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Tuesday, October 20, 2020

Why food and beverage firms have struggled

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It is inevitable that as social distancing measures triggered by Covid-19 become valid, food and beverage (F&B) firms have been adversely affected. However, why have many eateries closed after just a few months?

F&B is a segment of tourism and hospitality. It is prone to risks due to huge fixed costs, in the form of rentals, utilities, the wages of permanent staff, Internet fees, tax and bank interest.

Rentals account for a significant share (10-40% of income, depending on the location). Eateries in central business districts can gain access to many customers but incur staggering costs, too.

Fixed costs account for 50-60% of the total costs facing eateries. Consequently, the minimum output to help them break even is large.

Vietnam has a young population and is undergoing urbanization, so demand for F&B is substantial and boasts rosy growth prospects. Statistics by Statista indicate that the F&B market in 2019 reaped US$200 billion, with a growth rate of 20-30% per annum on average. However, many F&B firms have been bankrupt despite their reputation, as in Mon Hue’s case last year. Despite impressive volumes of customers, these eateries have been hampered by escalating costs.

For example, rentals account for 40% of Highlands Coffee’s income. With an area of more than 200 square meters in central HCMC, rentals can surge to almost VND400 million per month. This means it must sell at least 400 cups of coffee a day to break even, judging by the usual cost structure of a coffee shop.

The marginal profit ranges from 5% to 15% of income. With a profit of 10% of income and rentals hitting 40% of income, Highlands Coffee will take 12 months to offset the loss incurred from a three-month closure.

Giant brands such as Trung Nguyen, Starbucks, The Coffee House and Phuc Long also face the problem of limited profit.

Rentals and staff wages are significant costs confronting retailers and cannot be slashed. After all, access to large volumes to customers entails prime locations (which usually come with high rentals, about 15% of costs) and competent, friendly sales staff (18% of total costs). Meanwhile, rentals are limited for e-commerce since firms just need cheap storage space to facilitate delivery. Those with various warehouses can offer express delivery services (Tiki can deliver products within two hours) without incurring significant rentals.

Therefore, even when the economy fares well, F&B firms must grapple with sky-high costs and have to operate at full throttle to reap profit or at least minimize loss.

Challenges posed by Covid-19

High rentals have made it difficult for F&B firms to bear fixed costs for two or three months. Rentals in HCMC are similar to those of regional cities. When rentals are calculated in proportion with living standards, Hanoi and HCMC are among the most expensive worldwide.

Rentals as a share of land prices in HCMC are among the world’s highest, reaching 5.91%, far more than in bustling cities such as Tokyo. Hanoi ranks third (3.72%). A rate of 5.91% means that if the premises are purchased at VND10 billion, rentals are about VND590 million a year, or about VND50 million per month.

High rentals mean firms will try to raise prices, making products less affordable to consumers. When payment capabilities are low, capacity will be impeded. A product may sell like hot cakes at first, but as the novelty factor vanishes, consumers will focus on value for money. Revenue will gradually trail behind fixed costs.

Within the past two months, most eateries have closed while fixed costs remain. Consequently, firms will struggle to survive in the long run.

Risks abound in F&B, and they are getting even worse with the pandemic. As eateries keep changing hands, perhaps only those owning the premises benefit.

By Le Hoai An (CFA – Merlin Capital)

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