Wendy’s Chili Revisited

Introduction The main objective of this report is to determine the viability of retaining chili as an item on Wendys menu in terms of its costing and profitability. Our detailed analysis and discussion are found under the headings, Dollars and Sense (page 8 ) and The Case for Chili (page 12 ). We have also included discussions on Wendys attributes, The Wendys Edge( page 4), why Wendys had to broaden its menu Menu Unlimited, (page 6 ), the unique success of Wendys drive thru, Driving Ahead, (page 7), a look at how Wendys could have better managed the difficult 80s, What Could Have Been,(page 13) and a glimpse into the future of Wendys, Looking Ahead,( page 14).

The Wendys Edge Great chefs are not made they are born. David Thomas, the founder of Wendys International Inc., is a living example. Wendys was born out of his quest for the perfect hamburger. Despite fierce competition and a market rapidly approaching saturation, Wendys not only managed to stay abreast but also thrived. Instrumental to their success was the implementation of the philosophy which Dave Thomas liked to refer to as the Wendys Way. This was founded on the belief that the combination of product differentiation, market segmentation, quality food, quick service and reasonable prices would produce a successful company.

Wendys began with four core offerings – hamburgers, chili, french fries and Wendys Frosty Dairy Dessert. This limited menu enabled Wendys to concentrate their efforts on providing superior quality food items at competitive prices. Unlike their competitors who churned out assembly line hamburgers, Wendys was able to offer hamburgers customized to suit individual consumers tastes. Servicing orders to suit customer preferences can be a time consuming process but Wendys was able to anticipate demand and have a sufficient supply of hamburgers already cooking when the customer arrived at the restaurant and hence was able to deliver hot n juicy old-fashioned hamburgers in fast-food time. The tasty old-fashioned hamburger customized to individual preferences struck a chord with the consumer and enabled them to target adults and young adults with a higher disposable income as opposed to other fast-food chains that traditionally focused on a younger clientele.

Another distinguishing feature of Wendys approach was to locate outlets in high traffic urban and suburban areas. These superior locations heightened visibility and ensured a steady flow of customers to the outlets. The restaurants themselves were built on large plots of land with ample parking space to facilitate customer accessibility. Common interiors and exteriors across all the restaurants ensured a degree of standardization, a feature that led to increased brand equity.

Wendys policy of franchising aimed to mitigate unnecessary competition. Franchises were allotted on a geographical basis, as opposed to a restaurant specific basis, and did not exist in proximity to the company owned restaurants. The direct result of this policy was that the company and franchisee outlets did not erode each others revenue streams.

Wendys had a regulated system in place by which they offered technical assistance and consultancy to franchisees. This enabled the franchisee outlets to overcome any teething problems they might have otherwise experienced and instilled in them the philosophy underlying the Wendys Way. As a commitment to supporting franchise owners, the Wendys Management Institute was formed in December 1972 to develop management skills in restaurant managers, supervisors and franchise owners. Such technical assistance and consultancy also ensured a degree of standardization and uniformity across all the outlets, whether it was in the form of service provided or restaurant layout and design.

Menu Unlimited Despite its advantages, the limited menu meant that customers were restricted to eating hamburgers and french fries, when the fast food industry was gradually encompassing a larger variety of products. Management at Wendys realized the importance of extending consumer choice and decided to abandon the limited menu concept by introducing the salad bar in the late 1970s and baked potatoes in October 1983, making it the first fast food chain to do so on a nationwide basis. This was done primarily in response to increased competition from direct and non-direct sources, as well as to adapt to changing customer requirements and habits. By the mid 1980s, fast food had grown to encompass a much wider spectrum of items ranging from salads to ethnic foods. In addition, customers were gradually becoming more health conscious, and the limited menu of Wendys was typically high in cholesterol content. It was necessary for Wendys to introduce other items to their menu, in keeping with changing consumer tastes, and in an effort to garner a larger share of the quick service industry.

