The last time we talked about the capital cycle was in a summary of Capital Returns: Investing Through the Capital Cycle — part of the Capital Expertise Series. In that piece, I wrote:
The capital cycle is amongst the most basic patterns that you will find in finance, and one of its simpler ideas — perhaps second only in simplicity to the credit cycle. But of course the question that’s worth asking is: how do you exploit it? And I mean how do you exploit it as both an operator and an investor, for capital cycles occur in just about every industry.
(...) It’s not enough to say “oh, take counter-cyclical actions.” The difficult thing is how. If your business is cyclical in nature, you are — by definition — going to be cash rich when everyone else is rich, and cash poor when everyone else is poor. The real question, worth asking — which is on display throughout the Sampo case study above — is how to be cash rich when everyone else is poor. It’s really only in this manner that you may strengthen your hand whilst everyone else is suffering.
[Banker Björn] Wahlroos’s solution seemed to be to sell pieces of his business at peak market prices, and then to sit on cash until he could redeploy at the bottom of the market. Once you are aware of this pattern (that cyclical companies who do the best seem to be the ones who take advantage of their sector cycle) you start spotting it in all sorts of places.
This week’s case is a direct follow-up to our previous introduction to Will Guidara. In the previous piece we talked about Guidara learning the ropes of the restaurant business from the back office. The way Guidara talked about that was “restaurant smart vs corporate smart” — that is, good at hospitality and serving food, but also good at running the business as a business: the nuts and bolts of tracking costs, watching cash flow, and running at a profit. The point I was trying to make is that being data-driven is a matter of will, not just of skill: you really should just go ... look at your data. Preferably every week. Guidara learnt to look at his financials every day; if he could do that running a restaurant, working with paper, you can do it too.
But there’s another aspect of Guidara’s story that we left out of the essay, that was mostly on display in the case itself. This had to do with balancing standout service with smart costs:
Guidara had another stab at finding this balance when he became general manager of the casual food operations at the Museum of Modern Art (MoMA). By this point he had returned to working for Danny Meyer. Will writes:
“Every decision I made seemed to expose the natural tensions between improving the quality of the experience the guests were having and doing what was best for the business. Restaurant-smart meant leading with trust—including allowing the people who worked for me to do what they felt was best for the guests. Corporate-smart meant running a tight ship. Which was right?”
The question continued to haunt him when he began to design a gelato cart for the one-of-a-kind Sculpture Garden in the MoMA. But here Guidara discovered one way to achieve balance — something he called the ‘95/5 rule’.
What is the 95/5 rule?
It is to manage 95% of your financials down to the penny while spending the remaining 5% “foolishly”, and “splurging” the 5% on the guest experience to create an unforgettable experience.
The 95/5 rule came from … Guidara’s experience with gelato spoons.
Image Source: Will Guidara’s Instagram
If we take a step back, it’s a little ridiculous to say that a disposable spoon could be so impactful on the MoMA’s gelato cart. But Guidara’s instincts told him otherwise. It seemed obvious to him that the spoons were needed for the gelato cart to shine no matter what anyone had to say. The problem was that the spoons were terribly expensive. Guidara writes:
The first time my boss saw one of those spoons, she narrowed her eyes and asked me what they had cost. I told her, and her eyes got even narrower: “We’ll talk about this later.” But a month later, we sat down to review the first P&L for the cart, and I never heard another word about those spoons.
Guidara ensured that 95% of the cart budget was meticulously managed — he used MoMA’s name to get the gelato at a steep discount, and without needing to pay for the gelato cart. (The cart was paid for by Jon Snyder, owner of il laboratorio del gelato). Costs secured, Guidara went all-in on the spoons.
His gamble was an overwhelming success. One day, Guidara saw Glenn Lowry, the director of MoMA, buying gelato for a group of visiting curators. To Guidara’s deep satisfaction, the curators spent a moment admiring the spoons they held in their hands before digging into the gelato. These blue spoons have since become inseparable from the popularity of the gelato cart.
A few years later, Guidara’s early notions about finding balance between ‘restaurant smart vs corporate smart’ was put to the ultimate test: with the 2008 global financial crisis.
Eleven Madison Park on Survival Mode
The 2008 Global Recession was the most severe global economic crisis to occur after the Great Depression in the 1930s. Nobody was spared from its effects. Naturally, fine dining restaurants like Eleven Madison Park (EMP) were seen as an unnecessary expense amidst the severe economic and financial meltdown. Will Guidara, then-manager of EMP, writes of the aftermath experienced by EMP in his book:
“Our private-party business ground to a halt. Wedding parties downsized, either by cutting the guest list or fleeing to more modest venues. And companies, whose lavish private events and cushy expense accounts are a fine-dining restaurant’s bread and butter, had switched into austerity mode as well.”
