The world economy is like the places in which we eat
A man in the restaurant business once told me about an upmarket midtown Manhattan Italian restaurant whose owner gave a bonus at the end of each month to the waiter who sold the most coffee and dessert. Why so? Because coffee and dessert are among the highest-margin items in a typical fine-dining restaurant.
I also met a man who ran a very successful Chinese restaurant in the New York metropolitan area. After several years of loyal service, one of his employees decided to leave and start the same type of business right down the street. To distinguish himself from his former employer, he was going to serve fancy European-style desserts and coffee along with the usual Chinese fare. But according to my acquaintance, you should never serve coffee and dessert in a Chinese restaurant.
“When people have coffee and dessert in a restaurant,” he explained, “they take their time lingering and chatting at their table. In my business, we want to turn our tables over at least four or five times a night.”
The financial dimensions of these two types of restaurants provide a very simple, but useful, illustration of the essence of the DuPont or Return on Assets (ROA) model. ROA, defined as net income divided by assets, is a useful indicator of the financial performance of a company, because it indicates how effective a company is in using its assets to generate a profit. Essentially, this model says that a company’s ROA is a combination of its net profit margin (profit divided by revenue) and its total asset turnover (revenue divided by assets).
The Italian restaurant represents a business that achieves its ROA with a high margin and low asset turnover. In contrast, the Chinese restaurant represents the business whose ROA is achieved with a low profit margin and a high asset turnover. Taking this metaphor one step further, I contend that, essentially, global companies based in the developed economies are Italian restaurants, while those in emerging economies are Chinese restaurants.
According to a just-published study in September’s McKinsey Quarterly, the 30-year run of “profit growth, market expansion, and declining costs” of the world’s biggest corporations (Italian restaurants) “may be coming to an end”. Among the reasons cited in this article are: the global expansion of the industrial giants in emerging countries (Chinese restaurants), new business models introduced by high- tech companies, and digital platforms such as Alibaba and Amazon that enhance the ability of small and medium- sized businesses to compete on a global scale against companies of all sizes (i.e. fusion restaurants that have both high margins and high asset turnovers).
What should established Italian restaurants do in the face of these new global challenges? The McKinsey article talks about innovation and adjusting quickly to the changing environment. An article in October’s Harvard Business Review advises companies in this new competitive environment, to “be paranoid, disrupt yourself, and go to war for talent”.
In keeping with my metaphor, I would suggest that they should make sure they hire the best pastry chefs (new product innovation), train and motivate their waiters (build and keep the best talent), and find new ways to operate as both high- margin and high-asset turnover businesses (business-model innovation). Maybe one of them could start a chain of high-end food trucks that serve a fusion of Chinese and Italian cuisine. It might be called Ciao Mein.