Does the Shake Shack IPO mean you should stop eating there?

A simple theory of IPOs suggests that they arrive when a product or company is experiencing “peak buzz,” or at least when the insiders in the privately held company think they are at or near peak buzz.  This will maximize the expected returns on the IPO when it comes to market.

When it comes to food, peak buzz usually arrives a wee bit after peak quality, given reputational lags.  So if you are seeing peak buzz, it is probably time to bail on the restaurant, at least on a restaurant which is going to be sold.  Bailing on the restaurant may in fact be slightly overdue.

After an IPO, the equity share of the original creators — in this case Danny Meyer — is diluted.  Meyer’s incentive to maintain quality standards and his personal brand name is weakened.  The subsequent public shareholders are more likely to insist on a less risky and more mass market approach, which is not in tune with what you, highly intelligent reader of this blog, are likely to prefer.

In other words, both the signaling and the moral hazard arguments suggest that soon you should stop eating at Shake Shack.  Alternatively, perhaps you should now go lots of times, in quick succession, given that quality will decline even more and you must stock up on your fix as a kind of intertemporal substitution.

Comments

Umami Burger

What's that? Beef + MSG? Anybody can do that.

That's the simple theory. The more complex theory is that the markets err in pricing individual IPOs, but over the long run do a very good job valuing them... in some cases IPO prices are obviously too low (Amazon's IPO was approximately $1.50).

Insiders have little idea whether the IPO will price correctly or not. Call it the efficient market hypothesis or don't... An easier way to say it is that "nobody really knows a damn thing."

Some insiders plan to retain a piece of the company... Maybe Danny Meyer is one. Yes he'll be diluted, but may benefit even in the face of dilution by expanding the company more broadly - using equity financing to open up new markets. Either way, this simple model is too parochial. If you subscribe to the theory that they only IPO at "peak buzz," you wouldn't have a lot of America's very revolutionary companies.

I think TC is talking about 'on average', not outlier examples like Amazon.com or Apple or Microsoft.

The food IPO theory makes sense. Here in the Philippines, they don't really have a good reputation for good food but after a while I've gotten used to it, and even look forward to fried chicken or pork scraps, or even, God forbid, slow cooked osso buco pork stew with peanut butter, called Kari-Kari. No veggie dishes though, unlike India. No beef either, like India (or very stringy tough beef not fit for dogs). The restaurants here are all franchises such as Kenny Rogers Roasters (country style fried chicken) and Jollibee (a kind of McDonald's, which is also here; I hate Jollibees but my ~20 yo gf loves it, as do the masses, you have to wait 20 minutes in line for overpriced C-quality fare. It's not In-and-Out burger or even US style McDo), or, Andok's chicken (another franchise, you get a very salty --salt adds weight and masks flavor-- rotisserie chicken that's cut into 20 pieces with sharp bones in each piece, Filipino style, unless you tell them not to cut the chicken, which I keep forgetting to do, and I have to pick through my chicken like I'm eating fish with bones). You can also go to a 'family run' restaurant but it's very dicey as to quality, or a Chinese high-end (I used to like Lulong Cafe but their quality has gone downhill). I don't recommend going to ANY seafood restaurant in southeast Asia. Not a single one. NO! Why? They are famous (and it's happened to me twice despite me aware of the scam) for overcharging. Actually three times--I got hit hard by this scam in Plaka district, Athens, Greece, and remember I speak fluent Greek. No, four times, I forgot Bangkok, Thailand. Very very very common scam, where they bait and switch fish prices on you (say one thing, then the bill says another). Do. not. ever. go to a seafood restaurant. Ever. Maybe Red Lobster in the USA but that's it (you'll eat fake crab but at least you know the prices). Seafood is anyway not sustainable these days. Oh yes, I forgot Mang Inasal, a kind of traditional fast food BBQ where they use a banana leaf as a plate liner, and have 'unlimited rice' (white rice, the people in Asia hate anything but white rice, and in Japan they used to die of beri-beri because of it, until scientists added vitamin A). If you want to go native, you must also learn to eat rice with your fingers, curling said rice in a ball. And when using utensils you eat everything with a spoon, not a fork. The fork is to shovel stuff into the spoon, not for eating (not that anybody cares if you do it the wrong way). Bon appetite!

