Max _ Ermas Recommendations and Rationale

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					Max & Erma’s: Recommendations and Rationale




                Prepared by:
               Andrew Fessel
                 Matt Lease
               Ashley McCall
                Jill Schroeter




              February 29, 2004
                                  Executive Summary

After researching the restaurant industry for several weeks, our team has selected the
following as major issues we wish to bring to Max & Erma’s attention:

      Max & Erma’s should continue its franchising policies and expand into markets
       that similar competitors are already a part of, including Florida and Arizona.
       Arizona may particularly be a positive franchising investment because of its
       rating of second highest sales growth of 6.2 percent in 2002. Max & Erma’s
       should establish the franchise in these new regional markets, then purchase back
       the franchised unit developing roots as a start-up restaurant for further expansion.

      The restaurant should implement a preferred customer program that rewards the
       chain’s loyal, paying customers. A point system or entrée counting approach has
       a possible two-tier structure. The structure would be based on customer spending
       and would enable the chain to capitalize on its loyal customer foundation, an asset
       not all restaurants can boast.

      As the restaurant’s carryout sales grew 29 percent in 2003, we are recommending
       that Max & Erma’s emphasize its carryout / pick-up option by providing specific
       parking spots for customers with pick-up orders. As an overall trend, full-service
       restaurants are providing more convenient options for consumers “on-the-go.”
       Max & Erma’s should provide a take-out menu on their website and provide
       menus at the restaurant that customers can take home with them.

      Max & Erma's can expand its consumer base by catering to the trend toward
       healthy eating. Restaurants such as Ruby Tuesday and T.G.I. Friday’s have
       implemented a low-carb menu appealing to Atkins Diet followers. However, it
       may be in Max & Erma’s best interest to not only focus on one diet, but to offer a
       small selection in various diets. Expanding the customer base will ultimately
       result in increased sales.

      After composing a financial analysis of the restaurant chain, Max & Erma’s may
       want to consider using capital lease arrangements for its equipment when
       occupying new units.

We recognize that some of these suggestions may already be implemented or underway,
but we feel they are the most significant concepts in regards to the future of Max &
Erma’s.
                                      Introduction

Max & Erma’s has a unique approach in comparison to its competition in the casual
dining restaurant segment. It attempts to portray the image of “the hometown favorite”
while competing for customers against the larger, highly-advertised restaurants like
Applebee’s and Ruby Tuesday. The chain has been successful thus far, but needs to
continue to develop and entice its customer base, grow in number of units and expand its
regional boundaries, offer new carryout services to accommodate those “on-the-go,” and
provide a range of menu items that appeal to customers on various types of diets.


                           Recommendations and Rationale

The following four sections further explain the recommendations highlighted in the
executive summary.

Franchising

Max & Erma's (M&E) currently resides in at least nine states with more than 80 percent
of its restaurants owned by the company. It does not plan to expand internationally and
for any franchising rights there are necessary requirements regarding franchising fees and
qualifications for new owners.

There is a franchising fee of $40,000 for new investments and a required 4 percent
royalties and 2 percent advertising fee that must be paid to the company. Franchisees are
expected to have a cash investment of $400,000 to $500,000 and a contract with M&E
for either 10 or 20 years. An important aspect that M&E desires is to encourage
conversion, which means that executives wish to purchase back the franchise at some
time in the future. Similar competitors like Applebee’s have comparable franchising
requirements. Applebee’s requires 20-year contracts, 4 percent royalty fees, and 2.25
percent advertising fees. However, the initial franchising fee is $35,000 compared to
M&E’s fee of $40,000.

M&E currently only wishes to franchise in locations that match its current target market
of the mid-west, east coast, and the southeastern United States. To ensure success
through franchising, a new approach needs to be addressed. For instance, Applebee's
currently has restaurants within 48 states. The chain successfully conducts business in
the same states as M&E, but also in markets that we feel M&E should look into, such as
Florida and Arizona. Although there is a population disparity, racial, gender, income,
and homeowner percentages are similar between the two states. In addition, these
demographics also represent what M&E currently holds to be the target markets in many
of its current establishments (older customers who are willing to spend more and dine in).
See Appendix A for demographic statistics of Arizona and Florida.

