Case Study 2: Buenas Dias

Buenas Diaz – status quo or pivot!

Monika Hudson and Frank Ohara

Uh, oh!

As she eyed the pile of mail, Flora noticed one of the envelopes bore an official City of Houston seal. With a feeling of unease, she pushed aside everything else to open it. Half of what she scanned did not register, but the words “cease and desist” and “$5,000 per day fine” got through. A closer read revealed a City order to immediately remove her restaurant’s exterior loudspeakers and sidewalk tables as well as initiate major building repairs. Groaning, Flora realized she was going to need her family’s financial help. But, how should she approach that “ask,” given how angry her older brother was with her?

History of a family food business

Juan and Martha Diaz came to Houston, Texas, from Guadalajara, Mexico, in the early 1930s. They opened the first mechanized tortilla factory in their new city. In 1936, they expanded the tortilla factory by adding a small restaurant they named Buenas Diaz.

In the early 1950s, Juan and Martha’s daughter Marisol helped her parents further expand with the production of a Buenas Diaz line of tortillas that were sold in supermarkets in the Houston area. Their popularity grew, and the family was able to subsequently place their products in supermarkets throughout Southern Texas. Marisol and her parents, along with their Buenas Diaz restaurant and products, became well-known fixtures in the Houston Mexican and Anglo communities.

In the 1970s, while it continued to manufacture and distribute tortillas, the company began to produce a range of salsa products, taco shells, and tortilla chips. In addition, its locally famous restaurant continued to offer an array of Mexican dishes. The Buenas Diaz restaurant prepared its dishes from scratch, using primarily local ingredients. Designed to offer a fiesta for the senses, the restaurant resembled a Mexican border town café with a vibrant and contemporary décor. It featured an extensive variety of dishes including traditional enchiladas, burritos, and tacos as well as innovative items such as fresh fish, and shrimp fajitas. During this period, the Buenas Diaz restaurant regularly attracted 500-700 customers daily.

The theme of every Buenas Diaz dish continued to be freshness, a characteristic underlined by the placement of a replica of the family’s original tortilla maker, known as “El Machino,” in the center of the restaurant’s dining area. El Machino helped create a fun atmosphere for everyone, providing entertainment for children and enabling guests at this full-service restaurant (FSRs) to watch the tortilla-making process as they enjoyed their meals.

The restaurant industry

Buenas Diaz was one star in an exploding dining market. As of 2014, Mexican restaurants constituted 8 percent of the US national restaurant landscape (CHD Experts, 2014). US consumers spent more than $39 billion at Mexican restaurants annually, and the average Mexican restaurant earned more than $700,000 in revenue each year (CHD Experts, 2014). Of the approximately 54,000 Mexican restaurants in operation, roughly 56 percent were classified as FSRs with wait staff and table service.

The names of the institutions and individuals involved have been disguised, however the material facts of the case are authentic.

This case was prepared by the authors and is intended to be used as a basis for class discussion. The views presented here are those of the authors based on field research and professional judgment and do not necessarily reflect the views of The Case Journal. The names of the individuals, the firm, and its location have been disguised to preserve anonymity.

An earlier compact version of this case was presented by Aubrey Leung at the Baylor Student Case competition in January 2014.

Disclaimer. This case is written solely for educational purposes and is not intended to represent successful or unsuccessful managerial decision making. The authors may have disguised names; financial, and other recognizable information to protect confidentiality.

Monika Hudson is an Associate Professor at the Department of Entrepreneurship & Innovation, University of San Francisco, San Francisco, USA. Frank Ohara is a Professor and the Department Chair at the Department of Finance, University of San Francisco, San Francisco, USA.

PAGE 494 j THE CASE JOURNAL j VOL. 13 NO. 4 2017, pp. 494-512, © Emerald Publishing Limited, ISSN 1544-9106 DOI 10.1108/TCJ-01-2017-0006

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Independently owned as opposed to franchised restaurants dominated the industry; approximately 74 percent of the nation’s Mexican restaurants fell into the independently owned category. More than 36 percent of US Mexican restaurants were located in the states of California and Texas, followed by Florida, New York, and Illinois. Table I overviews Mexican restaurants’ penetration rates as a percentage of the total restaurant market in various states.

