Working the Subsidy Reduction Equation

Tracy Lawler

by Tracy Lawler

Management Fee vs. P&L

Over the last two decades, corporate clients have increasingly searched for ways to contain or reduce their food service costs. Many have moved from a benefits-based approach, in which meals were provided free or at a reduced cost to employees, to one in which foodservice is offered primarily as a convenience, with employees expected to pay its full cost (or at least a larger share of its cost).

As part of that transition, a great many have also sought to reduce the subsidies they formerly paid to operate their foodservices, or to have their foodservices operated under so-called profit-and-loss contracts instead of the management fee and subsidized account arrangements that were more common previously.

In fact, the concept of a management fee account is frequently confused with that of a subsidy account by many individuals on the client side. A management fee account is one in which a food service provider runs an operation in exchange for a guaranteed fee (the management fee). The fee may be incentivized or put at risk if the food service operator achieves or does not achieve certain benchmarks or budgets.

This structure typically places the bulk of the financial risk on the client side. If losses accrue, they are the client's responsibility. The amount by which an operation's expenses exceed its revenue becomes a subsidy funded by the client.

It's important to note that a management fee account is not always operating with a subsidy, although it may sometimes require one. A true subsidy account is one in which a subsidy is both planned and fully acceptable to the client.

A profit-and-loss account, on the other hand, places most of the risk on the side of the contract operator. A commission may be paid to the client, typically taken off the account's top line revenues, and all remaining profits or losses accrue to the operator.

Operators are not generally willing to enter into a profit and loss structure unless they are very con•dent the account will be profitable. Should circumstances change in a profit-and-loss account that threaten profitability (such as a reduction in the employee population or a change in policies or competition that reduces the capture rate) the operator will generally seek to have the contract changed to one with a management fee structure.

In fact, while true P&L operation is often not feasible, subsidy reduction is possible in quite a number of relationships. There are still a large number of clients running subsidies in the high six figures even though they have employee populations that may not warrant that large an expense. There are also smaller accounts that will always be on subsidy due to their smaller populations. Significant savings are often possible in either situation.(You can review many of the Strategies for Subsidy Reduction here)

To achieve them, the client liaison will need to commit a larger amount of time to research, invoice review and analysis, but it can pay off. The methods vary and in some cases involve a vendor change, but the task is by no means insurmountable.

Although it is a simplistic rule of thumb, I frequently advise clients that, as an employee population approaches 1500, a P&L contract should become more attainable.

That rule, of course, is greatly affected by the complexity of the operation. The more complex the operation and the greater number of services required (such as providing office coffee service or maintaining an executive dining room) the larger the population has to be to support a P&L approach. It also assumes that pricing can be established that is within 10% of street prices and that there is an appropriate breadth of offerings to attract customers.

Factors that may negatively affect an operator's ability to run a P&L include low participation rates, heavy local competition, lengthened hours of operation, multiple points of service, and low catering volume.

In particular, a second shift or weekend hours for a skeleton crew severely impact profitability.

However, even corporate accounts with a population of less than 1500 can generally reduce their subsidy, as long as they understand the financial drivers and work closely with their food service operator to effect change.

Management Fee Ranges and Profits
Management fees can range from a low of $15,000 to a high in the six figure range depending on the complexity of the account. Contract companies are often willing to earn a lower margin on a management fee account because it is essentially a guaranteed profit.

Understanding how your operator views your account in terms of profitability is important in your efforts to reduce the subsidy and or re-negotiate the contract.

As in any relationship, the business needs to work for both parties in order to maintain a successful ongoing partnership. The sidebars in this article outline some of the key strategies to consider when embarking on a subsidy reduction program.

Tracy Lawler is Executive Vice President at JGL Management Services and provides food service consulting to business and industry, cultural, and educational markets. Tracy can be reached at [email protected] or 732 274 1694.

For a related story, click here: The Immutable Laws of Profit and Loss