What happens to a successful company when it loses its founder, senior chairman, advertising icon, and beloved leader? That was the qucstion being asked about Wendy's International, Inc., in January 2002 after Dave Thomas, 69, passed away from cancer. In the words of Jack Schuessler, the company's chairman and CEO, "Dave was our patriarch. He was the heart and soul of our company." Without him, the company would never be the same. However, Dave Thomas left behind a legacy about valucs, ethics, product quality, customer satisfaction, employee satisfaction, community service and shareholder value that provided a solid foundation on which to continue the success the company had experienced for more than thirty ycars. Still, the patriarch was gone, and the futurc was uncertain. HOW IT BEGAN Wendy's International, Inc., was founded by Mr. R. David Thomas in Columbus, Ohio, in November 1969. Prior to that time, Mr. Thomas had purchased an unprofitable Kentucky Fried Chicken franchise in the Columbus area, turned it around, and subsequently sold it back to Kentucky Fried Chicken at a substantial profit. He then became a cofounder of Arthur Treacher's Fish \& Chips. So, at the time he founded Wendy's, Mr. Thomas was no stranger to the quick-service restaurant industry. Although he had been involved with busincsses specializing in chicken and fish, 1969 Mr. Thomas's favorite food was hamburgers, and he frequently complained that there was no place in Columbus to get a really good hamburger without waiting thirty minutes or more. Someone finally suggested (whether in earnest or in jcst was debatable) that he get into the hamburger business and do it his way. After thinking it over, that's just what he did, and he named his new company after his cight-year-old daughter, Wendy. His go 915 order, served quickly, and reasonably priced. By offering what he believed was a different product, Wendy's went after a different segment of the hamburger market- tarq er seq Wendy's International, Inc., chose as its trademark what the company called the "old-fashioned" hamburger. This was a hamburger made from fresh beef that was cooked to order and served directly from the grill to the customer. So that customers could see what they were cating, "old-fashioned" hamburgers were square in shape so as to extend beyond the round buns on which they were served. The unique shape also differentiated a Wendy's' hamburger from those of other restaurants. Mr. Thomas felt Q21e|1 that one way for Wendy's to remain price competitive and still serve a better-quality product was to limit the number of menu items. Thus, he decided on four main products: CASE: WENDY'S CHILI: A COSTING CONUNDRUM 91 hamburgers, chili, french frics, and Wendy's' Frosty Dairy Dessert. The standard soft drinks and other beverages were aiso included. Wendy's' old-fashioned hamburgers were pattied fresh daily from 100% purc domestic beef and served "hot " n juicy" in accordance with individual customer orders. 4 basicitems Customers could choose either a single (one 1/4lb. patty), a doublc (two l/4 lb. patties), or 256 combinations a triple (three l/4 lb. patties). With the many condiments available, Wendy's was able to offer varicty (256 possible hamburger combinations) even though its menu was limited to four basic items. Wendy's' chili was prepared daily using an original recipe. It was slow-simmered from four to six hours and served the following day. Each eight-ounce serving contained about a quarter-pound of ground becf. The same beef palties were used in making chili as were scrved as hamburgers. Although it was sometimes necessary to cook beef patties solely for use in making chili, most of the meat for sv1q Wendy's' chili came from "well-done" becf pattics that could not be served as "hot ' n, juicy" old-fashioned hamburgers. These "well-done" hamburgers were refrigerated and used in making chili the following day. Wendy's' french fries were prepared from high-quality potatoes and were cut slightly longer and thicker than those served by most other quick-service hamburger chains. The company used specialized fryers designed to cook the inside of thesc bigger potatoes without burning the outside. Wendy's' Frosty Dairy Dessert was a blend of vanilla and chocolate flawors that was too thick to drink through a straw. It was served with a spoon to be eaten as a dessert, but some customers ordered a Frosty in place of a soft drink. Whether served as a dessert or as a dairy drink, the Frosty was a distinctive and popular menu item. INITIAL GROWTH The first Wendy's restaurant opened in Columbus, Ohio, in November 1969. The second Wendy's opened in 1970, restaurants three and four opened in 1971, and restaurants five, six, and scven opened in 1972. In addition to these seven companyoperated stores, two franchised restaurants were opened in 1972. As shown in Table 1, a substantial increase occurred in the number of Wendy's restaurants opened between 1973 and 1978 , the majority of which were Iranchised nits. P2 PART II: FUNDAMENTALS OF PRODUCT AND SERVICE COSTING Both company and franchised restaurants were built to company specifications as to exterior style and interior decor. Most were frcestanding, one-story brick buildings, substantially uniform in design and appearance, and constructed on approximately 35,000-square-foot sites with parking for 3540 cars. Frecstanding restaurants contained [ about 2,400 square feet and included a cooking and food preparation area, a dining room designed to seat 92 customers, and a pick-up window to serve drive-thru customers. Wendy's restaurants were usually located in urban or densely populated suburban arcas, and their surcess depended upon serving a large volume of customers. As of December 31,1978 , the 288 company restaurants were located in 18 multi-county areas in and around the cities listed in Table 2. At this time, there were no franchised restaurants located in