In many ways, providers of luxury goods and services were the worst affected. Why? Well, businesses that sell expensive things are expensive to run. Guidara continues:
“We had all the expenses associated with running a four-star restaurant without the demand that came with the honour—or the ability to charge four-star prices.”
Even worse, EMP had yet to earn a spot in the Michelin Guide. Earning stars from the Michelin Guide was among the most prestigious honour that a restaurant could achieve. Without a star, EMP was at the bottom of the luxury restaurant food chain.
Another type of restaurant, however, thrived: casual dining restaurants which offered reasonable food at affordable prices. An example of this was Shake Shack. The quality of food and service at Shake Shack and the price at which it was sold appealed to the masses, and large crowds flocked to them for a sumptuous meal. Guidara writes:
“One couple brought a bottle of champagne to Madison Square Park and raised a glass to our huge windows from across the street—over an order of cheese fries from Shake Shack.”
The reason EMP managed to stay afloat was the financial support it received from the profits of Shake Shack. At the time, Shake Shack was owned by the same corporation that owned EMP, which in turn was a subsidiary of the Union Square Hospitality Group (USHG) run by Danny Meyer. Hence, the profits from Shake Shack were used to cover the losses incurred by EMP during the recession.
The First Step to Overcome a Crisis: Cutting Costs
Guidara was frustrated by the financial losses incurred by EMP. The dining room became emptier as the days went by, leading the restaurant to bleed cash. Moreover, Shake Shack couldn’t support EMP forever. The situation got to the point where Guidara almost gave into his despair at EMP’s potential closure. However, multiple calls to his father, Frank Guidara, gave him some support … as well as a way to reframe the situation. Guidara writes:
“He (Frank) was a cutthroat survivalist, never precious about the niceties of restaurants in general, and fine dining in particular. But as always, he pulled me out of the forest so I could see the trees. ‘Adversity,’ he told me, ‘is a terrible thing to waste.’”
In an economy where demand was unpredictable, Guidara focused on what he could control — minimising costs. He sometimes struggled to find expenses to cut given the high labour and food costs that luxury restaurants bore. However, at every Profits & Losses (P&L) meeting where Guidara and USHG discussed areas of concern and success, Paul Bolled-Beaven, (President of Core Businesses of USHG and Meyer’s partner) reminded him that “raindrops make oceans.”
Guidara became hyper-attentive to every cost at EMP — every expense was counted, and the money saved allowed them to survive another day. Cutting costs, however, did come with some trade-offs. Guidara writes:
“Our cooks wore tall paper toques because they were beautiful and classic and a link to Daniel’s European heritage. They were also disposable; the cooks could discard them when they got sweaty or stained. One night, I did the math. If a cook went through two or three toques over the course of a hard shift, and there were thirty cooks in the kitchen working two shifts a day, that meant we were spending thousands of dollars a year on those toques—whereas a box of the thick, washable cotton skullcaps most restaurants gave their cooks cost a few hundred, and we’d get at least a year out of those. That cut was hard: we’d chosen the toques because we wanted the cooks to feel a sense of pride and a connection to their culinary history every time they put them on. But leadership during a crisis means recognizing it’s more than the hats that give the cooks a sense of pride.” (emphasis added)
As Guidara went through these trying times, his father encouraged him to maintain a journal of his thoughts. Frank said: “Perspective has an expiration date, no matter how hard you try to hold on to it.”
The journals gave Guidara access to valuable experiences that he could carry into the future.
However, Guidara still had big dreams for EMP. In his words, “managing expenses is playing defence,” and it was not enough to sustain the business in the long run. They needed to play offence — investing capital to increase footfall and become the best restaurant in the world.
The Second Step to Overcome a Crisis: Getting Creative in Making Money
Guidara set a goal for EMP ‘to be the four-star restaurant for the next generation.’ By this he meant that the restaurant’s old clientele of high spenders — affluent patrons who could care less about the bills they ran up — had all but disappeared. Guidara needed to create a dining experience for a new set of customers: middle-class patrons who had dreams of living a more comfortable life. Guidara’s own dream was for EMP to grow with this new demographic.
As EMP continued to cut costs, Guidara used the money saved to launch creative experiments designed to earn profits. It began with the introduction of a $29 two-course lunch set. For context, an entree at EMP would have cost a minimum of $25 per plate before the recession. Guidara said:
“The check average at EMP had never been low, not even when it was a brasserie, but it helped to fill the empty seats and bring the energy back into the dining room.”
Instead of being discouraged by the low revenue earned per table, Guidara was determined to offset it. He described a tweak that earned EMP a 300% increase in dessert sales:
“At EMP, we introduced a dessert trolley—a cart stacked with delicious pies and cakes and tarts—that we could push right over to the table. Most of the time, when you offer people a dessert menu at lunch, they look at you like you’re an alien. It’s partly calories, but mostly no one has time to go through the whole rigmarole of ordering a dessert, then waiting for it to be plated and brought out and eaten and cleared before they can get the check. Dessert tacks half an hour onto your meal, and at lunch, especially in New York, people are in a hurry to get back to work. Roll up to their table with a dessert cart, though, and they turn into wide-eyed little kids struggling to choose their treat—especially because they know they can have the one they point at, right away. The cart was beautiful and experiential, and people loved it. Dessert sales went up by 300 percent.”
