Outback Steakhouse Case Study Essays

Outback Steakhouse Case Study Essays Outback Steakhouse Case Study Essay Outback Steakhouse Case Study Essay Overview of the Outback Case Study Analysis The authors of the Outback Goes International study, (hereinafter the â€Å"Study† or â€Å"Case†) depict a restaurant company, Outback Steakhouse, (â€Å"Outback†, the â€Å"Business†, or the â€Å"Company†) that by 1995 had experienced significant growth over the prior seven years. The Case addresses how management identified international expansion and product diversification as the principle elements of a strategic plan formulated to continue rapid expansion. This report will evaluate Outback’s strategies of international expansion and restaurant diversification in light of alternative means of achieving enhanced shareholder value via growth. Several uncertainties and challenges, which management acknowledged and the Case documents, faced Outback. The methodology used by the Company to consider its strategic options will be addressed by this report as well. The analysis contained herein will evaluate issues pertaining to those challenges, relying on the comparative performance of the Company’s publicly traded stock as the ultimate measure of management’s success or failure. This report will first evaluate the fundamental elements of the companies’ strategic plans, incorporating published academic research regarding strategic decisions, risks and the basis for management’s decisions. Additionally, further evaluation of the opportunities and competitive achievements in the international arena will be conducted. Finally, this report will attend to and appraise the ultimate financial performance achieved by the Company since the establishment in 1995 of its strategic plans and subsequent preparation of the Case being analyzed herein. Comments from Outback’s legendary C. F. O. Bob Merritt, will serve to punctuate the conclusion of this analysis; Outback’s strategies of product diversification and international expansion did not pay off for shareholders. Strategic Planning Methodology In evaluating Outback’s strategic plan this report adopts the fundamental assumption that management has as its primary objective the creation of shareholder value. Presumably, strategic decisions of management are designed to support this value proposition. A number of alternatives exist for companies to create value and Outback’s challenge was to weigh potential returns of alternatives against their inherent risks. Adrian J. Slywotzky and John Drzik of Mercer who document seven classes of strategic risk in their April 2005 article Strategic Risk Management published in the Harvard Business Review, set forth that in managing strategic risks there are an, â€Å"array of external events and trends that can devastate a companys growth trajectory and shareholder value. † It is evident that Sullivan, Outback’s chief executive, was aware of risk when he stated, â€Å"†¦the world is becoming one big market, and we want to be in place so we don’t miss that opportunity. † Management can react to risk through five generic responses as addressed in A framework for integrated risk management in international business, published in 1992 by Dr. Kent Miller in the Journal of International Business Studies . Miller’s five responses are identified as avoidance, control, cooperation, imitation, and flexibility. Sullivan and his management team’s plans reflected their primary concerns over two of the strategic risks identified by Slywotzky and Drzikclear; stagnation and competition. Stagnation is characterized as flat or declining sales volumes; in the case of Outback slower growth. The risk of competition is characterized by emerging competitive threats; in the case of Outback this strategic risk was represented by restaurant competitors in their markets. These were appropriate concerns and priorities given the facts of the Case. In responding to these threats, management’s reaction reflected four of Miller’s five categories of risk responses including control, imitation, cooperative responses and organizational flexibility . Sullivan and his team sought to control uncertain variables rather than passively treat the uncertainties as constraints by continuing to gain market power via growth in units. In addition they resorted to imitation of rival organizations strategies to cope with uncertainty by pursuing a â€Å"multipronged† strategy that both encompassed new restaurant concept development and international expansion; a strategy that had been adopted by other competitors including their former employer and competitor Brinker International. Outback also intended to utilize joint venture and franchise agreements as a cooperative response by creating partnerships that produce interdependence. Finally, as Miller points out, the Company adopted organizational flexibility by embracing, â€Å"the most widely cited example of flexibility in the strategy literature†¦product or geographic market diversification. † International expansion and new restaurant concept development certainly fulfilled this documented organizational flexibility response to risk. Absent from the Case and potentially excluded from Outback’s strategic considerations was the alternative response of expansion and diversification through a merger or acquisition. While the Company did acquire an Italian concept, Carrabbas Italian Grill, for development purposes, the business was very small at the time and as a result did not generate synergies or make significant near term contributions to revenue and profits. While Outback may have evaluated acquisition or merger alternatives, the Company did not integrate this strategic alterative into its plans. In fact, in June of 1999, Ruth’s Chris Steakhouse was available for sale . This company represented several hundred million in annual revenues with obvious synergies. However, despite in-depth discussions, Outback avoided making an offer to acquire the business and Ruth Chris was sold to the private equity firm of Madison Dearbourn Partners. Ironically, Ruth Chris went public in August of 2005, raising $235 Million that represented, â€Å"the richest IPO from a restaurant firm since Dominos Pizza (DPZ) kicked off in July, 2004 with proceeds of $337 million†, according to Thomson Financial. This was an opportunity the Company missed, and reflects an error in not considering acquisitions as a prong in its â€Å"multipronged† plan. In reviewing the Case, and researching the basis for Outback’s evaluation of strategic alternatives in 1995, management’s decisions appeared prudent at the time and reflected established theories in strategic thinking, planning and risk evaluation. Expanding internationally and diversifying through new restaurant concept development represented sound direction at the time. To further support the basis for the aforementioned strategic direction of the Company, one can look at the growth trajectory of the business. At the end of 1994, Outback had 214 locations in operation. Its annual sales growth from inception in 1988 until its fiscal 2004 year end averaged 53. 