any of the market areas served by company restaurants. company 2 tanchisees t sepatcte ma NY REVENUES Wendy's' initial revenues came from four principal sources. As shown in Table 3, these were: sales made by company restaurants, royalties paid by franchise owners (franchisees), technical assistance fees paid by franchise owners, and interest earned on investments. The increase in the percentage of total revenues that resulted from royalties during the five-year period covered by Table 3 was primarily caused by the substantial increase that occurred in the number of franchised restaurants relative to the number of company restaurants. Tftsnchre rrernue Table 3 Percentage Revenue Composition 1974-1978 Revenue from sales made by company restaurants was recognized as soon after the sales occurred as was practicable. Because the amount of cach company restaurant's daily net sales was to be reported to corporate headquarters in Dublin, Ohio, by 8:00 a.m. the next day, these sales werc generally recorded by the corporate accounting staff the day after the sales were made. Wendy's' franchise agreements stipulated that every franchisee must pay to Wendy's International, Inc., a technical assistance fee for each restaurant the franchisec agreed to build within the franchised area.' The due date for payment of the technical assistance fee (sometimes referred to as a franchise fee) was negotiated with each franchisec. The earliest duc date was at the time the franchise agreement was signed; the latest duc datc was 30 days prior to the opening of each restaurant. According to Wendy's' management, the technical assistance fees did not contribute substantially to company profits inasmuch as they were generally fully cxpended on providing a varicty of services to franchise owners prior to the onening of cach restaurant. These serviccs included: site selection assistance, standard construction plans and specifications, initial training for franchisc owners and restaurant managers, advertising materials and assistance, national purchasing agreements, and operations manuals. Technical assistance fees received anytime prior to the opening of the related franchised restaurants were recorded by the company as "deferred technical assistance fees." Technical assistance fees were recognized as revenuc at the time the franchised restaurants commenced operations. Once a franchised restaurant was opened, franchise owners had to pay Wendy's International, Inc., a royalty of 4% of gross sales. In connection therewith, franchisees were required to submit to the company weekly sales reports (due the following Monday) for each restaurant. Payment of the royalty was made on a monthly basis and was due, along with a monthly sales report, by the 15 th of the following month. Royalties were 2e2v2 recognized on an accrual basis at the end of each month based on the weekly salcs reported by franchisees. If nccessary, these monthly accruals were adjusted at the time the royalty payments were reccived from franchisecs. Wendy's did not select or employ any personnel for franchisees, nor did the company scll fixtures, food, or supplics of any kind to franchisees. Also, unlike many other restaurant chains, Wendy's did not derive revenue from owning the franchised units tike C and leasing them to franchisees. All of Wendy's' franchise owners either owned their "mo franchiscd restaurants or leased them from independent third parties. [Interest and other "owne, income represented the amounts earned on investments, principally ccrtificates of (4) deposit, bankers' acceptances, and commercial paper. These amounts were recognized by the company on an accrual basis as earned. CHILl AND THE WENDY'S WAY Wendy's was founded on the belief that the combination of product differentiation, market segmentation, quality food, quick service, and reasonable prices would produce a successful company. This combination was oficn referred to by Mr. Thomas as the "Wendy's Way." The decision to include chili as one of the original menu items was made after careful consideration of the most desirable product mix in keeping with the Wendy's Way. The first and most important of Wendy's' products was, of course, the "oldfashioned" hamburger. French fries were the second item included on the menu, primarily because so many customers ate french fries with their hamburgers. It was at this point that a product decision needed to be made that would enhance the successful implementation of the Wendy's Way. Wendy's' management knew that the only way their restaurants could serve old-fashioned hamburgers directly from the grill in accordance with individual customer orders, and still be able to scrve 1 hem quickly, was for the cooks to anticipatc customer demand and have a ufficient supplof hamburgers already cooking when the customers arrived at the restaurants. The problem with such an approach, however, was what to do with the hamburgers that became too well-done whenever the cooks overestimated customer demand and cooked too many hamburgers. Throwing them away would be too costly, but serving them as "hot 'n juicy" oldfashioned hamburgers would result in considerable customer dissatisfaction. The solution to this dilemma was in finding a product that was unique to the restaurant industry and that required ground beef as one of the major ingredicnts. Thus, Wendy's' "rich and meaty" chili became one of the four original menu items. DIFFICULTIES IN THE 1980s Wendy's continued its growth in total number of restaurants, revenues, and income throughout the first half of the 1980s. Responding to competitive pressures and changing customer demands, Wendy's added chicken to its menu through the acquisition of Sisters International, Inc. The company also expanded and improved its Garden Spot salad bar, added stuffed baked potatoes to the menu, and changed its restaurant decor to reflect a more upscale environment. As a means of