Automation and robotics are expected to have a significant impact on the restaurant industry, increasing efficiency, consistency, and profitability. In this episode of William Blair Thinking Presents, William Blair equity research group heads Sharon Zackfia and Larry De Maria discuss how automation is set to bring value and organic growth to the sector.

Moderated by Chris Thonis, director of equities marketing and media relations.

Podcast Transcript

[00:00:00] Chris: Welcome to William Blair Thinking Presents a new podcast series that aims to provide in-depth expertise on today's capital market landscape. What's different about this podcast, this is a look at William Blair's most exclusive and best ideas. The ethos, if you will, of our equity research and capital advisory.

[00:00:26] Chris: I'm Chris Thonis, head of equities marketing and media relations, and I'm delighted to be your host. On today's episode of William Butter Thinking Presents, we welcome equity research analyst, Sharon Zackfia, who's a partner, CFA and group head of the consumer sector, and Larry De Maria CFA, group head of global industrial infrastructure.

[00:00:42] Chris: Now, these two analysts just released a fascinating new report that focuses on one big question, is restaurant automation an idea whose time has finally come? Well, let's dive in to find out. Let's touch on some of the specific areas of the report. First and foremost, you talk about how automation and robotics are set to create a wider gap between the haves and the have-nots and the restaurant industry over the next decade.

[00:01:05] Chris: If you don't mind kicking us off, Sharon. How so?

[00:01:07] Sharon: Sure. I mean, the restaurant industry is notorious for being very fragmented and for having low barriers to entry. So there have been very few concepts that have really sizably scaled in the restaurant space. We think robotics, along with automation and digitization, are really at the frontier of how companies can invest in a way that can structurally change the paradigm.

[00:01:28] Sharon: For example, investing in automation and robotics can make the product more consistent, can improve throughput and speed of service, it can improve the employee experience, and all of that ultimately would manifest in higher unit level margins. And the restaurant then has a choice, right? You can harvest those higher margins or you can reinvest those in a better value proposition for the consumer.

[00:01:54] Sharon: It's really a win-win choice for the restaurant at that point, but you have to have the foresight and we, we see some restaurants already doing this, the foresight to invest in these kind of next-gen automation processes to get to that level where you have that structural advantage. Basically, you're deepening a competitive moat in an industry where it's hard to have any moat.

[00:02:14] Chris: For the companies that do have that foresight, what would you say are the core benefits of automation? I know  you line them up throughout the report, but can you get into those a little bit?

[00:02:21] Sharon: Yes, so part of that goes to the employee morale. Part of that goes to improve customer satisfaction, which should manifest itself and improve [00:02:30] frequency.

[00:02:30] Sharon: So there's a lot of what I was mentioning, that kind of manifests itself in, in terms of  the positives here. As well as speed of service. Much of the restaurant industry is pretty time sensitive, so having an accurate product that comes out and a faster throughput paradigm can unlock greater sales.

[00:02:49] Sharon: And, ultimately, if we have Chris's burgers and Sharon's burgers and I've invested in automation and I can price my product 20% less than yours, I have better, more accurate, faster product. It doesn't take a lot to see kind of where the consumer goes in that framework.

[00:03:06] Chris: Right. So…Larry, I'm going to go over to you. Where are we in the automation adoption phase? And what's the evolution of automation and commercial food service?

[00:03:16] Larry: As Sharon just mentioned around scalable technologies, industrial companies really come in to help restaurants and concepts achieve the goals of scalability and reduce these pinch points that they're having, and they bring in scalable manufacturing and ROI driven solutions.

[00:03:31] Larry: I look at it at three different levels of automation. First is the embedded automation that's here and now. We're thinking about conveyors for pizza, two-sided grills, speech, cook ovens. These have been around for 20-plus years and are continuing to grow in size in a bigger installed base. More recently, we've added (internet of things) IoT and that's certainly gaining momentum.

[00:03:50] Larry: That's been the last couple years, and we will continue to grow significantly over the next few years. The starting gun has already happened there. We're developing SaaS models. Those will become more meaningful. These help with remote diagnostics, more uptime and actuating. The equipment and the combination of embedded automation and IoT solutions is really leading towards robotics.

[00:04:10] Larry: Robotics are becoming a commercialized solution. The starting gun is about now, and that'll happen over the next decade, and certainly is happening in some phases now with some trials out in the field. But, as long as the paybacks are compelling, which they appear to be so far, I think we're going to see it come into certain verticals within the restaurant industry and with specific tasks.

[00:04:30] Larry: So those three areas embedded automation, IoT, and that the combination of those leading towards robotic automation is how we see things developing. And we're in the  early innings of robotics and we're a little bit into the IoT solutions.

[00:04:46] Chris: I have two follow-up questions to that. First, do you see startups or incumbents as main players long term?

And then the second, do you think automation will be additive or cannibalize existing offerings?

[00:04:58] Larry: Yes, that's an interesting question, Chris. We really think that the restaurant industry is a very large industry, and the industrial world's a very large industry as well, and we think that they'll be both startups, which we're starting to see some of them now, as well as the long-term incumbents.

