A&M leaders discuss loyalty programs used by restaurants and the key considerations in understanding these programs when evaluating a restaurant transaction. In addition, they continue their series on driving customer growth, through penetration.
Accounting for loyalty programs
Loyalty programs are commonly used by restaurants to attract and retain customers. Customers sign up for a program and earn points that can be redeemed for free or discounted items at future visits. Quite often, smaller restaurant chains with unsophisticated systems don’t track or account for the programs in accordance with Generally Accepted Accounting Principles (GAAP). However, when considering a restaurant transaction, buyers should ensure reported results accurately reflect the cost and obligation of loyalty programs.
When a customer makes a purchase and earns loyalty points, the restaurant should record an expense and a liability for the incremental cost of satisfying the loyalty points. The incremental cost can vary and should be based on the company’s best estimate of what will ultimately be redeemed by the customer. When the customer redeems the points, the liability should be relieved. In instances where points expire, the restaurant may record breakage income using a reliable and rational approach, which is usually based on historical redemption history.
Prospective investors should understand the linkage between the system that is used to track points and the restaurant’s accounting system. Systems are usually separate and linking them is often a manual process. Although a manual process is not necessarily a red flag, the investor should understand the accuracy, timing, and consistency of the process.
If the restaurant does not maintain an accrual for loyalty points, this likely indicates that the costs of fulfilling the obligations are recorded on a cash basis. It may also indicate an unrecorded liability, potentially impacting valuation.
A careful examination of loyalty programs during due diligence will prevent surprises following the completion of a restaurant transaction.
Driving Same Restaurant Store Sales – The Right Way, Part III
In our last newsletter, we discussed retention as part of the Retention Penetration and Acquisition (RPA) methodology for generating and measuring growth. In the third edition of our customer growth series, we will be focusing on Penetration. Penetration can be defined as how much additional business was obtained from current customers. Similar to retention, penetration is best measured on a year over year basis for the restaurant industry to account for all visit occasions. Penetration success comes from increased visit frequency and higher average ticket.
Increased visit frequency reflects a higher share of wallet with your current customers. One of the most significant drivers of repeat visits is a loyalty program that offers intrinsic rewards. Intrinsic rewards can come in many forms such as going to the head of the line on a busy Friday night or a call from the restaurant CEO to thank the customer for their many visits. One of the critical success metrics of the loyalty program should be to measure the percentage increase in visit frequency.
Penetration in the form of higher average ticket lies in close alignment with the success of food and drink add on promotions. Food and drink promotions encourage the customer to try new items that they otherwise may not have ordered. Over time, a percentage of customers will continue to order the same items off promotion because they enjoy the particular food item or drink.
Thinking about penetration through visit frequency and average ticket offers the best chance to have current customers spend more. In our next and final article, we will dive into the “A” in RPA, acquisition.
Restaurant M&A Activity Summary
Strategic acquirers continued to drive momentum in restaurant transactions. During the 3rd quarter of 2016, there were 21 announced restaurant transactions involving strategic acquirers compared to five transactions involving financial sponsors. Fast/mass casual restaurants continue to be the target of choice, although transactions involving quick service targets have increased in recent quarters.