providing more flexibility in dealing with franchisecs and of facilitating expansion, Wendy's began the use of the single-unit CASE: WENDY'S CHILI: A COSTING CONUNDRUM 95 franchise method whereby franchise rights were granted on a restaurant-by-restaurant basis, rather than on an area basis as had been the company's previous practicc. In 1985, revenues excecded $1 billion for the first time, and income set a new record at $76.2 million. Notwithstanding this impressive performancc, management faced some formidable challenges. The U.S. economy was softening, and lower discretionary a consumer spending served to increase competitive pressures in the quick-service restaurant industry. The company's major competitors had substantially improved the quality of their products, service, and facilities, and they had boen aggressively introducing new menu items. The year 1986 turned out to be the worst in the company's history. Total revenues increas than two percent over the previous year, and the company recorded $75 million chargg for busines6 realignment expense. Consequently, Wendy's reported a loss for the year of approximately $5 million, its first loss ever. As an example of the competitive nature of the industry, Wendy's made a strategic decision to serve breakfast on a system-wide basis in June 1985. Shortly thereafter, the economy worsened, and Wendy's' major competitors introduced new products targeted specifically at Wendy's' customers. This created an environment where it was difficult to justify the investment nccessary to accomplish a system-wide breakfast offering. Thereforc, in March 1986, brcakfast became arcoptionai ment item for both company and franchised restaurants. In 1987, Wendy's sold Sisters International, Inc., and began a systematic reduction in the number of company restaurants both inside and outside the U.S. The company also continued to expand the availability of its new three-section Super Salad Bar, and by year-end, it was installed at more than 90% of company restaurants and approximately 40% of franchised restaurants. Due to a \$15 mullion income tax benefit and a $1 million extraordinary gain on early extinguishment of debt, Wendy's reported income of $4.5 million in 1987. I IN THE 1990s As Wendy's entered the 1990s, there were indications that the company was about to regain the momentum it had lost during the latter part of the previous decade. Company restaurant opcrating profit margins, return on average assets, and return on average equity had all begun to improve, and most of the unprofitable company restaurants had becn closed. Wendy's was ready to begin a program of prudent, aggressive growth both domestically and internationally. One of the interesting debates that occurred from time to time during the "realignment period" of the late 1980s and carly 1990s had to do with the role of the company's original menu items in light of the introduction of what became known as Wendy's' "balanced product and marketing approach." This approach had been introduced to enable the company to respond in a timely manner to ever-changing customer trends with respect to menu composition and pricing. Although Wendy's had abandoned its original "limited menu" concept during the late 1970s, the four original menu items continued to be soid as part of a group of product offerings that management referred to as tho core menu As a guide for the 1990 s, management identified six specific operating objectives, which then became known as "the keys to success." Key \#1 was to grow the total number of Wendy's restaurants, with a goal of 5,000 by 1995 . Key \#2 was to gencrate consistent real sales growth (e.g., without prices increases) from quarter to quarter. Kcy \#3 was to continue to improve restaurant operating margins. Key \#4 was to manage corporate overhcad expenses prudently. Kcy H5 was to enhance return on assets. And Kcy \#6 was to continue to strengthen the entire restatrant system through the selective salc of company units to strong cxisting or new franchisecs, while acquiring units in need of attention from cxisting franchisecs. In addition to Wendy's' new operating objectives, the company continued to experiment with new menu items throughout the 1990s. In March 1992, the company began offering five fresh salads to go. In addition, the company introduced a spicy chicken sandwich, and it then added a 5-picce chicken nugget item to its 99-cent Super Value menu. Management's hard work paid off, and the company added almost 2,000 restaurants during the decade. e A A significant event occurred for the company in December 1995, when the company merged with Tim Horton, a coffee and baked goods company headquartered in Canada. This merger enabled both companies to expand their own operations across the United States/Canada border, and provided a strong foundation for further expansion of Wendy's' and Tim Horton's franchise operations. THE CHALLENGES OF THE 2000S The new millennium brought many changes to Wendy's. John "Jack" T. Schuessler was named CEO and Chairman of the Board in March 2000, and the company opened its 6,000th restaurant in October 2001. However, these milestones were overshadowed by the death of Dave Thomas in January 2002. Maintaining the momentum of the past decade was going to depend on Wendy's' ability to establish itsclf as the franchisor of choice for franchisees, the cmployer of choice for employees, and the restaurant of choice for customers. Thus, one of the most critical aspects of customer satisfaction had to do with the quality, pricc, and varicty of the products sold. Menu decisions would likely becomc increasingly important as Wendy's continued to implement its portfolio approach of "super value" menu items, "specialty" menu items, and "core" menu items. As the company began its post-Dave Thomas era, management thought that perhaps the time had come to give serious consideration to eliminating at least