[00:05:13] Larry: I think the long-term incumbents probably have an advantage to some degree because they already have equipment going out the door with digital connectivity. They have the scalable manufacturing, the domain knowledge, and the distribution to sell and provide aftermarket service. I think the startups have some great ideas and they're going to have to attract some capital, obviously, but with their good ideas and the ability to go out and team up with robotics companies and integrators, I think that long term, there certainly will be a number of companies that would be classified as startups now come to market and they could become existing players industry or get bought out by larger players.

[00:05:49] Chris: Sharon, I'm going to go back to you. A little bit deeper in the report you lay out the restaurant characteristics that are most suitable for automation. I found this would be particularly interesting. Do you mind touching on those real quick? It doesn't sound like Michelin star restaurants are going to be adopting these anytime soon.

[00:06:05] Sharon: Yes and I think you're absolutely right. I mean, you're going to pay enough to go to a Michelin star restaurant that they can invest in all the labor they want. But going back to the haves and the have nots, you almost have to be in a have category and already have some level of success in order to invest in automation, right?

[00:06:21] Sharon: High volume restaurants, which have standardized processes are going to be better positioned to leverage that investment in automation. Repetitive tasks, are elements that nobody likes to do, including in the restaurant industry so they're easier to automate because they're repetitive. They're the least liked parts of the job because they're repetitive.

[00:06:43] Sharon: So again, lends itself very well to automation. We also look at form factors. And form factors would be something like a pizza or a taco or a bowl, or you know, a sandwich that would be a form factor. And so easy-to-assemble form factors, particularly like bowls and salads,  lend themselves to automated assembly.

[00:07:05] Sharon: And if it's a streamlined menu, all the better for automated assembly. High digital mix would be something that we would look for as well, because Chris, if you ordered online, it could be fed automatically into a digitized robotic assembly station, could make your food. Literally, nobody has to touch it at the restaurant until it comes out the other end and they hand it to you.

[00:07:28] Sharon: Right. So that's another interesting element. And then, frankly, we think restaurants that are primarily company owned are going to be more apt to adopt these kinds of technologies in the early innings. They have direct exposure to labor costs. They have every kind of incentive to look at ways to improve throughput, improve labor.

[00:07:51] Sharon: We don't think that necessarily means franchisors won't look at this more over time. But I, I frankly think it needs to be proved out in any way, shape, or form at a company on location even at a franchised ecosystem. Franchisees tend not to want to spend money unless there's a proven ROI on that investment.

[00:08:09] Sharon: Ultimately, the companies are going to have to prove that out, but right now, the companies we see that are doing the most exciting work in robotics or next-gen automation are all company owned.

[00:08:27] Chris: Based on these characteristics, you mapped out a handful of labor-intensive kitchen processes that could prove highly automatable: frying, sushi, automated make lines, pizza assembly, and beverages. Sushi surprised me, but can you break those out a little bit?

[00:08:41] Sharon: Yes, sushi probably surprises you, but it wouldn't if you stopped and thought about it.

[00:08:45] Sharon:  Who makes sushi at home? It's really, really hard. It could take 10 years to become a sushi chef. So the gating factor in scaling sushi has been. The talent of the, the cooks, right? The, the sushi chef.. Sushi robots can take out a lot of that element of training. And Chris, then you could go work at the sushi restaurant.

[00:09:05] Sharon: Sushi lends itself very well to this paradigm of frying one of the least liked jobs in the restaurant industry. Along with dishwashing that, again, very repetitive, easy to automate. Make lines is actually the area that I'm most excited about though, because assembly, if you look at it from a restaurant perspective, assembly takes a high degree of variable labor in the restaurant.

[00:09:27] Sharon: And there's a high degree of human error that can go into assembly. If I want extra guacamole, someone's has got to get that right. The machine probably will get it right all of the time. Having that automated make line potential, I think is the biggest game changer for those restaurants that have a form factor that lends itself to automated, make lines, and then pizza, assembly, and beverages.

[00:09:50] Sharon: These are big categories, so, and Larry can talk to this, but you see. The solutions providers want to target big categories.  Pizza's a huge category in the United States, so it's no surprise there's a lot of attention spent by the restaurant technology providers on pizza because there's a huge addressable audience.

[00:10:09] Sharon: Same with beverages, right? So those naturally lend themselves to investments in those end products.

[00:10:17] Larry: I'd like to add to that while there are some front of the house automation solutions coming, like that sushi example and some of the makeshift lines, I think a lot of it's also going to be back of the house and taking on these repetitive tasks in high volume situation.

[00:10:29] Larry:  I also think beverage is going to be a large category from soft drinks to hot drinks. And to your earlier point, I think this is all going to be really additive to the industrial markets, right? We're replacing labor. We're not replacing equipment per se, and we're automating tasks. So you still need a fryer.

[00:10:45] Larry: You still need a pizza oven in many cases, and I think adding robotics to these solutions will add organic growth to the commercial food service equipment segment.