Tyler isn't talking about it as an equity proposition; he's talking about it as a sit-there-and-eat-the-food proposition. In fact they might run opposite.

That's exactly what the Sausage King of Chicago would say.

Yep. Driving my Tesla was cool before 2010; but now people just shout "Corporate whore!" at me in the street. I've tried searching for another independent car manufacturer, but I haven't been able to use Google since 2004.

In fairness, Tyler only suggested that peak quality occurs slightly before peak buzz for restaurants.

Only if it was barely worth going to when it was at its peak.

A "simple theory of IPOs" offered without the slightest evidence nor factual support. Simply unconvincing, but perhaps theoretically adequate blog fluff for a slow holiday week.

He had the temerity to assume you occasionally read elsewhere.

This post makes no sense to me. The unstated assumption here is that you should only go to a restaurant before it approaches "peak quality". Therefore, if we are able to determine when peak quality occurs, we know when to stop going.

But that assumption seems to me to be incorrect. You should be willing to go to a restaurant before or after peak quality, so long as the quality remains above some threshold necessary for making the utility of going there >0. In other words, it's not the slope of the quality curve that matters, only its value. And shake shack's quality value may be sufficiently great for a long time after its IPO.

It makes sense if time is finite and food options are not. To the extent that a person favors discovery and variety over habit (see TC), both the fading novelty and the lower-than-before quality are good reasons to leave. That isn't to say the restaurant won't remain above average for people who like a predictable, familiar experience.

Yes, if a person favors discovery and variety, then the utility of going to a familiar place is likely to be relatively lower for that person. But that does not change the basic fact that whether or not the restaurant has reached peak quality is irrelevant to the decision whether to eat there. So long as the utility is sufficiently great, you should eat there, regardless of whether it is before or after peak quality.

You're making the unobjectionable (if circular) point that if you still enjoy a restaurant, you should still eat there. Tyler simply implies that if quality declines, he won't enjoy it.

At time T1, the quality was 7 quality units. Tyler enjoyed the meal.
At time T2, the quality was 10 qu. Tyler enjoyed the meal.
At time T3, the quality was 9 qu. Does Tyler enjoy the meal or not?

Rohan, the answer you're trying to trick me into isn't at all a strange answer. Tyler The Consumer is a different entity at T1, T2, and T3. TC2 has different expectations and enjoyment than TC3.

I think it's easier just to look at this post as saying "Shake Shack probably won't be the prima facie best burger option any longer". Whether or not you actually believed that to be true in the first place is another story.

A marginal decrease in quality doesn't indicate that you should stop eating there if you really, really like eating there.

If you're a consumer whose preference for Shake Shack over alternatives is small, this may be true, but if it's your favorite, it should have little effect on your behavior.

Technical note: the WSJ struggles to describe the complicated IPO structure, but the gist is that the pre-IPO owners will retain majority voting control and there will be a staggered board (Gallagher and Grundfest will be pleased!). So don't go blaming the new shareholders for quality declines, they are mostly just along for the ride.

Actually, the IPO signals we ALREADY should have stopped going.

When Shake Shack opened at New York's JFK airport (and then opened a second JFK location, 14 gates down from the original), and Delta started serving Danny Meyer's Blue Smoke on-board it became clear that Meyer had traded on reputation and accepted lower quality.

You can't reprise the same quality in an airport -- rents and myriad tastes of travelers aside, security regulations make getting ingredients airside and actually cooking (while chef's knives are chained to the wall) impossible. And reproducing quality inflight...?

I think my unsophisticated, dated approach will be to eat at Shake Shack (rarely as that is) until I notice that it starts to suck or is no longer worth my money compared to other places.

Right. As a purely academic point, this may be a good way of predicting trends in quality, but given that the cost of one disappointing meal is not high, you might as well just keep going until it no longer beats the opportunity cost.

Although I suspect that this post was tongue-in-cheek and not actual advice to ditch a favorite restaurant on the grounds that its quality is likely to decline.

Most of the comments hassling Tyler can be reduced to, "If it's degraded but good, you should still eat there."

What if the disappointment and dilution of new Shake Shack experiences diminish the utility of old Shake Shack experiences? If Tyler quits now, he has a lifetime of fuzzy Shake Shack memories.