one of the original menu items. Of these, chili seemed to be the most likely candidate. In addition to being the menu "maverick," chili represented a relatively small percentage of total restaurant sales, and there was considerable controvcrsy over its true profit margin. The issue, it sccmed, had to do with determining the actual cost of a bowl of chili. This same issue had, in fact, been debated but never resolved back in 1979 when Wendy's' salad bar CASE: WENDY'S CHILI: A COSTING CONUNDRUM COSTING THE CHILI Wendy's' chili was prepared daily by the assistant manager, in accordance with Wendy's' secret recipe. It was slow-simmered in a double boiler on a separate range top for a period of from four to six hours. While cooking, the chili had to be stirred at least once each hour, and at the end of the day it was refrigerated for sale the following day. Normally, it took between ten and fifteen minutes to prepare a pot (referred to at Wendy's as a batch) of chili. First, the forty-eight l/4 lb. cooked ground beef patties nceded for a batch were obtained, if available, from the walk-in cooler. This took about one minute to do. These patties wcre ones that had been "well-done" sometime during the previous three days. Most of the time it was not necessary to cook any meat specifically for use in making chili, although the need to do so was more likely to occur during the months of October through March when approximately sixty percent of total annual chili sales occurred. If, as only happened approximately ten percent of the time, it became necessary to cook meat specifically for use in making chili, the number of becf patties needed were taken from the trays of uncooked hamburgers that had been prepared using a special patty machine, at the rate of 120 patties cvery five minutcs, carlicr that morning. On average, it took ten minutes to cook forty-eight hamburger patties. 10mins48bur. Before placing the meat in the chili pot, it had to be chopped into small picces. This generally took about five minutes to do. The remaining ingredients then had to be obtained from the shelves and mixed with the meat. This process also took about five minutes to complete, after which the chili was ready to be cooked. The quantities and costs of the ingredients needed to make a batch of chili, and the labor costs associated with the different classifications of restaurant personnel are shiown in Tables 4 and 5. Other direct costs associated with the chili included: scrving bowls, $.035 each; lids for chili served at the carry-out window, $.025 each; and spoons, $.01 each. CHILI SALES 'The selling prices for all of Wendy's' products sold by company restaurants were sec at corporate headquarters. Although some price diffcrences existed among restaurants in different locations, representative prices for 2001 were $.99 for an 8-ounce serving of chili, $1.59 for a 12 -ounce serving of chili, and $1.89 for a "single" hamburger. Chili sales werc scasonal, and comprised about 5% of total Wendy's' store sales compared to about 55% for hamburgers. As shown in Exhibit I, Wendy's' consolidated cost of salcs, as a percent of retail revenues, increased to 63.8% in 2001 from 63.1% in 2000 . Food costs in 2001 reflected a 13.4% increase in becf costs, which was partially offsct by a 1.6% selling price increase. Retail sales increased by 6.5%, and net income increased by about 14% during 2001 . Notc: The batch of chili described above yielded approximately 57 eight-ounce servings. Note: Payroll taxes and other cmployee-related costs averaged about 10% of the above amounts. 1. How was Wendy's able to achicve its initial success and to grow so rapidly at a time when the quick-service hamburger business appeared to be saturated? 2. What benefits might have resulted from Wendy's' "limited menu" concept? What were the disadvantages of such a concept? Why was the concept eventually discontinued? 3. Why was Wendy's' drive-thru window successful when other quick-scrvicc restaurant chains had been unsuccessful at implementing the same conccpt? 4. How much does a bowl of chili cost on a full-cost basis? An out-of-pocket basis? 5. For determining the truc profitability of chili, how much does a bowl of chili really cost? 6. Would you recommend dropping chili from the menu? Why or why not? Exhibit 1 WENDY'S CHILI: A COSTING CONUNDRUM Statement of Income for the Years Ended December 31, 2001 and 2000 CHILI CONUNDRUM \begin{tabular}{l|l|r|} \hline Restaurant Labor Costs* & & Payroll Fees \\ \hline Store Manager & $800 per week & $80.0 \\ \hline Co-Manager & $12.50 per hour & $1.3 \\ Assistant Mgr. Wage & $10.50 per hour & $1.1 \\ & $2.63 per 15 mins & $0.3 \\ Management Trainee & $7.00 per hour & $0.7 \\ Crew & $5.75 per hour & $0.6 \\ \hline \end{tabular} DM Variable Overhead* Payroll taxes/other costs Assistant manager wage (1/4 hour) *is this how we should classify this? Payroll (.1)= wage) Need to determine: Chili: full cost (see next tab) Chili: out of pocket cost (relevant cost) Chili: cost for true profitability SKETCH - out of pocket DM $3.20 DL $2.63 is the assistant manager wage relevant? Thinking it might not be since he/she would be there anyway VOH $1.1 same for payroll - relevant? TRUE profitability - would that include the non-relevant costs? INCOME STATEMENT 2001 Revenue RetailOperationsOther,principallyinterest$1,925,319$465,878$2,391,197 Costs and Expenses \begin{tabular}{lr} \hline Cost of Sales & $1,229,277 \\ Comp. Restaurant & $406,185 \\ Operating Costs & $91,701 \\ \hline Operating Costs & $216,124 \\ \hline General and Admin & \\ expenses & $118,280 \\ \hline Depreciation and & $1,722 \\ amortization of property & $20,528 \\ and equipment & $2,083,817 \\ \hline International Charges & $307,380 \\ \hline Other expense & \\ \hline Interest, net & \\ \hline \end{tabular} can we just use 5% of the operating expenses? Income before income taxes Income taxes Net income $193,649 