Driving Ahead In November 1970, Wendys pioneered the concept of a drive-thru window by opening its second restaurant in Columbus featuring a pick-up window with a separate grill a unique feature in the quick service restaurant industry. Competition was quick to catch onto the trend, with McDonalds and Burger King introducing a similar feature at some of their outlets soon after. However, amongst the fast food chains, Wendys has been the only one to successfully implement such an offering. Instrumental to their success has been the location and layout of their restaurants. All the outlets were constructed as stand alone restaurants, with ample space to accommodate such a facility. As a result, the drive-thru facility was incorporated across all Wendys outlets company as well as franchise owned. Competitors did not locate entirely at stand-alone restaurants and therefore the drive-thru facility was not a ubiquitous feature. The limited menu offering of Wendys served to expedite the speed at which the customer placed an order at the drive thru counter and was served. In addition, as each drive thru window had a separate grill, the process was efficient and vehicle queues were kept short.

Dollars and Sense The Cost of Chili (i) Out-of-pocket cost basis Ingredients for a Batch Quantity Rate Amount Tomato (Can) 1.00 $1.75 $1.750 Tomato Juice (Can) 5.00 $0.70 $3.500 Seasoning (Pkt) 1.00 $0.50 $0.500 Red Beans (Can) 2.00 $1.35 $2.700 Ground Beef (Lbs) 12.00 $1.25 $15.000 Direct Labor (Hrs) 0.50 $5.75 $2.875 $26.325 Servings Produced per batch 57.00 Avg. Cost $0.462 Serving Bowl $0.035 Lid $0.025 Spoon $0.010 Cost of a Bowl of Chili $0.532 On an out-of-pocket basis, a bowl of chili costs $0.532 (see above). There are, however, a few factors that must be noted before accepting this cost.

Firstly, if at all times the chili was prepared using the overcooked ground beef patties, the cost of beef would not have been included in this calculation as it would essentially be the waste of the previous process and thus a sunk cost. However, patties have to be specifically grilled for the chili ten percent of the time and this constitutes a direct cost that should be added to the cost of chili.

Secondly, direct labor expense is based upon the 20 minutes that is required for preparing the ingredients for chili and the 10 minutes that is required when patties need to be separately grilled. The labor rate charged is that of the Assistant Manager because we are not sure of the person (Assistant Manager or Crew) who may prepare the ingredients and therefore we have charged the higher rate in keeping with the principle of conservatism.

Finally, the costs of the lids (which are required for take-away) are also included in the cost because there is no information available on how much is sold for in-house dining and how much at the take-away counter. Again it is submitted that over costing is the lesser evil as compared with under costing where chili could be sold for less than its cost.

Please refer to Appendix A for a discussion on various types of costs and products.

(ii) Full-cost basis Particulars Quantity Rate Amount Tomato (Can) 1.00 $1.75 $1.750 Tomato Juice (Can) 5.00 $0.70 $3.500 Seasoning (Pkt) 1.00 $0.50 $0.500 Red Beans (Can) 2.00 $1.35 $2.700 Ground Beef (Lbs) 12.00 $1.25 $15.000 Direct Labor (Hrs) 0.50 $5.75 $2.875 $26.325 Servings Produced 57.00 Avg. Cost $0.462 Serving Bowl $0.035 Lid $0.025 Spoon $0.010 Fixed Overheads * $0.180 Cost of a Bowl of Chili $0.712 The cost of chili on a full-cost basis is $0.712. This is essentially the sum of the per unit cost of chili on an out-of-pocket basis and the fixed overheads allocated to chili.

*Please refer to Appendix B for the calculation of Fixed Overheads (iii) The real cost The real cost of a bowl of chili is made up of the direct materials consumed, the direct labor applied and a portion of the overheads of the outlet, which includes expenses on rent, electricity, cooking gas, cooking oil, salaries, etc. The costs of materials and labor are available but there is no information on the other possible overheads of an outlet, therefore it is not possible to calculate the real cost of a bowl of chili. However it may be added that this real cost will be slightly higher than the cost of chili on a full-cost basis.