Were we less temporal and judgmental creatures, there would be no axiom of, "You're only as good as your last [x]."

In other words Shake Shack is about to be prole-ified.

Shake Shack is more than 10 years old now.

It's ok, but it's not much different from generic fast food. Most of its popularity seems to stem from the fact that there is a sizable market of people who want to eat junk food but don't want to be seen eating at typical junk food establishments and are willing to pay extra to avoid looking like one of "those people" who eat at ordinary fast food places..

Interesting theory, it might explain the food court at my local mall, where there is a Chipotle and Taco Bell side-by-side, and Chipotle is absolutely dominating. I certainly don't think the quality difference alone can explain it.

Now I know how my girlfriend feels when I say her expensive handbags are ridiculous. Not differentiating those two restaurants is pretty strong stuff.

"I certainly don’t think the quality difference alone can explain it."

Reading comprehension is your friend.

You demonstrate your own point exquisitely.

I suspect that this is correct. In the past year I went to both Shake Shack and Five Guys for the first time and found them to be decent but nothing special. If a place makes its hamburgers to order, it automatically has a strong taste advantage over fast food places that make their food in advance.

See, e.g., Krispy Kreme

The IPO issue is a red herring. Only Gary Leff and maybe Ray Lopez seem to get this.

A chain of restaurants always produces mediocre quality food, because the founder of the restaurant simply can't devote the same attention to the chain as to a single restaurant. Even opening up a second location of an excellent restaurant dilutes the quality. Shake Shack has declined in quality due to its being a chain, not because of the IPO, except in the sense that you never see IPOs for single, standalone restaurants.

A single, standalone restaurant might have worse food than a chain, in other words it might be terrible, though regulations designed to reduce disease and food poisoning, and people (generally) avoiding patronizing really bad restaurants limit the downside. I try to eat in standalone restaurants as much as possible when I eat out.

I also think the quality of restaurants in general tends to degrade over time because of the pressure on margins, which eventually has to be satisfied by cutting corners on costs/ quality. This is especially true in high rent areas. The restaurants that escape this are either very new, or very old (the owners have found ways to reduce pressures on margins through relationships with suppliers, owning their own building, etc.).

Viewed as an East Coast attempt to do In and Out, or an attempt to do a better version of McDonalds, Shake Shack succeeds. The best location still seems to be the original location. I wonder if that is true of McDonald's as well. I also have started staying away from seafood, you can't escape what is happening to the oceans.

While I do agree that chains have the disadvantage of not having 100% of the chef/owner's attention devoted to any single restaurant, I think the chain penalty is much smaller for something like a burger joint with a simple menu than it is for a restaurant with a complex menu that relies on a large number of ingredients. Obviously airport locations and licensed operations should still be avoided but chains like Shake Shack and Smashburger sure are a lot better than the standalone options in most places. I can't imagine saying the same thing about any other type of restaurant.

It's going to be finish of mine day, however before end I am reading this enormous post to increase my experience.

I think Shake shack will still be great. It is a very simple formula. - Brad Ingarfield

It will go in the opposite direction. Shake Shack loses an part of its narrative as this happens. If it becomes a big company with shareholders and such, it loses its cachet - and that cachet is very important for its hipster clientele.

When you go to Shake Shack going forward, you aren't paying as much for the narrative (as opposed to the food), so you will get a better deal if what you care about is the food.

I wonder if this peak quality effect accelerates if the establishment has a story or philosophy?

Steak 'n Shake.

Never heard of Shake whatever before this week. I'm sure it is as bad as Five Guys.

No possibility that the IPO might bring something positive to the table? An outside board of experienced food service management professionals, who know (say) far more about efficient supply chain management and human resources practices, ultimately providing burgers at a lower cost? No effect of decreasing management's risk aversion by separating ownership and management, allowing Shake Shack to experiment more? And not that I'm personally accusing anyone of anything, but I think external monitoring of management is generally important.

I wouldn't bet long odds that these effects are stronger than the hype effect and the moral hazard effect, but I wouldn't bet the other way either. I bet Shake Shack will eventually be seen as representing a new movement for higher quality in fast food.

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