What happens to a successful company when it loses its founder, senior chairman, advertising icon, and beloved leader? That was the qucstion being asked about Wendy's International, Inc., in January 2002 after Dave Thomas, 69, passed away from cancer. In the words of Jack Schuessler, the company's chairman and CEO, "Dave was our patriarch. He was the heart and soul of our company." Without him, the company would never be the same. However, Dave Thomas left behind a legacy about valucs, ethics, product quality, customer satisfaction, employee satisfaction, community service and shareholder value that provided a solid foundation on which to continue the success the company had experienced for more than thirty ycars. Still, the patriarch was gone, and the futurc was uncertain. HOW IT BEGAN Wendy's International, Inc., was founded by Mr. R. David Thomas in Columbus, Ohio, in November 1969. Prior to that time, Mr. Thomas had purchased an unprofitable Kentucky Fried Chicken franchise in the Columbus area, turned it around, and subsequently sold it back to Kentucky Fried Chicken at a substantial profit. He then became a cofounder of Arthur Treacher's Fish \& Chips. So, at the time he founded Wendy's, Mr. Thomas was no stranger to the quick-service restaurant industry. Although he had been involved with busincsses specializing in chicken and fish, 1969 Mr. Thomas's favorite food was hamburgers, and he frequently complained that there was no place in Columbus to get a really good hamburger without waiting thirty minutes or more. Someone finally suggested (whether in earnest or in jcst was debatable) that he get into the hamburger business and do it his way. After thinking it over, that's just what he did, and he named his new company after his cight-year-old daughter, Wendy. His go 915 order, served quickly, and reasonably priced. By offering what he believed was a different product, Wendy's went after a different segment of the hamburger market- tarq er seq Wendy's International, Inc., chose as its trademark what the company called the "old-fashioned" hamburger. This was a hamburger made from fresh beef that was cooked to order and served directly from the grill to the customer. So that customers could see what they were cating, "old-fashioned" hamburgers were square in shape so as to extend beyond the round buns on which they were served. The unique shape also differentiated a Wendy's' hamburger from those of other restaurants. Mr. Thomas felt Q21e|1 that one way for Wendy's to remain price competitive and still serve a better-quality product was to limit the number of menu items. Thus, he decided on four main products: CASE: WENDY'S CHILI: A COSTING CONUNDRUM 91 hamburgers, chili, french frics, and Wendy's' Frosty Dairy Dessert. The standard soft drinks and other beverages were aiso included. Wendy's' old-fashioned hamburgers were pattied fresh daily from 100% purc domestic beef and served "hot " n juicy" in accordance with individual customer orders. 4 basicitems Customers could choose either a single (one 1/4lb. patty), a doublc (two l/4 lb. patties), or 256 combinations a triple (three l/4 lb. patties). With the many condiments available, Wendy's was able to offer varicty (256 possible hamburger combinations) even though its menu was limited to four basic items. Wendy's' chili was prepared daily using an original recipe. It was slow-simmered from four to six hours and served the following day. Each eight-ounce serving contained about a quarter-pound of ground becf. The same beef palties were used in making chili as were scrved as hamburgers. Although it was sometimes necessary to cook beef patties solely for use in making chili, most of the meat for sv1q Wendy's' chili came from "well-done" becf pattics that could not be served as "hot ' n, juicy" old-fashioned hamburgers. These "well-done" hamburgers were refrigerated and used in making chili the following day. Wendy's' french fries were prepared from high-quality potatoes and were cut slightly longer and thicker than those served by most other quick-service hamburger chains. The company used specialized fryers designed to cook the inside of thesc bigger potatoes without burning the outside. Wendy's' Frosty Dairy Dessert was a blend of vanilla and chocolate flawors that was too thick to drink through a straw. It was served with a spoon to be eaten as a dessert, but some customers ordered a Frosty in place of a soft drink. Whether served as a dessert or as a dairy drink, the Frosty was a distinctive and popular menu item. INITIAL GROWTH The first Wendy's restaurant opened in Columbus, Ohio, in November 1969. The second Wendy's opened in 1970, restaurants three and four opened in 1971, and restaurants five, six, and scven opened in 1972. In addition to these seven companyoperated stores, two franchised restaurants were opened in 1972. As shown in Table 1, a substantial increase occurred in the number of Wendy's restaurants opened between 1973 and 1978 , the majority of which were Iranchised nits. P2 PART II: FUNDAMENTALS OF PRODUCT AND SERVICE COSTING Both company and franchised restaurants were built to company specifications as to exterior style and interior decor. Most were frcestanding, one-story brick buildings, substantially uniform in design and appearance, and constructed on approximately 35,000-square-foot sites with parking for 3540 cars. Frecstanding restaurants contained [ about 2,400 square feet and included a cooking and food preparation area, a dining room designed to seat 92 customers, and a pick-up window to serve drive-thru customers. Wendy's restaurants were usually located in urban or densely populated suburban arcas, and their surcess depended upon serving a large volume of customers. As of December 31,1978 , the 288 company restaurants were located in 18 multi-county areas in and around the cities listed in Table 2. At this time, there were no franchised restaurants located in