91%. Since 1992 the company had more than doubled revenues, growing from $189. 2 Million in 1992 to $415. 9 Million in 1994. As the Study notes, Chairman Sullivan described this growth, expressing that, â€Å"we can do 500 to 600 restaurants (domestically)†¦ over the next five years. † In the year 1995 had Outback maintained its averaged unit growth rate of 53. 91% over the prior three years the Company would have reached U. S. market penetration of 600 locations in a matter of a few years. In fact the Case notes, although somewhat more conservatively, â€Å"At the rate the Company was growing (70 units annually), Outback would near the market’s saturation within 4 to 5 years. † Therefore Sullivan had to explore alternative methods of growth to continue to create value. The business had, according to the Study, a â€Å"multipronged strategy† that included the expansion of its Italian chain â€Å"Carrabbas Italian Grill† and the development of new dining themes. Interestingly, by 1994 Brinker International, a key competitor of Outback, had already achieved a degree of international expansion and planned to continue its pursuit of this strategy. According to Brinker International’s 10K filing with the SEC dated September 27, 1994, â€Å"During the past two years, the Company entered into several international franchise agreements, which will bring Chilis to Australia, France, Puerto Rico, and the United Kingdom in the next 12 months. In fiscal 1994, the first Chilis restaurants outside North America opened in Singapore and Malaysia on February 4, 1994 and June 15, 1994, respectively. The third, fourth and fifth overseas Chilis locations opened in Egypt, Australia and Puerto Rico on July 19, 1994, August 28, 1994 and September 6, 1994, respectively. The Company intends to continue pursuing international expansion and is currently contemplating development in other countries. † In addition to Brinker’s international expansion, it also had amassed 458 locations that included six different restaurant concept brands. It is apparent that Brinker International had already pursued the plan that Outback ultimately adopted, further confirming Outback’s adoption of Miller’s imitation response to risk referenced previously. Restaurant competitors of Outback that served the casual, full-service dining segment generally had not expanded internationally like fast food restaurants. This is confirmed by the Case, which lists T. G. I. Friday’s and Applebee’s, the only direct competitors of Outback on the list, as having only 39 international locations as of 1994. The Case failed to include Brinker International in its data, but given the documented expansion, the number of casual dining chains engaged in international expansion was relatively limited in 1994 at the time Outback was considering its plans. Obviously an opportunity existed for international growth; but would this growth add value to shareholders? Recall that this report addresses the strategic decisions of the Company in the context of appreciation in shareholder value, which represents the ultimate measuring stick of performance. A June 2005 report in the Outlook Journal titled Getting a Truer Picture of Shareholder Value, concluded that, â€Å"there is a limited and diminishing correlation between those measures (net income and earnings per share) and share prices. A company’s income statement usually accounts for only about 4 percent of market value for a stock with a typical price/earnings ratio of 25, while the balance sheet covers about 25 percent. The remaining 70 percent of market value consists of intangible assets and expectations of future growth. † Pushing continued expansion to support or further promote publicly traded share prices is common. However, as Motley Fool’s Brian Green attests in a February 2000 article commenting on then popular P. F. Chang’s, a recent star in the domestic casual dining segment, stock, â€Å"Its at this point in the script when the customer lines are stretching out the door and the national expansion plan is gearing up that so many hot restaurant operators of yesteryear have screwed up everything. † In fact, the notion that international expansion is an intelligent strategic option for a business in the service sector, such as Outback, is questionable. While it is generally understood that a firm’s financial performance improves with a greater multinational presence, empirical studies have rejected this notion. Instead, becoming an international business has been shown to have, â€Å"Both a U-shaped relationship (which suggests an initially negative effect of international expansion on performance, before the positive returns of international expansion are realized) and an inverted-U-shaped relationship (which suggests that international expansion beyond an optimal level is again detrimental to performance, and results in a negative slope). Meaningful analysis of expansion in the international marketplace by restaurant companies and the related financial performance of such companies is not readily identifiable. However, the Case does address many issues that created great challenges for international expansion, including location, distribution, local appeal, and other factors. Undoubtedly, if a proven financial model exists for a restaurant brand domestically, this does not mean that the same formula is applicable in foreign markets. Regardless, over the past decade Outback has expanded to 123 units internationally and developed six new restaurant concepts including Carrabbas Italian Grill, Lee Roy