Taking the real cost of chili as $0.712 the profitability of chili can be calculated as follows: Revenue $0.990 Less: Cost of a Bowl of Chili $0.532 Contribution $0.458 Less: Fixed Overheads $0.180 Net Profit per Bowl $0.278 The Case for Chili Chili sales have historically contributed roughly 5% of revenues at Wendys. This may appear marginal when compared with the 55% contributed by hamburger sales. Nevertheless, it is our recommendation that management retains chili as one of the items on the menu for the following reasons: (i) Chili generates a healthy contribution margin of $0.458, which on a selling price of $ 0.99 per serving is substantial. Even after deducting fixed overheads in terms of labor costs apportioned to a bowl of chili, chili sales generate a net profit of $ 0.278 per serving.

(ii) The manner in which chili is prepared serves as an economical method of utilizing the overcooked patties. By so doing Wendys is able to add value to the patties at a low cost and at the same time produce an additional and unique menu item.

(iii) If chili was dropped from the menu, Wendys would experience a fall in total revenues that may not be compensated by increased hamburger sales. To counter this reduction in revenues Wendys would possibly have to introduce and promote another item with no guarantee of success.

(iv) Given that chili has been served at Wendys from its beginnings, it is likely that a loyal fan base would have developed that may be lost if chili was removed.

Please refer to Appendix C for an analysis of the price effect of beef and a model for determining the price of chili.

What Could Have Been In the late 80s, Wendys profit growth was hit by a slowing economy and intense competition. Competitors had expanded rapidly and substantially improved the quality of their products, services and facilities. They began targeting Wendys niche of adult customers by introducing new menu items and reconfiguring stores to make them more family oriented.

One of the things Wendys could have done to better handle the competition was to reconfigure their restaurants to make them more child-friendly, in order to diversify from their traditional customer base and attract families. During the slowdown a majority of the competitors were offering value meals at discounted prices. In addition to competing on price, Wendys should have focused on keeping costs at a minimum. This would have increased their margins.

Looking Ahead The onset of the 1990s heralded dynamic changes to the quick service restaurant industry. To maintain their market share, Wendys management will have to effectively tackle a shift in consumer tastes, changing demographics and a quantum increase in competition within the industry.

Booming economic growth in the 90s has had a significant impact on consumer lifestyles. With additional disposable income, primarily due to double income families, consumers are willing to purchase a higher ticket meal rather than a quick and convenient fast food option. In addition, increased health consciousness has made the attraction of fast food less alluring to the average American. Fast-food restaurants will be forced to adapt to consumer requirements by altering their menu to provide a more nutritious and healthy selection. Apart from having to change the way food is prepared, Wendys should consider including a host of low calorie items such as yogurts and sorbets and a wider selection of fish and poultry items.

Wendys stand-alone restaurants provided them with a locational advantage in the 1970s, as it provided customers with ample parking space and ease of accessibility. However, the 1990s have witnessed the onslaught of the mall culture, with malls providing customers with numerous dining options. This shift in demographics has seen the fast-food industry capture an increasing percentage of sales from traffic in malls and shopping complexes as opposed to stand-alone outlets. Malls act as natural catchments for customers as they provide a whole range of activities under one roof. People tend to eat where it is convenient after a long day of shopping or the movies. This is where Wendys strategy of building recognizable stand-alone outlets may limit its growth. Wendys should focus on co-branding, possibly with cinema halls and gas stations to further increase its penetration in the market.

The quick service restaurant industry has witnessed a surge of new entrants. Apart from direct competition in the form of traditional fast food restaurants, ethnic food restaurants and delis have flooded the market. Consumers are increasingly opting for the latter as fast food is perceived as unhealthy. In addition, these specialty restaurants provide a delivery service, making them an attractive alternative. To compete, Wendys could look into providing delivery to areas within a square mile or so of their outlets.