Expanding to Arizona is especially important for two reasons. First, Arizona would
provide access to a western regional market that could be beneficial in the future.
Currently, M&E is expanding toward the east coast. As shown in Appendix A, west
coast statistics are similar. Eventually expanding to the west coast would be easier if
M&E were first established in a state like Arizona that has a lower cost of land/living and
less risk than say California. In other words, Arizona would be a great place to “test the
waters” also allowing full potential to grow toward the west coast down the road.
Second, Arizona experienced the second highest increase in restaurant sales of 6.2
percent in 2002, which could benefit M&E.

Attractive options for expanding into these markets include setting up a franchise in a
metropolitan suburban environment and then once established, purchase back the
restaurant to establish roots in the community. From there, further franchises could be
established in other cities with the same intention of company buy-back and then further
expansion beyond that. Further discussion of franchising is discussed in the financial
analysis section.

Preferred Customer Program

Max & Erma’s marketing emphasis has shied away from discounting and mass media
within the last few years in order to project a more hometown feel and promote loyal,
paying customers. The restaurant believes that although its customer count may have
declined slightly, replacing discount-paying customers with paying customers is more
beneficial. However, establishing a “preferred customer” program might be the best way
to encourage an increase in the number of “ideal” M&E customers: loyal to the
restaurant chain and willing to pay its prices.

There are two possible programs that could be implemented. First, Max & Erma’s could
allot a certain number of points per dollar amount spent with the points accumulating to
receiving free soup, appetizers, or entrees depending on the points earned. T.G.I.
Friday’s has a similar program encouraging repeat visits from all age groups. However,
if M&E felt this would not serve to increase the average check amount per visit, perhaps
it could establish a “buy 10 entrees and get one free” program. In order to give its
customers more options, the restaurant could give customers the choice to elect a free
appetizer after 5 entrees, or wait until 10 entrees are purchased to get the free meal. With
a program such as this, M&E could reward its high paying customers, making them more
likely to return again soon. (Note: These numbers are fairly arbitrary; Max & Erma’s
executives could determine a correct number using cost accounting and inside
information unavailable to college students.)

In addition, the program should provide a card similar to a credit card that could be
applied for (free of charge) and swiped when used to keep track of purchases. With this
type of computerized technology, M&E could acquire an important stream of data such
as demographics of its most frequent customers and menu items they order. If the
program went well enough, there might be an opportunity to create a two-tiered program.
For example, customers spending a certain amount consistently could be bumped up to a
more rewarding card that may require, say, only buying 9 entrees before earning one free.
Although many devoted M&E customers receive monthly e-mails (called “Ermail”)
advertising anything from the company’s history, to new menu items, to gift certificate
specials (usually around the holidays), Ermail is not the same as a preferred customer
program. Ermail is a great way to keep loyal customers up-to-date with the company’s
activities, but the preferred customer program would convey the feeling that M&E wants
to thank not just every customer, but it’s most prized customers for their support
throughout the years. It’s a way of saying, “We wouldn’t be where we are today without
you,” and (indirectly), “We need you in the future too.” A preferred customer program
would make the customer feel needed and appreciated, which goes hand-in-hand with
Max & Erma’s overall strategy.

Carryout / Pick-up Option

Another recommendation is to add parking spots specified for pick-up orders only. A
customer could call ahead, place an order, and learn the approximate time the order
would be ready. When the customer arrives at the restaurant, the hostess or other
employee can watch for the car to pull into the designated parking space and deliver the
order without having the customer get out of the car. M&E could provide a take-out
menu on its website or provide menus at the restaurant customers could take home with
them.