any of the market areas served by company restaurants. company 2 tanchisees t sepatcte ma NY REVENUES Wendy's' initial revenues came from four principal sources. As shown in Table 3, these were: sales made by company restaurants, royalties paid by franchise owners (franchisees), technical assistance fees paid by franchise owners, and interest earned on investments. The increase in the percentage of total revenues that resulted from royalties during the five-year period covered by Table 3 was primarily caused by the substantial increase that occurred in the number of franchised restaurants relative to the number of company restaurants. Tftsnchre rrernue Table 3 Percentage Revenue Composition 1974-1978 Revenue from sales made by company restaurants was recognized as soon after the sales occurred as was practicable. Because the amount of cach company restaurant's daily net sales was to be reported to corporate headquarters in Dublin, Ohio, by 8:00 a.m. the next day, these sales werc generally recorded by the corporate accounting staff the day after the sales were made. Wendy's' franchise agreements stipulated that every franchisee must pay to Wendy's International, Inc., a technical assistance fee for each restaurant the franchisec agreed to build within the franchised area.' The due date for payment of the technical assistance fee (sometimes referred to as a franchise fee) was negotiated with each franchisec. The earliest duc date was at the time the franchise agreement was signed; the latest duc datc was 30 days prior to the opening of each restaurant. According to Wendy's' management, the technical assistance fees did not contribute substantially to company profits inasmuch as they were generally fully cxpended on providing a varicty of services to franchise owners prior to the onening of cach restaurant. These serviccs included: site selection assistance, standard construction plans and specifications, initial training for franchisc owners and restaurant managers, advertising materials and assistance, national purchasing agreements, and operations manuals. Technical assistance fees received anytime prior to the opening of the related franchised restaurants were recorded by the company as "deferred technical assistance fees." Technical assistance fees were recognized as revenuc at the time the franchised restaurants commenced operations. Once a franchised restaurant was opened, franchise owners had to pay Wendy's International, Inc., a royalty of 4% of gross sales. In connection therewith, franchisees were required to submit to the company weekly sales reports (due the following Monday) for each restaurant. Payment of the royalty was made on a monthly basis and was due, along with a monthly sales report, by the 15 th of the following month. Royalties were 2e2v2 recognized on an accrual basis at the end of each month based on the weekly salcs reported by franchisees. If nccessary, these monthly accruals were adjusted at the time the royalty payments were reccived from franchisecs. Wendy's did not select or employ any personnel for franchisees, nor did the company scll fixtures, food, or supplics of any kind to franchisees. Also, unlike many other restaurant chains, Wendy's did not derive revenue from owning the franchised units tike C and leasing them to franchisees. All of Wendy's' franchise owners either owned their "mo franchiscd restaurants or leased them from independent third parties. [Interest and other "owne, income represented the amounts earned on investments, principally ccrtificates of (4) deposit, bankers' acceptances, and commercial paper. These amounts were recognized by the company on an accrual basis as earned. CHILl AND THE WENDY'S WAY Wendy's was founded on the belief that the combination of product differentiation, market segmentation, quality food, quick service, and reasonable prices would produce a successful company. This combination was oficn referred to by Mr. Thomas as the "Wendy's Way." The decision to include chili as one of the original menu items was made after careful consideration of the most desirable product mix in keeping with the Wendy's Way. The first and most important of Wendy's' products was, of course, the "oldfashioned" hamburger. French fries were the second item included on the menu, primarily because so many customers ate french fries with their hamburgers. It was at this point that a product decision needed to be made that would enhance the successful implementation of the Wendy's Way. Wendy's' management knew that the only way their restaurants could serve old-fashioned hamburgers directly from the grill in accordance with individual customer orders, and still be able to scrve 1 hem quickly, was for the cooks to anticipatc customer demand and have a ufficient supplof hamburgers already cooking when the customers arrived at the restaurants. The problem with such an approach, however, was what to do with the hamburgers that became too well-done whenever the cooks overestimated customer demand and cooked too many hamburgers. Throwing them away would be too costly, but serving them as "hot 'n juicy" oldfashioned hamburgers would result in considerable customer dissatisfaction. The solution to this dilemma was in finding a product that was unique to the restaurant industry and that required ground beef as one of the major ingredicnts. Thus, Wendy's' "rich and meaty" chili became one of the four original menu items. DIFFICULTIES IN THE 1980s Wendy's continued its growth in total number of restaurants, revenues, and income throughout the first half of the 1980s. Responding to competitive pressures and changing customer demands, Wendy's added chicken to its menu through the acquisition of Sisters International, Inc. The company also expanded and improved its Garden Spot salad bar, added stuffed baked potatoes to the menu, and changed its restaurant decor to reflect a more upscale environment. As a means of