Given the current market scenario, it is clear that the challenges facing Wendys in the future are daunting. Management undoubtedly did a good job turning the company around since the late 80s but any optimism has to be guarded given the more competitive operating environment. Good food alone is no guarantee of success – there are only so many ways to cook a burger. Wendys limited brand equity will make potential tie-ups more difficult as partners will prefer established names with greater pull. In addition, Wendys will find it extremely difficult to diversify revenue sources the way McDonalds has through movie merchandise agreements and the like. Revenue growth will have to be generated from food sales alone. Wherever Wendys opens a new restaurant, it is likely that there is already a McDonalds or a Burger King nearby. Its larger competitors would easily win out in prolonged price competition with Wendys as they generate higher traffic and margins.

Conclusion Our cost and profit analysis leaves little doubt that chili is a profitable item and that Wendys should continue to serve it at its outlets. Not doing so would mean losing the revenue and profits chili would otherwise contribute.

Wendys could indeed post steady growth in the future if management executes its operating objectives well. However, long-term success is far from assured and the company needs to maintain its vigilance.

Appendix A Common costs are those costs of facilities and services that are shared by multiple users. Depreciation on furniture and fixtures, climate control expenses, repairs and maintenance expenses, to highlight a few, are costs that are not attributable to a single product or department and are treated as common costs. On the other hand, joint costs are the costs incurred to manufacture joint products until the split-off point. Analyzing the cost of ground beef based on this distinction will lead us to conclude that it should be treated as a joint cost. At Wendys the ground beef patties are placed on the grill during the hamburger making process. In keeping with their hot n juicy product offering, those patties which are not used up in the preparation of hamburgers within a specified time limit become well-done and are not suitable to be served as burgers. These well-done patties are stored and used in the preparation of chili. As the process up to the point where patties are put on the grill is the same for hamburgers and chili, the costs of the ground beef patties are considered joint costs. This is the usual practice. However, at times the preparation of chili requires uncooked ground beef patties to be grilled. At these times, the cost of the ground beef patties must be apportioned as direct costs in the preparation of chili.

A by-product of a manufacturing process is classified as a product that (1) is not readily identifiable until manufacturing reaches a split-off point and (2) has an insignificant total sales value relative to the main product. Compared with hamburger sales at Wendys, chili sales are much lower but definitely not insignificant. A joint product has two noticeable characteristics firstly, it has a significant sales value and, secondly, it is not separately identifiable as an individual product until the split-off point is reached in the manufacturing process. Chili meets both these criteria. Chilis classification as a joint product is subject to the condition that the patties used in its preparation are well done patties originally intended for use in the making of hamburgers. When fresh beef patties have to be grilled for making chili, then it is no longer classified as a joint product. However, this seldom occurs. Up to the point where the patties are on the grill, they cannot be distinguished whether they are for use in the preparation of hamburgers or chili. Only when the patties get overcooked are they stored for use in the preparation of chili in the coming days and therefore chili should be treated as a joint product and the costs up to this point as joint costs.

Appendix B Without information on the other typical fixed expenses, the calculation of fixed overheads consists of only the salaries paid to the personnel employed at a store. These calculations are based on the assumption that there is only one employee of each category working 16 hours per day.

Rate Time Spent Amount Store Manager (Per Week) $575.00 1 Day $82.143 Co-Manager (Per Hour) $6.50 16 $104.000 Assistant Manager (Per Hour) $5.75 15.5 $89.125 Management Trainee (Per Hour) $5.60 16 $89.600 Crew (Per Hour) $4.50 16 $72.000 Sub Total $436.868 Taxes and Additional Expenses (@ 10%) $43.687 Total $480.555 Allocation to Chili (@ 5%) $24.028 Allocation per bowl of Chili** $0.180 Without sufficient information on how many employees are employed at a typical outlet we have to assume that there is only one of each category. This is slightly far fetched for the number of Crew but from the calculations it can be ascertained that even if their number goes up to10, chili sales will still remain profitable.