[00:10:54] Sharon: Interesting. Ultimately, the amount of labor you can replace depends on the amount of variable labor you have in the restaurant. I always think about fix versus variable, right?

[00:11:04] Sharon: In the restaurant ecosystems. And if you can replace a significant amount of variable labor, that's where you get the structural margin lift. It really depends. So, for example, going to frying. You may have somebody, you may do enough fries at a restaurant that you have one person that that's all they do are fries, and you can really replace that person with an automated solution.

[00:11:26] Sharon: However, if fries are one of many sides that you have, maybe that person just gets redeployed. It's an advantage in that you take away something people don't like to do, but it's not really a labor savings per se. So it really does depend on the menu of the restaurant and the way that they utilize labor in the back of the house and, and that's where you see a lot of restaurants do the ROI analysis.

[00:11:48] Sharon: Am I really going to be able to replace labor with the solution or do I get the improvement in labor retention as a result? Or is this just a nice to have but not a need to have and I can't justify the expense right now?

[00:12:02] Larry: Part of this obviously is to Sharon's point, we're taking out labor, and that's because labor is scarce and, also, labor is becoming more expensive.

[00:12:10] Larry: But also almost equally important is because of the high turnover that we're seeing in restaurants. And when you bring your automation, you can make that product more consistent. You can reduce the labor cost and deal with that turnover issue in the restaurants.

[00:12:22] Chris: Makes perfect sense. This is super interesting.

Thank you so much for joining us here. Before we let you go, is there anything else worth touching on regarding restaurant automation?

[00:12:33] Sharon: I would just say we're also seeing more bespoke automation. So really large companies are developing their own proprietary systems in some cases, or they're working with startups to create specific solutions to their menus, and that's something that is unique over the past year or two that we haven't seen historically.

[00:12:54] Sharon: Again, we've typically seen focus on frying, flipping, or pizza, because those are big categories.  It's interesting to see some more bespoke solutions start to enter the market.

[00:13:06] Larry: I think many times what we see is in the industrial world as a large company is a first mover and they reduce their costs, improve their margins, and they get an advantage.

[00:13:16] Larry: What we see after that is fast followers. That's one of the reasons why we're so optimistic over the long term on this robotics industry really developing is that we only need a few companies to start moving forward. And then it almost forces adoption with, uh, with the competition. And we saw that with the embedded automation.

[00:13:34] Larry: Now we're seeing with IoT and I think we'll also see with robotics.

[00:13:37] Chris: Do you have a sense of when that might be? A few years from now?

[00:13:40] Larry: I think IoT, and digital business models, are really the enabler to robotic automation. As that becomes more and more ubiquitous and is already starting to be all of the equipment essentially going out from these large equipment companies now is connected.

[00:13:56] Larry: And as we have bigger and bigger installed base connected equipment that makes automation and robotics much easier. So, I really think over the next two years we'll see commercialization of this. And then over the next three to five years, we'll see probably more of a mass adoption.

[00:14:10] Sharon: I do think it's interesting though, Larry, because this is also  controversial when you talk to restaurant operators.

[00:14:17] Sharon: I mean there are as many Yays versus Nays, particularly when you talk about next-gen automation or robotics. I think one of the elements where I, that could maybe create a headwind to the fast follower situation, at least in the interim, would be the real margin pressure. A lot of restaurants have seen from third-party delivery providers taking, you know, 20 to 30% off the top of every order, as well as massive food inflation over the last few years.

[00:14:44] Sharon: So, that I think has created some ceiling on who's really considering structural automation right now, which is why I'm excited that some companies are pursuing this and at a time when many are just not interested.

[00:15:01] Larry: Yes. I think another fair headwind, Sharon, is that the upfront capital cost can be high, as you mentioned.

[00:15:06] Larry: There's already some margin pressure from the delivery companies, but that'll also bring some new business models, right? I think you're going to have some companies selling robotics and some will bring the leasing of robotics to have…let's say… an easier upfront cost that makes it smoother for them to adopt some of this technology over time.

[00:15:24] Chris: I'm going to throw out one more curve ball. How does AI connect any of this and as far as the, the progression, the quick progression in AI, I feel like automation and AI tend to fall into the same category in some regards. I'm just curious to know, is this an area that you're watching as well?

[00:15:41] Larry: AI is a key component of robotics and automation.

[00:15:46] Larry: One thing we didn't talk about was a safety factor in the kitchens, right? There are hazardous work zones when you're talking about hot oil and hot ovens, et cetera. But then you start throwing robotics and automation arms. You have to really be prepared. So, I think as the robotics that are being put in the kitchens are going to need to have some machine learning and AI in part for the safety.

[00:16:08] Larry: And in part, I think they're also going to learn to become more efficient over time.

[00:16:12] Chris: Thank you very much to both of you for joining.

[00:16:14] Sharon: Chris, it was good to catch up.  

[00:16:15] Larry: It's been a pleasure working with Sharon, and we're really excited to have this report out there, and thanks very much for having us.

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