Selmons, Cheeseburger in Paradise, Bonefish Grill, Paul Lee’s Chinese Kitchen, and Flemings Prime Steakhouse Wine Bar. The Company also has a joint venture development relationship with Roy Yamaguchi, the chef and creator of Roys Restaurants located in Hawaii, the U. S. , and Japan. These accomplishments are in line with the strategies management outlined over ten years ago. However, despite achieving their goals, the ultimate judge of the strategic plan should be defined by the financial performance of the Company and finally the enhancement of shareholder value. Outback Financial Performance – The Results As mentioned in the introduction, increasing shareholder value is a primary objective of management. The results of a businesses’ profitability, growth prospects and returns contribute to investors’ valuation and ultimately judge management performance over the long haul. Share prices of public companies are objective reflections of market value and serve to compare Outback’s performance during the past ten years to a number of its main competitors. It should be noted that each of the competitor companies included in the comparison are large chains, with significant revenues, market capitalization of several billion dollars, managing multiple concepts and having significant international operations. These restaurant chains are identified as the â€Å"four big players† , in the restaurant industry. For additional evaluative purposes, the broad S 500 index is also included. (THIS SPACE LEFT BLANK FOR FORMATING PURPOSES ONLY) Graphic of Competitive Stock Price Appreciation From 8/26/95 through 8/26/05 Graph 1 Outback Steakhouse = OSI, EAT = Brinker International, APPB= Applebee’s, DRI = Darden Foods sp500=S 500 Of the four companies depicted in Graph 1, Outback has generated the poorest appreciation in stock price during the past decade. Darden Foods experienced the greatest appreciation, rising nearly 400%, Brinker International appreciated nearly 250%, Applebee’s nearly 150%, and Outback, below the performance of the S 500, appreciated 100% over the past decade. These are disappointing results and would not reflect the optimism demonstrated in the Case performed on Outback regarding its plans in 1995. What is the cause of this poor performance in shareholder value appreciation? Regrettably, financial disclosure documents submitted by Outback and its competitors described in this report do not provide adequate evaluation and disclosure of international operations to ascertain the relative financial performance of its international business. While Outback has successfully opened 123 units internationally since its strategic decision a decade ago, the specific financial contributions from these ventures are indeterminable. However, the appreciation of the Company’s stock is irrefutable. An interesting development pertaining to the financial performance of Outback is the recent surprise retirement of its CFO, Bob Merritt. Highly regarded and referenced extensively in the Case, it would be interesting to learn of Merritt’s perspective. Perhaps these observations would provide clues as to Outback’s performance issues. Thankfully, in a June 2005 interview with Chain Leader Magazine written by David Farkas entitled, Parting Shots, Merritt is rather candid. The article first substantiates Merritt’s stature as described in the Case. â€Å"Bob’s legacy will be as the pre-eminent CFO in our industry over the past two decades,† says investor and former Brinker International CFO Jim Parish. SG Cowen’s Paul Westra, who has followed Outback since 1994, considers Merritt to be â€Å"the granddaddy† of CFOs. While Merritt cites frustrating changes in financial accounting standards as a motivation for his abrupt departure from the Company, his thoughts are not limited to this point and he provides some keen insights to what has gone on in the halls of his former employer. When asked about his perspective on the casual dining segment, Merritt opined, â€Å"It’s going through a fundamental change. You now have four big players†, these are the companies included in this report’s stock price comparison, â€Å"and they are all net generators of cash. He added, â€Å"It’s also the most competitive environment and the worst cost environment. † Merritt makes an interesting point that goes to the heart of the issue of growth in the industry when he says, â€Å"There is an inflection point in the development of any restaurant concept. The cost to build the incremental restaurant escalates faster than the ability to raise prices. The consumer doesn’t care that the cost to open a restaurant in 2005 is 50 percent higher than the cost of the one five miles away that was built in 1995. They are not going to pay proportionately more to eat in the new unit. As a result, returns go down. At some point the incremental return doesn’t justify the incremental investment. † Finally Merritt points out, â€Å"Will they (management) do what they have historically done and continue to mindlessly expand these concepts well past this inflection point and destroy capital, or will they change and become more concerned about generating real shareholder value and how to grow it? A number of companies in this industry are destroying capital by continuing to grow even though incremental returns don’t exceed their risk-adjusted capital cost. † Was Merritt referring to Outback’s expansion strategy, given its relatively dismal performance during the past decade? It certainly sounds like it based on the review of share price appreciation of his former employer, Outback Steakhouse. Conclusions Outback’s plans as described in the Case and reviewed in this analysis seemed quite prudent at the time. However, if the objective of management is to maximize shareholder value, given Mr. Merritt’s commentary, is this best accomplished by expansion that might not fundamentally provide adequate financial returns? Judging by the results and Mr. Merritt’s thoughts, Outback’s expansion plans have not been successful. Outback’s results as compared to its competition fail to reflect a business that achieved what it had hoped to. While adding many units, it is clear that the incremental benefit from its expansion did not enhance value in a manner that compares to its competitors. Perhaps the results of the strategy had more to do with poor execution.