Catering contracts: What's it worth?

03 February 2006
Catering contracts: What's it worth?

In the light of Compass's recent trading woes and controversy over hidden purchasing discounts, business and industry clients are wondering: "Do I get a fair deal from my contractor? Could I be doing better?"

Such questions are becoming more prevalent. Food costs paid by the client in "cost-plus" contracts are the first to be examined. Suspicion has grown that clients are paying inflated food prices to augment the contractor's income. Such doubts are confirmed when the client sees he can buy cheaper food at the local supermarket.

This leads to mistrust and a deterioration in relationships, resulting in poorer service for the end-user. The "cost-plus" contract is fundamentally at fault because the client picks up all bills presented, however they are incurred. And it's actually in the contractor's interest to increase costs if he is receiving discounts from suppliers. This is a situation open to abuse.

A commercial-style contract with no subsidy is simpler. A client engages a contactor on a "concession" contract, with the contractor paying an income to the client as a fixed rent or as a percentage of sales, or a mixture of both. The contractor declares his sales figure and the client can work out what he's due.

This is an extension of the high street, where tenants (Pret A Manger and PizzaExpress, for example) pay a fixed annual rent through a lease that allows them to fit out the premises with their concept and trade with the public. In this case, the tenant is taking all the risk on capital investment and paying a fixed rent for many years in the hope that his concept will attract customers and be profitable. In this scenario, the tenant's expectation of a high net operating profit is proportionate to the level of commercial risk.

Less risk
By comparison, a business and industry catering contractor is not taking anywhere near the same risk and so does not deserve such a high return.

Although the number of truly commercial activities in the B&I sector is increasing, the continuing existence of some form of subsidy and client-enforced operating constraints means commercial contracts will be difficult to bring in for the foreseeable future.

In the meantime, the best arrangement is a guaranteed-performance contract.

Why? In contrast to cost-plus contracts in which the client picks up the tab for all food costs, a guaranteed-performance contract ensures unit food costs are no longer the client's concern.

It is the contractor who will penalise himself through poor food purchasing and cost control. If he fails to offer the users good value by cutting costs, he will lose utilisation (take-up) as specified in the contract and will be in breach.

The process of contract tender and award will set the desired commercial levels. While overall responsibility for managing staff lies with the operator, the budgeted cost is a consequence of the client's decisions on concept, hours, site population and opening hours.

Clearly the client affects the basic trading conditions, market size (site population), the offer (menu range) and price (tariff or subsidy level). The contractor is taken on as a professional food-service operator who can offer quality (measured in increased utilisation and average spend) and efficiency (measured in lower costs and higher productivity).

In this type of contract, the contractor guarantees his performance in terms of quality through key performance indicators and service-level agreements, and financially through a fixed gross profit percentage. The client accepts responsibility for changing or setting any of the parameters over which he has control (see table on opposite page).

In contrast to a commercial set-up in which the gross profit generated on the sale of food should fund labour costs, overheads and provide a profit, under a B&I guaranteed-performance contract, the gross profit may be insufficient. The client will be expected to fund the balance of cost with a subsidy. A simple example is shown in the table above.

At the time of contract tendering, the successful bidder will have agreed to all the SLAs, KPIs and budget and committed himself to a fixed gross profit percentage. No matter what the sales are, in this example the contractor will guarantee to use 50% of gross profit to cover costs (food, labour and overheads). As a consequence, the client is no longer interested in the cost of frozen chips.

Assuming the contract is bid competitively, the successful contractor will have worked out what level of his purchase power to return to the client in his bid for the gross profit percentage. He will set the management fee according to the market rate.

Let's now focus on the client. For too long, clients have squeezed the fee in their negotiations with contractors, then complained when the contractor seeks to maximise his company's EBITDA (earnings before interest, tax, depreciation and amortisation) by other means. It's high time the true price for providing a service was established. The client must decide what the service is worth.

Catering services are more than just a non-taxable benefit for staff. They're a key to creating a dynamic, attractive, all-day working environment that can attract and retain the best personnel and provide conditions that encourage internal networking, knowledge-sharing and a forum for innovation that most companies need to maintain a competitive advantage.

Catering plays a crucial role throughout commerce and industry. So what is it really worth? Some years ago I undertook a project for a French company interested in buying a UK contract catering business. It was horrified at the high asking prices. "The reason," I said, "is because of their high levels of net operating profit in relationship to their real commercial risks."

No clients Alain Dupuis, chief executive of Compass's Emerging Markets Division, replied: "On the Continent, if a contractor in B&I achieves less than 4% EBITDA, he will have no shareholders, and above 6% he will have no clients."

For me, this defines a margin that contract caterers in B&I should be aiming at. It takes account of the fact that the risks and rewards are lower in B&I than in the high street. This is therefore a fair reward for advising on and managing a client's catering service.

A simple extrapolation shows a 5% net profit, a 5% head office and support cost, and therefore a management fee of 10-15% of total costs (not the total sales in a subsidised operation) depending on the size, location and level of complexity.

For example, a contract turning over about £350,000 and feeding 200 people should allow a contractor to earn £35,000-£50,000 in a transparent fashion for a well-delivered service.

If this is the fair price and worth of a successful contract, contractors have to convince their clients they are not seeking to enhance their income through hidden charges. A guaranteed-performance contract will help achieve this. They also need to prove they're true innovators capable of improving the current service.

Tony Horton is CEO of Tricon Foodservice Consultants

Annual budget for a guaranteed-performance contract

\ \
Food cost250
Gross Profit250 (50% of sales)
\* Management fee60 (10% of total costs)

*This should represent the total contribution to the contractor from this contract and may include certain financial incentives related to performance.

Areas of accountability/responsibility

Site population Food purchasing
Opening hours Income control
Menu range Utilisation
Tariff Average spend
Space Cost control
Food service concepts Productivity
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