Higher income households are an important aspect to sales growth at casual dining
establishments. Household incomes have increased, especially due to working moms or
the dual-income family, which has created the desire for convenience as people have less
time to cook or dine in. To accommodate the growing trend, a large number of casual
dining restaurants are now offering carryout meals and services. A recent survey found
that 42 percent of adults would be interested in full-service restaurants delivering food to
their homes. The survey also found that 43 percent of consumers would be interested in a
drive-thru option at their favorite full-service restaurant. This was especially important
among younger adults and households with children. More than half (51 percent) of adult
consumers indicated they would like full-service restaurants to provide a separate area of
the restaurant for ordering and pick-up of takeout food. We are not recommending that
M&E attempt to re-open a drive-thru window, as its first attempt was unsuccessful and
the chain may be hesitant. However, the restaurant does need to pay attention to this
growing trend of quick, convenient food service which is why we recommend the parking
spot solution.

In addition, M&E should focus on marketing dinner entrees for carryout or pick-up.
Lunch-time (11 a.m. to 4 p.m.) carryout food consumption tends to lean toward fast food
such but deli, bagel, and donut shops. However, during the evening hours (after 4 p.m.),
full-service restaurants and their carryout options become more competitive. In addition,
research has also shown that casual dining restaurants focus primarily on young families
and couples over the age of 43 who have spare time and a fair amount of disposable
income. The young family is more inclined to have their food to go, while older couples
would rather sit down and eat. Why not extensively cater to both groups? M&E already
appeals to the dine-in crowd, but it should increase the availability of carryout services to
cater to its family customers.

Menu Items

Max & Erma’s should also make a few changes to its menu for two reasons. First, the
changing demographics of the country indicates that menu selection should focus more
on what the baby boomer generation would like to eat. We are not necessarily saying
that the menu does not appeal to baby boomers, but it should be re-evaluated to ensure
that it is. Second, the selection needs to appeal to the health conscious customers also.
Roughly 32 million people are on some sort of diet plan right now, and at least one in
four people have tried the low-carb diet. There is a chance of “killing two birds with one
stone” as the baby boomers are generally concerned about their weight and eating right.

Although M&E is testing out the low-carb diet options on its menu, it should not solely
focus its attention there. We feel the restaurant needs to have a selection of foods that
encompass all major diets. They not only need to include low-carb food options, but
low-fat, low-calorie, and low-sodium options as well. As a result, the chain will attract a
larger customer base, boosting revenues. Max & Erma’s currently has “No Guilt” menu
items; however, these options do not specify a health food category. For instance, are the
menu items low-calorie, low-carb, or low-fat?

Max & Erma’s competitor, Ruby Tuesday, has just rolled out a new menu focusing on
the Atkins Diet. It proudly advertises its offering of over 30 different options for those
following a low-carb diet. The problem is they are targeting a select group of people.
Why not offer menu items that target more than just one diet? T.G.I. Friday’s and
Applebee’s also both recently came out with low-carb items, so M&E should try to
anticipate what the next menu options should be.


                                    Financial Analysis

To supplement our readings, we also conducted a financial analysis of Max & Erma’s
comparing it to Applebee’s and Ruby Tuesday. These two competitors were chosen as
benchmarks because they are in the casual dining segment with M&E and have been
financially successful throughout expansion. Refer to Appendix B to see the breakdown
of financial ratios calculations, common size income statement comparisons, and a
summary of cash flows.