CHD FIND (2014) stated that 33 percent of the Mexican restaurants in its database had an average check range of $10-$15, with another 24 percent with an average check range of $5-$7. This would indicate that a majority of Mexican restaurants, even full-service ones, offered a range of more affordable plate options compared to non-Mexican full-service eating establishments.

Buenas Diaz and the Mexican food industry

Given the size of the growing Latino population in the USA, one might expect that these consumers would serve as a built-in audience for Mexican food. Indeed, Latinos were among the largest consumers of these products (CHD Experts, 2014). However, what helped grow Mexican food into a multi-billion-dollar revenue category was the fact that it had become mainstream. For example, any number of US consumers did not even think about the fact that a significant portion of their grocery purchases were actually classified as Mexican foods (e.g. tortilla chips). Increasingly, as a means of growing sales, manufacturers had struck a balance between offering products that were perceived as “authentic” by hardcore Mexican food fans and concurrently offering sauces and baked goods that were appealing to the large portion of the US population that was simply interested in “adding a little spice (but not too much) to their plate” (Mintel, 2011).

2013 statistics related to supermarket sales of Mexican foods and sauces are summarized in Table II.

Table II Data table: supermarket categories by dollar, unit sales

Categories Dollar sales Dollars sales % Chg YAgo Unit sales Unit sales % Chg YAgo

Mexican food $1,699,297,000 1.81 806,995,800 0.79 Mexican sauces $1,011,285,000 1.18 384,365,400 0.67

Note: Top supermarket product categories by dollar sales and unit sales for the 52 weeks ending June 16, 2013 Source: Infoscan Reviews (2013), a Chicago-based market research firm

Table I State by Mexican menu type – percent of total

Largest % of market TX – Texas 16.7 NM – New Mexico 14.1 CA – California 13.8 AZ – Arizona 13.6 CO – Colorado 12.2

Smallest % of market CT – Connecticut 3.6 MA – Massachusetts 3.1 PA – Pennsylvania 2.9 VT – Vermont 2.9 ME – Maine 2.6

Source: Available at: www.chd-expert.com/resource-center/2014-mexican-restaurant-industry-land scape♯sthash.gFmEaWhY.dpuf (accessed July 20, 2015)

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With 2015 annual supermarket sales of $15 million, Buenas Diaz food products represented less than 1 percent of the combined Mexican food and sauces supermarket categories, but the family believed the company could increase its market share in both areas to at least 5 percent by 2020. Towards that end, the two oldest siblings concentrated their efforts on enhancing supermarket shelf space and geographic markets outside of their established Texas base.

The family firm owners

Over the last ten years, Carlos, the eldest of the Diaz siblings, had overseen manufacturing and Texas distribution activities for the family’s Buenas Diaz food production and distribution firm. Company revenues increased from $2.5 million in 2000 to almost $15 million in 2015, in line with the overall growth in US consumption of Mexican-themed food products. Carlos credited his management skills with having shepherded the family’s business activities from a small but beloved restaurant to an emerging food production powerhouse.

A large man with an easy laugh, at 51, Carlos had won countless awards for his business savvy and community investment in the greater Houston area. Although he shared ownership of the building that housed his parents’ restaurant with his two younger sisters, Carlos had not been involved in its day-to-day operations for at least ten years, preferring to concentrate on the faster-growing food production side of the family business. After an argument about a year ago, Carlos had also not had direct contact with his sister, Flora.

Maria, the middle of the Diaz siblings, worked closely with Carlos on product line development and retail market placements. Within the family firm, the 45-year-old’s role was to develop and expand the salsa, tortilla, taco, and tortilla chip lines into new markets as well as to oversee national distribution of all Buenas Diaz food products outside of Texas. Maria provided Flora with opportunities to work on expanding the company’s distribution into targeted markets, particularly in the Pacific Northwest and New England areas.

A small, nervous woman, Maria got along with Flora as well as with Carlos. Although she tried to remain neutral, Maria often sided with Carlos when it came to making collective decisions about local and national production and distribution matters.