providing more flexibility in dealing with franchisecs and of facilitating expansion, Wendy's began the use of the single-unit CASE: WENDY'S CHILI: A COSTING CONUNDRUM 95 franchise method whereby franchise rights were granted on a restaurant-by-restaurant basis, rather than on an area basis as had been the company's previous practicc. In 1985, revenues excecded $1 billion for the first time, and income set a new record at $76.2 million. Notwithstanding this impressive performancc, management faced some formidable challenges. The U.S. economy was softening, and lower discretionary a consumer spending served to increase competitive pressures in the quick-service restaurant industry. The company's major competitors had substantially improved the quality of their products, service, and facilities, and they had boen aggressively introducing new menu items. The year 1986 turned out to be the worst in the company's history. Total revenues increas than two percent over the previous year, and the company recorded $75 million chargg for busines6 realignment expense. Consequently, Wendy's reported a loss for the year of approximately $5 million, its first loss ever. As an example of the competitive nature of the industry, Wendy's made a strategic decision to serve breakfast on a system-wide basis in June 1985. Shortly thereafter, the economy worsened, and Wendy's' major competitors introduced new products targeted specifically at Wendy's' customers. This created an environment where it was difficult to justify the investment nccessary to accomplish a system-wide breakfast offering. Thereforc, in March 1986, brcakfast became arcoptionai ment item for both company and franchised restaurants. In 1987, Wendy's sold Sisters International, Inc., and began a systematic reduction in the number of company restaurants both inside and outside the U.S. The company also continued to expand the availability of its new three-section Super Salad Bar, and by year-end, it was installed at more than 90% of company restaurants and approximately 40% of franchised restaurants. Due to a \$15 mullion income tax benefit and a $1 million extraordinary gain on early extinguishment of debt, Wendy's reported income of $4.5 million in 1987. I IN THE 1990s As Wendy's entered the 1990s, there were indications that the company was about to regain the momentum it had lost during the latter part of the previous decade. Company restaurant opcrating profit margins, return on average assets, and return on average equity had all begun to improve, and most of the unprofitable company restaurants had becn closed. Wendy's was ready to begin a program of prudent, aggressive growth both domestically and internationally. One of the interesting debates that occurred from time to time during the "realignment period" of the late 1980s and carly 1990s had to do with the role of the company's original menu items in light of the introduction of what became known as Wendy's' "balanced product and marketing approach." This approach had been introduced to enable the company to respond in a timely manner to ever-changing customer trends with respect to menu composition and pricing. Although Wendy's had abandoned its original "limited menu" concept during the late 1970s, the four original menu items continued to be soid as part of a group of product offerings that management referred to as tho core menu As a guide for the 1990 s, management identified six specific operating objectives, which then became known as "the keys to success." Key \#1 was to grow the total number of Wendy's restaurants, with a goal of 5,000 by 1995 . Key \#2 was to gencrate consistent real sales growth (e.g., without prices increases) from quarter to quarter. Kcy \#3 was to continue to improve restaurant operating margins. Key \#4 was to manage corporate overhcad expenses prudently. Kcy H5 was to enhance return on assets. And Kcy \#6 was to continue to strengthen the entire restatrant system through the selective salc of company units to strong cxisting or new franchisecs, while acquiring units in need of attention from cxisting franchisecs. In addition to Wendy's' new operating objectives, the company continued to experiment with new menu items throughout the 1990s. In March 1992, the company began offering five fresh salads to go. In addition, the company introduced a spicy chicken sandwich, and it then added a 5-picce chicken nugget item to its 99-cent Super Value menu. Management's hard work paid off, and the company added almost 2,000 restaurants during the decade. e A A significant event occurred for the company in December 1995, when the company merged with Tim Horton, a coffee and baked goods company headquartered in Canada. This merger enabled both companies to expand their own operations across the United States/Canada border, and provided a strong foundation for further expansion of Wendy's' and Tim Horton's franchise operations. THE CHALLENGES OF THE 2000S The new millennium brought many changes to Wendy's. John "Jack" T. Schuessler was named CEO and Chairman of the Board in March 2000, and the company opened its 6,000th restaurant in October 2001. However, these milestones were overshadowed by the death of Dave Thomas in January 2002. Maintaining the momentum of the past decade was going to depend on Wendy's' ability to establish itsclf as the franchisor of choice for franchisees, the cmployer of choice for employees, and the restaurant of choice for customers. Thus, one of the most critical aspects of customer satisfaction had to do with the quality, pricc, and varicty of the products sold. Menu decisions would likely becomc increasingly important as Wendy's continued to implement its portfolio approach of "super value" menu items, "specialty" menu items, and "core" menu items. As the company began its post-Dave Thomas era, management thought that perhaps the time had come to give serious consideration to eliminating at least