After our analysis, a few key points should be highlighted:

       Max & Erma’s receivables and inventory turnover are higher than its
        competitors. This may be evidence that the restaurant’s collection process is
        efficient and its distribution channel is also.
       Cost of goods sold, as a percentage of company-owned revenues, is comparable
        to and even slightly better than Applebee’s and Ruby Tuesday. Max & Erma’s
        decision to stay with one primary distributor looks to be a reasonable one.
       M&E is highly leveraged compared to its competitors. This may be because it is
        a smaller chain with fewer total assets. However, too much debt can be risky.
       Lastly, M&E’s operating and net profit margins are low compared to its
        competitors. Despite the chain’s commendable sales growth in the past few
        years, its bottom line is pinched by costs. When looking at the common size
        income statements, other operating expenses for M&E seems to be substantially
        higher. Part of the reason is the chain includes advertising costs as an “other”
        expense rather than as SG&A. Another reason deals with the equipment rental
        agreements M&E establishes when occupying a new unit. Other operating
        expenses are primarily composed of direct and occupancy costs; M&E
        occupancy costs are high because of establishing operating leases rather than
        capital leases. Under SFAS 13, business enterprises are to expense operating
        leases (rent expense); instead, M&E should arrange capital leases, recording an
        asset on the books and recording only its depreciation expense. Adopting a
        capital lease approach may lower its other operating expense to a more
        comparable level.

One final point should be mentioned regarding Max & Erma’s franchising strategy. The
company’s intention is to buy back its franchised units to ensure that the chain’s quality
of food and service remains high. However, costs of company-owned restaurant sales are
much higher than franchise restaurant sales because franchisees must bear the burden of
some costs. M&E may want to find a better balance between the number of company-
owned units and franchised units. It could boost the chain’s operating and net profit
margins to a more competitive status.


                                       Conclusion

The economy is recovering and the future for Max & Erma’s looks bright; however,
along with the future always comes change. Companies that fail to look ahead and
incorporate trends into strategies tend to struggle. Overall, we believe that M&E has
done a good job in business thus far, but some ideas mentioned should be strongly
considered. Expanding its franchise operations to include Florida and Arizona,
establishing preferred customer offerings, embracing carryout services as a means to
attract the busy customers, and developing new healthy entrees will all contribute to the
success of Max & Erma’s now and in the future.
                                      References

Applebee’s International, Inc. and Subsidiaries. 2000 SEC Filings. 10-K. S&P Market
      Insight. Located at http://www.library.ohiou.edu:2261/cgi-mi-
      auth/mihome.cgi?tree=APPB&tab=company&branch=&seed=11011011110011#
      EDGAR

Applebee’s International, Inc. and Subsidiaries. 2002 Annual Report. Located at
      http://media.corporate-ir.net/media_files/NSD/appb/reports/APPB_2002_AR.pdf

Max & Erma’s Restaurants, Inc. 2000 SEC Filings. 10-K. S&P Market Insight.
      Located at http://www.library.ohiou.edu:2261/cgi-mi-
      auth/mihome.cgi?tree=MAXE&tab=company&branch=
      &seed=11011011110011#EDGAR

Max & Erma’s Restaurants, Inc. 2002 Annual Report. Located at
      http://www.maxandermas.com/PDF/7215.pdf

Max & Erma’s Restaurants, Inc. 2003 SEC Filings. 10-K. S&P Market Insight.
      Located at http://www.library.ohiou.edu:2261/cgi-mi-
      auth/mihome.cgi?tree=MAXE&tab=company&branch=
      &seed=11011011110011#EDGAR

Ruby Tuesday, Inc. 2000 SEC Filings. 10-K. S&P Market Insight. Located at
      http://www.library.ohiou.edu:2261/cgi-mi-auth/mihome.cgi?tree=RI&tab=
      company&branch=&seed=11011011110011#EDGAR

Ruby Tuesday, Inc. 2001 Annual Report. Located at
      http://www.rubytuesday.com/company/default.htm

Ruby Tuesday, Inc. 2003 Annual Report. Located at
      http://www.rubytuesday.com/company/default.htm

http://www.franchise1.com/articles/article.asp?articleid=76

http://www.worldfranchising.com/profiles/Max&Irma.htm

http://secfilings.nasdaq.com/edgar_conv_html%2F2003%2F03%2F17%2F0000853665-
03-000154.html

				
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