** The number of bowls of chili sold per day has been derived from the Annual Sales per restaurant on the assumption that chili still contributes 5% to the overall sales of the outlet, as it did in the 1970s.

Average Sales per Restaurant 966,000.00 Chili Sales in $ (5% of Sales) 48,300.00 No. of Bowls Sold per annum 48,787.88 No. of bowls sold per day 133.67 Appendix C As outlined in Table 12-4 of the case, the price of beef is the single largest cost in the making of chili. Thus, in the cost accounting system, the price of beef will be the critical cost driver for chili. It follows then that an increase in the price of beef will increase the direct cost of making chili. Ideally, management should increase the price of chili following the increase in price of any raw material input. However, that would be difficult in practice. We have calculated the contribution margin of chili as 45.8% and the net margin as 27.8%, which we deem to be healthy. This should give the company the ability to absorb small increases in the price of beef without adversely affecting profitability. In the event of a large increase in the price of beef, management will have to evaluate the effects of an increase in price on demand and on the demand for competitors products. A price increase should not be instituted to offset higher input costs before careful consideration of market factors.

The sale of chili at Wendys exhibits a slight seasonal pattern; sales for the six months from October to March account for 60% of annual chili sales. Due to the higher demand in these months the probability of having to grill fresh ground beef patties specifically for preparing chili is higher. This likelihood entails a slight additional cost of energy (cooking gas), chefs time and machine time (patty making machine) required for preparing the grilled patties for chili. These costs are normally avoided when there is a sufficient stock of well-done beef patties required for the preparation. Although there is a small probability of an increase in costs at this time, it is not advisable to vary the price of chili during the mentioned season because the pricing decision is made at Wendys headquarters but the need to grill extra beef patties may not exist across all the outlets. The more appropriate method would be to treat these additional costs as joint costs and allocate them to the cost of chili at a standard rate.

Ground beef is the major ingredient of both chili and hamburgers at Wendys. Hence it is essential for management to correctly establish the cost of the beef patties in order to find the profitability of chili and hamburgers. The cost of ground beef patties should include all the material cost, labor cost and the other direct expenses up to the point where the patties are cooked. Material cost would include the raw beef cost, condiments added to the mixture, cooking oil used, etc. Labor cost must include the time required for putting the mixture in the patty machine and the average time taken to cook the patty for a hamburger or chili (the extra time beyond this is non value adding activity). The other expenses relevant to the patties are the expenses on power to run the patty machine, gas expenses to fire the grill, depreciation on the grill and patty machine, etc. When all these expenses are aggregated, the average cost of a ground beef patty can be found. This cost will be uniform as an input cost for both chili and hamburgers even when patties have to be cooked for the chili, as the process up to the point of grilling is the same. This cost data is also of utmost importance because once the cost of the patty has been settled, the profitability of the products can be established with no difficulty after adding the costs of the other ingredients and the other relevant costs.

Fundamental to determining the selling price of a bowl of chili is the calculation of the cost associated with preparing one serving. To do so, we should adopt the absorption costing technique in which all costs are charged to the product. This differs from the contribution costing method, which only includes variable costs in its determination. The real cost of a bowl of chili would include costs associated with direct materials and labor charges, and a percentage of fixed overhead that is apportioned to the cost of preparing chili. These fixed overhead expenses would include, amongst others, costs incurred on rent, electricity, salaries, depreciation on equipment and utility charges. The advantage of using absorption costing is that in the long run, all costs need to be recovered in order to remain in a competitive business environment. Eventually, even fixed costs fluctuate as output exceeds the relevant range; therefore it is prudent to assume that all costs, in the long run, are variable. To arrive at the selling price of a bowl of chili, Wendys should adopt a cost plus pricing formula, by charging a mark up that will generate the target revenue from the sale of chili. This mark up should be reflected as a percentage of absorption costs.