one of the original menu items. Of these, chili seemed to be the most likely candidate. In addition to being the menu "maverick," chili represented a relatively small percentage of total restaurant sales, and there was considerable controvcrsy over its true profit margin. The issue, it sccmed, had to do with determining the actual cost of a bowl of chili. This same issue had, in fact, been debated but never resolved back in 1979 when Wendy's' salad bar CASE: WENDY'S CHILI: A COSTING CONUNDRUM COSTING THE CHILI Wendy's' chili was prepared daily by the assistant manager, in accordance with Wendy's' secret recipe. It was slow-simmered in a double boiler on a separate range top for a period of from four to six hours. While cooking, the chili had to be stirred at least once each hour, and at the end of the day it was refrigerated for sale the following day. Normally, it took between ten and fifteen minutes to prepare a pot (referred to at Wendy's as a batch) of chili. First, the forty-eight l/4 lb. cooked ground beef patties nceded for a batch were obtained, if available, from the walk-in cooler. This took about one minute to do. These patties wcre ones that had been "well-done" sometime during the previous three days. Most of the time it was not necessary to cook any meat specifically for use in making chili, although the need to do so was more likely to occur during the months of October through March when approximately sixty percent of total annual chili sales occurred. If, as only happened approximately ten percent of the time, it became necessary to cook meat specifically for use in making chili, the number of becf patties needed were taken from the trays of uncooked hamburgers that had been prepared using a special patty machine, at the rate of 120 patties cvery five minutcs, carlicr that morning. On average, it took ten minutes to cook forty-eight hamburger patties. 10mins48bur. Before placing the meat in the chili pot, it had to be chopped into small picces. This generally took about five minutes to do. The remaining ingredients then had to be obtained from the shelves and mixed with the meat. This process also took about five minutes to complete, after which the chili was ready to be cooked. The quantities and costs of the ingredients needed to make a batch of chili, and the labor costs associated with the different classifications of restaurant personnel are shiown in Tables 4 and 5. Other direct costs associated with the chili included: scrving bowls, $.035 each; lids for chili served at the carry-out window, $.025 each; and spoons, $.01 each. CHILI SALES 'The selling prices for all of Wendy's' products sold by company restaurants were sec at corporate headquarters. Although some price diffcrences existed among restaurants in different locations, representative prices for 2001 were $.99 for an 8-ounce serving of chili, $1.59 for a 12 -ounce serving of chili, and $1.89 for a "single" hamburger. Chili sales werc scasonal, and comprised about 5% of total Wendy's' store sales compared to about 55% for hamburgers. As shown in Exhibit I, Wendy's' consolidated cost of salcs, as a percent of retail revenues, increased to 63.8% in 2001 from 63.1% in 2000 . Food costs in 2001 reflected a 13.4% increase in becf costs, which was partially offsct by a 1.6% selling price increase. Retail sales increased by 6.5%, and net income increased by about 14% during 2001 . Notc: The batch of chili described above yielded approximately 57 eight-ounce servings. Note: Payroll taxes and other cmployee-related costs averaged about 10% of the above amounts. 1. How was Wendy's able to achicve its initial success and to grow so rapidly at a time when the quick-service hamburger business appeared to be saturated? 2. What benefits might have resulted from Wendy's' "limited menu" concept? What were the disadvantages of such a concept? Why was the concept eventually discontinued? 3. Why was Wendy's' drive-thru window successful when other quick-scrvicc restaurant chains had been unsuccessful at implementing the same conccpt? 4. How much does a bowl of chili cost on a full-cost basis? An out-of-pocket basis? 5. For determining the truc profitability of chili, how much does a bowl of chili really cost? 6. Would you recommend dropping chili from the menu? Why or why not? Exhibit 1 WENDY'S CHILI: A COSTING CONUNDRUM Statement of Income for the Years Ended December 31, 2001 and 2000 CHILI CONUNDRUM \begin{tabular}{l|l|r|} \hline Restaurant Labor Costs* & & Payroll Fees \\ \hline Store Manager & $800 per week & $80.0 \\ \hline Co-Manager & $12.50 per hour & $1.3 \\ Assistant Mgr. Wage & $10.50 per hour & $1.1 \\ & $2.63 per 15 mins & $0.3 \\ Management Trainee & $7.00 per hour & $0.7 \\ Crew & $5.75 per hour & $0.6 \\ \hline \end{tabular} DM Variable Overhead* Payroll taxes/other costs Assistant manager wage (1/4 hour) *is this how we should classify this? Payroll (.1)= wage) Need to determine: Chili: full cost (see next tab) Chili: out of pocket cost (relevant cost) Chili: cost for true profitability SKETCH - out of pocket DM $3.20 DL $2.63 is the assistant manager wage relevant? Thinking it might not be since he/she would be there anyway VOH $1.1 same for payroll - relevant? TRUE profitability - would that include the non-relevant costs? INCOME STATEMENT 2001 Revenue RetailOperationsOther,principallyinterest$1,925,319$465,878$2,391,197 Costs and Expenses \begin{tabular}{lr} \hline Cost of Sales & $1,229,277 \\ Comp. Restaurant & $406,185 \\ Operating Costs & $91,701 \\ \hline Operating Costs & $216,124 \\ \hline General and Admin & \\ expenses & $118,280 \\ \hline Depreciation and & $1,722 \\ amortization of property & $20,528 \\ and equipment & $2,083,817 \\ \hline International Charges & $307,380 \\ \hline Other expense & \\ \hline Interest, net & \\ \hline \end{tabular} can we just use 5% of the operating expenses? Income before income taxes Income taxes Net income $193,649