At 34, Flora was the youngest of the Diaz children. She ran the Buenas Diaz restaurant out of the family-owned building and helped her older sister with targeted national distribution efforts. It had been Flora’s idea to place “El Machino” in the restaurant, where it was so popular.

Family tensions

Marisol passed away in 2005 and her three children, Carlos, Maria, and Flora, assumed control of the family empire. After her death, the two older siblings further expanded into the wholesale Mexican food market, which had increased company revenues 12 percent annually over the last ten years. However, the generational transition was anything but seamless as Marisol had left no written succession plan.

When the Diaz siblings assumed control of Buenas Diaz, Carlos became the unofficial leader. There had always been friction between Flora and Carlos with their differing ages and personalities. Further, given that he was the eldest and only male child, Carlos had always seemed to Flora to act as if he had been Marisol’s favorite.

As company CEO, Carlos believed he was the “face” of the firm and bore the greatest responsibility for carrying on the family name and legacy. Therefore, he felt he should wield the most decision-making power regarding directing family firm operations. In contrast, Flora believed the responsibilities for maintaining and growing the business should be distributed and that all three siblings should have an equal say in company decisions.

Flora was always looking for ways to prove her business acumen and value to the firm. Maria was often in the middle of any sibling conflicts, acting as an intermediary and peacemaker between her older brother and younger sister.

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Restaurant operations

Each of the siblings received a $10,000 per month ownership distribution, as a result of all combined Buenas Diaz’s production activities. Flora used some of her distribution to supplement the restaurant’s operations, which had been experiencing negative cash flows of almost $2,000 per month. While she had not completed a structured market analysis, Flora’s staff reported that daily customer counts had fallen to 300-400 individuals over the last six months.

Having to supplement restaurant operations from her personal financial distribution had sparked Flora’s interest in trying to appeal to the emerging adult/hipster market in Houston. She felt that growing the events side of the family’s restaurant business would be a good move because its original patrons were aging and this might be an effective way to incorporate a younger clientele into the Buenas Diaz consumer base. In an effort to attract an 18-25-year old audience, Flora began hosting Sunday afternoon dances featuring local Tex/Mex music artists. Being the “spot” for alternative music, along with dancing in the patio area, led to new positive social media reviews. However, some of the new patrons called the restaurant a “dive,” noting that the building appeared run down.

After ten events, Flora estimated that at least 200 new customers were now regularly coming to Buenas Diaz each month. She saw this as proof of her efforts to revitalize the restaurant’s audience.

The crisis

A year ago, Flora and Carlos had a disagreement during an informal family gathering not meant to be about the business regarding how the firm’s taco shells and tortilla chips should be manufactured. Flora suggested that Carlos streamline manufacturing by purchasing machines that would mechanically shape large numbers of their shells and chips, eliminating at least five employee positions from the hand-manufacturing process and allowing for greater economies of scale. Carlos was offended by Flora’s suggestion. Basically, he felt that since Flora had never been involved in large-scale manufacturing, her knowledge about how to modify the company’s current systems was very limited compared to his. He stated that he felt Flora was disrespectfully trying to impose her opinions on him. To date, he had not told Flora what to do with the restaurant, so she certainly was not in a position to instruct him on manufacturing matters. Boundaries mattered to Carlos.

Despite Maria’s attempts to intervene, both Flora and Carlos left the family dinner furious. Over the next months, Maria asked Flora to leave Carlos alone, stating that was Carlos’s request. While Carlos and Flora had not spoken directly since the incident, both used Maria as the go-between for some limited intra-family communications.

At the Permitting Center Counter

With notice in hand, Flora headed over to the Houston Permitting Center. She planned to get the fine dismissed and obtain permission to continue her restaurant events. Permitting Center staff pulled her file and, after a quick review, the building technician told Flora that the center’s key concerns appeared to relate to the increase in noise and traffic, tables blocking the sidewalk, and building code violations noted by the inspector including insufficient fire sprinklers and no disability access.

