are aware about healthy food and may choose products with lower fat and cholesterol. Fabiosa and Soliman, (2008), Fabiosa (2008) Average income families usually can afford to eat once a month outside, although dining outside of home is increasing in popularity among many consumers. More well-off households and single people may eat out more than once a week. The young consumer segment, especially wealthier segment, typically eats out more than it cooks at home and the consumption can reach as much as four or five times a week. Fabiosa, (2008) 3.4. Technological factors The several advancements in technology have allowed the food production to grow massively and at much lower costs than it used to be. Now, there are several ways a person can order his food; through telephone, internet, and drive-through fast-food chains. All of these ways are of course available beside the traditional way of ordering fast-food which is take-away. Due to technological advancements, buying fast-food is one of the easiest tasks a person can do nowadays. Technological advancement also reached the food itself, now with the increased health awareness, fast-food chains try to focus on producing healthy food and reducing all the harmful ingredients. For instance, KFC announces that they are using Trans-Fat free ingredients which raised many health concerns among consumers. Also technology offers wide array of flavors that can be added to make food more appealing to consumers. A.Hamza, (Branch Manager Hardees Restaurants. Personal Interview. 1st of Feb, 2010). 4. The Egyptian fast food sector Entering the fast food market in Egypt can be successfully done in two main ways according to the successful stories in Egypt which will be explain later; first is acquiring a franchise license from an international-branded fast food chain, The second is to create a new brand that is developed locally and independently. Opening an independent (locally branded) fast food chain is the total opposite of franchising. Instead of buying a franchise license from a well known established brand, the founder decides to create a new brand enduring all of the associated costs and taking the risk of creating a new brand image that requires time to gain the desired reputation. Aboul Fath ,(2008) 5. Franchising as an international business tool Internationalization became one important way of doing business allover the world.1980s shows the increasing in distribution number of international retailers. The retailers were acquired and forced to move and enter international markets as the domestic market gave them a limited option to distribute their products or services. By this increasing numbers of distributing in international markets which continued in 1990s the retailers considered developing themselves to enter new markets outside, Quinn Alexander, (2002). To enter a new market there are three main ways which are first is independent as to invest in the new market and work directly from there. On the other hand there is two ways which are distributorship and formal relationship and these two ways are to work throw another party which could be in many ways, figure 1 briefly explain this ways. Entry modes Independent Distributorship Formal relationship Joint venture Acquisition Franchising Licensing (Figure 5: Modes of entry) Distributorship theory which is having a relation with the supplier, the distributor buys in bulk quantities and sell in smaller quantities, this independent distributor can work with many suppliers and he may not receive training or support from the supplier and the relation simply is to buy the product from the supplier no more. Formal relationship: Elaborating more on the facts showed in the chart, there are other options in this case is to join another party as acquisitions, joint venture, licensing and franchising. 5.1. Franchising Concept Many people think that fast food restaurants like KFC, Pizza Hut, MacDonalds or Burger King are the only examples of franchising but already there are many types of franchising and as Mr. Sidney J. Feltenstein the chairman of international franchising association says one out of every three dollars spent by Americans for goods and services is spent in a franchised business. Homes we buy can be throw franchised business, cars we buy clean or cared also can be through franchised business. We can travel from country to another through franchised business transportation firms so there are many types of franchising. (Beshel, 2000). Beshel, (2000) defined franchising as an agreement between two parties or two independent persons which give that: one from this two parties (franchisee) get the right to trade or to work by the trade mark of the second party (franchisor) Franchisee gets the right to use the operating system of franchisor and his obligation to pay fees to the franchisor. Franchisors obligation to provide rights to support franchisee. So franchise is a continuing relation between the franchisor and the franchisee. This relation depends on the franchisors experience, history, image and success. Also franchisor technique in doing business is important point to be consider when use franchising. The agreement of franchise can be made using several arrangements. It can be by fixed fees, percentage of sum of sales or the franchisee purchasing the product from the franchisor. Rothenberg, (1976). Independent vs. Franchised Comparing between the two routes for analyzing the effectiveness of franchising on food market in Egypt, some points considered to show that. To gather such in-depth information, interviews were conducted with several fast food chains managers and supervisors (franchised and local) to help us compare and choose the most appealing strategy for market entry. 6.1. Start-up Capital To acquire a franchise license is a very difficult task, the reason is that the franchisor expects from his franchisee to be withholding a respectable amount of monetary resources that can enable the franchisee to be up to the franchisors expectations and standards. For instance, the franchisee can be subject to some strict conditions set by the franchisor asking him to open a minimum number of chains with certain quality standards or else the franchise contract will be voided. Kaufmann Dant, (2001) (Calhoun 1975) A.Aly. (CEO of Target Franchises. Personal Interview. 11th of Feb, 2010) On the other hand, starting up an independent local fast food chain can be much easier and much less in terms of cash resources required. You can start small and then expand and grow gradually without having the limitations and strict conditions of a franchise contract that can be in terms of: Huge initial franchise fees Previous experience Quality standards Size vs. time frame available for growth Thus, keeping up with the franchisors conditions and standards require huge capital investments at the beginning which can be a drawback for choosing the franchise route as an entry strategy for the fast food market. But in some cases, financing a franchise can be easier because are sometimes more likely to offer loans to buy a franchise with a good reputation. O.Eslam, (General Manager of Target Franchises. Personal Interview. 11th of Feb, 2010).H.Anis( Founder of Harris Cafà ©. Personal Interview. 28th of Feb,2010). 6.2. Established Name A franchise opportunity provides its franchisee a well established and internationally recognized brand name and image that can acquire customers. In other words, buying a franchise can be like buying a business with built-in customers. Franchising a brand also doesnt carry the same risk as building a new one because when considering the option of entering the fast food market with an independent brand chains, founder will be struggling at first to achieve a good reputation and strong brand image that can earn the trust of consumers without having any doubts related to health or quality issues because one of the most difficult things to do when starting a business is to develop a recognizable presence with customers. This usually only happens over time and franchises eliminate this obstacle which saves both money and time. Also the franchisees will capture the benefits of the parent companys national marketing campaigns and advertising. A.Aly. (CEO of Target Franchises. Personal Interview. 11th of Feb, 2010) S.Edward, (CEO of Future Franchises. Personal Interview. 13th of Feb., 2010). O.Eslam, (General Manager of Target Franchises. Personal Interview. 11th of Feb., 2010). M.Yacoub,.( Branch Manager of Cook Door. Personal Interview. 25th of Feb., 2010). (Peterson Dant, 1990) 6.3 Access to Technology and Training When buying a franchise, the franchisor gives you support usually including training and orientation to help setting up the business and they provide you with manuals telling you how to run the business and ongoing advice. Also, most of the times the franchisor provide you with all the equipment, supplies and materials needed to conduct the business so you dont have to worry about acquiring assets that include state of the art machines and equipments like you do when opening an independent new chain. (Peterson Dant, 1990) M.Telleb,. (Branch Manager Starbucks Cafe. Personal Interview. 28th of feb, 2010). 6.4 Operating cost The franchisee will be able to acquire all necessary supplies at much lower costs because the prices are negotiated by the company with the suppliers in behalf of all the franchise units. Because of the size and regular occurrence of orders, the franchisor is able to get huge discounts on supplies. This gives an advantage compared to the route of entering the market with a new local independent brand. M.Yacoub,.( Branch Manager of Coo