Guidara put into action the 95/5 rule he devised while designing a gelato cart for the one-of-a-kind Sculpture Garden in the MoMA. Guidara’s 95/5 rule is to manage 95% of your financials down to the penny while spending the remaining 5% “foolishly”, and “splurging” the 5% on the guest to create an unforgettable experience. In the gelato cart incident, the 95% had been the financially disciplined way Guidara had set up the gelato cart, and the 5% his decision to “splurge” on distinctive blue gelato spoons! At EMP, however, Guidara decided to splurge on a big party celebrating the Kentucky Derby. Held in Louisville, Kentucky, the Kentucky Derby was the most-watched and attended horse race in the US. For Southerners, it was equivalent to a national holiday. It did not make sense to throw a huge party in the middle of a recession, but Guidara did it anyway. He capitalised on homesick Southerners and the joy of having fun without a reason. At the end of the night, Guidara had only broken even, but he had fostered a loyal crew who were passionate and happy about their work.
The Fruits of Their Labour
EMP’s financial position improved by leaps and bounds, its profit margins had never been better. Soon enough, they caught the attention of Frank Bruni, a restaurant critic for the New York Times — the man who would decide if they got the four-star review they had been vying for.
The review process was unexpectedly long. Compared to the usual few weeks it took to review a restaurant, the process to evaluate EMP took months. Guidara didn’t leave anything to chance, making sure that everyone in the restaurant performed their tasks as if Bruni was in their restaurant every day. Guidara writes:
“I thought about this when I watched The Last Dance, a documentary about Michael Jordan and the Chicago Bulls, the team he led to six NBA championships. Jordan’s competitiveness was legendary; it was his fuel. If another player dared trash-talk him on the court, or disrespect the Bulls in the media, watch out. But if nobody dared, then Jordan would fan the flames himself, inventing slights and interpreting accidental bumps as personal attacks. Any hint of disrespect, even fabricated, was enough to motivate him to rise to the occasion. He’d create stakes, even when there were none. Most nights, the critic in our restaurant wasn’t real, just as the rivalry Michael Jordan created in his head wasn’t real, but it doesn’t have to be real to work.” (emphasis supplied)
Finally, on August 11, 2009, all the guests and employees of EMP celebrated when the restaurant was awarded a four-star New York Times review.
Surviving, Not Thriving
At the end of The Capital Cycle I wrote:
One final note. I will say that the biggest impact that Capital Returns has had on me is this sense of “here’s what the game looks like when you’re dealing with a cyclical business.”
I think this is useful. It is too easy to say “oh, just get out of cyclical businesses” or “go build a moat!” — as if the average business owner is able to so radically change the businesses he or she is in. And, ok sure, yes, over the long term this is possible — you can build a moat to blunt the effects of supply in a cyclical industry, and you can evolve your business out of cyclicals. In fact both of these moves show up in the story of Danaher, a conglomerate that shifted their business composition from cyclical industrials to more desirable healthcare businesses over the course of three decades.
But what if you work in a cyclical industrial? What if you were one of the managers that Danaher left behind at Fortive — the holding company for all its old industrial businesses? For the vast majority of late career operators, jettisoning out of a cyclical business that you are good at is not a real choice. So, yes, go get a moat (and Fortive has one) — but Marathon’s ideas give you a better sense of the financial forces acting on your business. I think that gives you a route to winning.
One of the bigger questions that I have is “how do businesses, run by competent operators, deal with the broader economic cycle — assuming that you can’t diversify out from a fundamentally cyclical business?” Sure, things are good if you run a bank, like Sampo, which holds relatively liquid assets, or if you run a diversified manufacturing-and-biotech conglomerate like Danaher, that consists of cyclical and non-cyclical subsidiaries. But what do you do if you run ... a corner store? Or, worse ... a fine dining restaurant? This case with Eleven Madison Park is useful because it lays out the most boring base case: here is what it looks like when a competent restauranteur rises to the occasion, when faced with the financial test of a lifetime.
(Unfortunately the answer in this instance seems to be “be lucky to have a diversified low cost food option like a popular burger stand contributing to your P&L, while you do everything else to survive”!)
As we add more cases to the Commoncog Case Library, we will return to this question again and again — but with different businesses, from different time periods, and in different industries. I’m eager to see what we find.
Originally published , last updated .
This article is part of the Operations topic cluster, which belongs to the Business Expertise Triad. Read more from this topic here→
This article is part of the Capital topic cluster, which belongs to the Business Expertise Triad. Read more from this topic here→