Flora calmly explained that while the restaurant was located adjacent to several homes, it was on a street now zoned for commercial use, making the noise and traffic complaints somewhat moot. She agreed to ensure that the loudspeakers for the music were focused within the restaurant’s patio, reducing the impact on her residential neighbors. Using a map, Flora and the technician identified some ways that the exterior tables could be positioned to reduce the impact on passersby. Finally, Flora pointed out that the building was more than 75 years old and had been retrofitted in the early 1980s to meet the then required building codes.

Since Flora held events only on Sundays, the technician agreed that her proposed strategies should mitigate the noise and traffic concerns identified in the complaint. However, the technician

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also pointed out that the fire sprinkler code requirements had been in place more than 15 years and the inadequate fire protection constituted a public health and safety hazard. Further, given increased community pressure from local disability activists around access to public facilities and the fact that Buenas Diaz was well known for the excellence of its food, the technician noted that the restaurant either needed to install the required Americans with Disabilities Act (ADA) improvements or plan to pay the daily fines for not providing appropriate access for all members of the community.

Renovation estimates

The very next day, Flora began to identify contractors who might be able to handle the health and safety upgrades. She found several who specialized in updating older buildings to meet current fire and ADA codes. She settled on Willock Construction, owned by one of her high school classmates, Bruce Willock. After calling him to set up an appointment for a site visit, Flora felt excited to have gotten things started.

Given their connection, Bruce Willock decided to handle the initial inspection personally. When he arrived on site, Bruce immediately saw that the restaurant was in desperate need of repairs. As Flora showed off the beautiful murals on the walls of the patio where the dances were held, Bruce noticed old knob and tube wiring and evidence of mold on the underside of the gutters. After doing some rough mental calculations, Bruce let Flora know that, in addition to the fire sprinklers and ADA ramps, she would probably need to have some electrical work and hazardous material cleanup completed, all of which would probably increase the costs of the project. He told Flora that he could have her estimate within the next three to five days.

Bruce called Flora back three days later with a preliminary estimate. He indicated that Flora would need to spend about $450,000, including the required building permits, to deal with the electrical, fire sprinkler, and physical modifications. While the company’s standard policy was to get half of the estimated payment as a deposit at the time that the contract was signed, given their long-time relationship, he was willing to work with Flora and would require only a $100,000 deposit prior to having his construction firm begin work. Bruce asked Flora to give him two weeks’ notice so that he could properly stage his team for this job.

The decision

Although it was a registered Texas C-corporation, Buenas Diaz had no official dividend distribution policy. Like her siblings, Flora had been receiving $10,000 per month to cover her personal expenses. Over the last six months, she had been using a portion of this amount to cover the operating deficits associated with the restaurant. Neither the restaurant nor the manufacturing operation had reserves set aside for building renovation expenses.

Given these facts, Flora realized she needed to be practical. She was going to have to call a family meeting if she wanted her siblings to give her any part of the money she needed for the restaurant repairs. But after reviewing the company’s financial data and comparing it to industry standards, she wondered if it really made sense to take $450,000 from the company’s manufacturing reserves to save the restaurant. Further, if she could prove continuing to operate the restaurant was a good investment, what strategies should she use to persuade her angry older brother as well as her sister to agree with her assessment? (Tables III-VII).

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Table III Industry balance sheet benchmarks

Bakeries and tortilla manufacturing (asset class: all) Industry

standard % Industry standard % applied

to Buenas Diaz Buenas Diaz

actuals Buenas Diaz standard %

Corp average balance sheet 2012 $15,000,000.00 15,000,000.00 2014

Cash 5.10 $765,000.00 $1,050,000.00 7.00 Receivables 9.32 $1,398,000.00 $1,050,000.00 7.00 Inventory 6.60 $990,000.00 $750,000.00 5.00 Other current assets 2.57 $385,500.00 $450,000.00 3.00 Total current assets 23.59 $3,538,500.00 $3,600,000.00 24.00 Fixed assets 57.17 $8,575,500.00 $8,550,000.00 57.00 Other non-current assets 19.24 $2,886,000.00 $2,850,000.00 19.00 Total assets 100.00 $15,000,000.00 $15,000,000.00 100.00 Accounts payable 7.42 $1,113,000.00 $1,050,000.00 7.00 Loans/Notes payable 1.74 $261,000.00 $300,000.00 2.00 Other current liabilities 10.94 $1,641,000.00 $1,800,000.00 12.00 Total current liabilities 20.10 $3,015,000.00 $3,150,000.00 21.00 Other long-term liabilities 36.95 $5,542,500.00 $5,550,000.00 37.00 Total liabilities 77.15 $11,572,500.00 $11,850,000.00 79.00 Equity 22.85 $3,427,500.00 $3,150,000.00 21.00 Total liabilities + equity 100.00 $15,000,000.00 $15,000,000.00 100.00

