With revenues expected to rise by no more than 2 percent annually from now until 2010, the US food service industry is starved for growth.¹ For some players, the prospects are even slimmer. Fast-food chains, such as McDonald’s, and companies in the full-service restaurant business, such as Applebee’s International, together account for some 60 percent of this $400 billion market. They are now suffering because more consumers are demanding what neither can profitably offer: fresh food served quickly in a distinctive, casual environment. For the burger joints, "fresh" is an operational challenge, while traditional full-serves, which do have the fresh food consumers crave, lack the operational expertise to be efficient at scale.

Our research indicates that growth will come in the middle ground: the "fast-casual" area, in industry parlance. This market, we believe, will be worth $35 billion annually by the end of the present decade and could account for more than half of all food service growth over the period. To maximize profits, operators should concentrate on dinner, already the consumer’s favorite meal prepared outside the home. And the gap between it and other meals is widening: by 2005, when measured by total occasions, dinner will surpass breakfast and lunch combined (Exhibit 1). In addition, patrons spend, on average, 40 percent more on dinner than on lunch, the next most popular meal. How then can beleaguered chains get dinner right?

Our market analysis indicates that time-strapped consumers value control, personality, and choice when making their dinner plans. At Chipotle Mexican Grill (owned by McDonald’s), control begins at the counter, where diners decide how much of each ingredient goes into their burritos. At Cafe Express (in which Wendy’s International is an investor), the key is the restaurants’ "oasis tables," where patrons top off their meals with anything from Parmesan cheese to capers. Customers like the customized product; restaurants, unsurprisingly, like not having to bear the cost of waitstaff. On the personality front, Corner Bakery Cafe aims for a comfortable, old-fashioned bistro feel, while Panera Bread sports fireplaces in many shops to project coziness.² Fluorescent lighting and plastic utensils are taboo.

When it comes to food choice, operators have lots of leeway. In fact, today’s adventurous and food-savvy consumer is willing to try almost anything—if it is fresh. Successful fast-casual restaurants offer broad menus (15 sandwiches at Panera, for example, served on 11 types of bread) and fresh salads for calorie counters. A wide and changing selection of entrées brings customers back, and they are willing to pay—up to $12 a throw—for their tastes. Contrast this approach with the burger shops’ margin-crushing "value menus," which feature items priced under a dollar.

Fresh food, however, is more expensive to transport and prepare than the frozen variety, and the cost of installing fireplaces soon adds up. Clearly, even the best service concept will fail if it lacks scale or operational efficiency; Cosí, a New York-based bread-and-coffee chain, generated $70 million in sales in 2001 from more than 60 restaurants but recorded a net loss of $35 million. Yet with comparable sales, Baja Fresh Mexican Grill—which has nearly 160 outlets, backed by the operational muscle of Wendy’s—made a tidy $1 million operating profit.

Fast-food companies would thus seem to have an intrinsic advantage in moving into the fast-casual market: their operations are streamlined; they possess extensive distribution networks; and many of them wield hefty purchasing clout. But they have scant experience beyond their limited menus, and their supplier relationships are narrow and not configured to deliver fresh food. Moreover, the image and value proposition of fast-food restaurants are a liability as far as consumers are concerned. To compete, these companies must embrace a broader set of suppliers and consider acquiring proven concepts through M&A. Full-service restaurants, for their part, offer fresh food and creative menus, but their service is comparatively slow and labor costs are a whopping 36 percent of sales. They must look for ways to lower their costs (and prices) while granting customers more control over the dining experience—perhaps by leveraging existing take-out operations.

As Exhibit 2 shows, no one in the industry has yet found a way to combine distinctive dinner service with the operational performance necessary for scale. Even the smallest and most fragmented players—supermarkets and convenience stores—can take steps to move in the right direction.

Fast-casual restaurants, though, are clearly best positioned to meet the consumer’s dinner needs, but their quandary remains the bottom line—and profits will come only with scale. The payoff, we estimate, could be great: operating margins of up to 15 percent (Exhibit 3). One way to achieve scale is superior portfolio management. Companies with established portfolio capabilities—such as Brinker International, the owner of eight food service concepts, including Corner Bakery Cafe and Romano’s Macaroni Grill—will be at a distinct advantage. If fast-casual restaurants maximize consumer choice (and minimize operational overlap by consolidating their supplier relationships), they can afford to take risks with new food concepts and thus eventually serve even broader groups of customers.