Table IV Industry financial ratios

Bakeries and tortilla manufacturing (asset class: all) Industry standard

Industry standard applied to Buenas Diaz

Buenas Diaz actuals

Buenas Diaz standard %

Corp average financial ratios 2012 $15,000,000.00 $15,000,000.00 2014

Return on sales 4.02% $603,000.00 $224,500.00 1.50 Return on assets 5.14% $771,000.00 $224,500.00 1.50 Return on net worth 11.97% $1,795,500.00 $1,069,047.62 7.13 Quick ratio 0.72 $10,800,000.00 $4,556,962.03 0.30 Current ratio 1.17 $17,550,000.00 $3,417,721.52 0.23 Inventory turnover 19.37 $290,550,000.00 $250,000,000.00 16.67 Assets: sales 0.78 $11,700,000.00 $9,750,000.00 0.65 Total liabilities: net worth 1.33 $19,950,000.00 $19,500,000.00 1.30

Table V Industry balance sheet benchmarks

Restaurants (asset class: all) Industry

standard % Industry standard % applied

to Buenas Diaz Buenas Diaz

actuals Buenas Diaz standard %

Corp average balance sheet 2012 $16,00,000.00 16,00,000.00 2014

Cash 21.01 $3,36,160.00 $72,000.00 4.50 Receivables 3.57 $57,120.00 $1,76,000.00 11.00 Inventory 6.01 $96,160.00 $1,28,000.00 8.00 Other current assets 5.22 $83,520.00 $48,000.00 3.00 Total current assets 35.81 $5,72,960.00 $4,24,000.00 26.50 Fixed assets 52.73 $8,43,680.00 $7,20,000.00 45.00 Other non-current assets 11.46 $1,83,360.00 $4,56,000.00 28.50 Total assets 100.00 $16,00,000.00 $16,00,000.00 100.00 Accounts payable 7.14 $1,14,240.00 $1,12,000.00 7.00 Loans/notes payable 3.41 $54,560.00 $32,000.00 2.00 Other current liabilities 27.73 $4,43,680.00 $1,92,000.00 12.00 Total current liabilities 38.28 $6,12,480.00 $3,36,000.00 21.00 Other long-term liabilities** 24.50 $3,92,000.00 $9,76,000.00 61.00 Total liabilities 62.78 $10,04,480.00 $13,12,000.00 82.00 Equity 37.22 $5,95,520.00 $2,88,000.00 18.00 Total liabilities + equity 100.00 $16,00,000.00 $16,00,000.00 100.00

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Corresponding author

Monika Hudson can be contacted at: mhudson@usfca.edu

Table VI Industry financial ratios

Restaurants (asset class: all) Industry standard

Industry standard applied to Buenas Diaz

Buenas Diaz actuals

Buenas Diaz standard %

Corp average financial ratios 2012 $16,00,000.00 $16,00,000.00 2014

Return on sales 6.50% $1,04,000.00 $72,000.00 4.50% Return on assets 35.03% $5,60,480.00 $3,68,000.00 23.00% Return on net worth 94.13% $15,06,080.00 $12,80,000.00 80.00% Quick ratio 0.64 $10,24,000.00 $4,86,075.95 0.30 Current ratio 0.94 $15,04,000.00 $3,64,556.96 0.23 Inventory turnover 89.69 $14,35,04,000.00 $2,66,66,666.67 16.67 Assets: sales 0.19 $3,04,000.00 $10,40,000.00 0.65 Total liabilities: net worth 1.69 $27,04,000.00 $20,80,000.00 1.30

Table VII Cash basis pro-forma statement – working model

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