Between fast food and fine dining lies the rapidly growing fast casual business sector. Many companies have combined casual dining and fast food convenience to create the fast casual industry. Operating within this model are restaurants Chipotle (CMG), Shake Shack (SHAK) and Panera (PNRA), among others.

Notably, Shake Shack, a burger chain that originated in New York, has found success offering a casual dining experience at a fast food pace. Shake Shack’s recent IPO valued the company of 63 restaurants at around $700 million. After its first day of trading, the chain's stock grew 123% with a market cap north of $1.5 billion.

Fast casual restaurants, including Shake Shack, provide consumers with freshly-prepared, high-quality food traditionally absent from quick service restaurants. As American consumption trends toward healthier, organic choices, fast food chain sales have declined. In particular McDonalds (MCD), has witnessed sharp declines in sales, some of which can be attributed to food scares and supply chain mishaps. In the United States, however, McDonald’s faces increasing competition from fast casual and quick service restaurants.

Traditionally, fast food chains have gained market share by offering simpler and cheaper alternatives, while fast casual chains provide consumers with higher quality meals. As fast casual outlets continue to grow, the fast food industry must evolve to remain competitive. (For more, see: "Healthifying" The Fast Food Market.)

The Fast Casual Model

While fast casual chains do not compare to the robust revenue stream of restaurant giants like McDonalds, the industry has witnessed growth rates not seen in the quick service industry. It is reported that sales of fast casual outlets rose by 10.5% in 2014, compared with 6.1% for fast food chains. Notably, industry leader Chipotle is enjoying 20% annual growth rates.

Combining ambience and meal quality comparable to casual dining with the convenience of a quick service chain, the fast casual industry has been a model for current and future success. A number of factors, including affordability in conjunction with quality, taste, convenience, and customer service, form the basis for fast casual outlets.

In general, a fast food meal costs between $5 and $7 while offering average food quality, no table service, and limited customization. Conversely, the fast casual concept incorporates affordability with high quality ingredients. While the typical cost of fast casual meals is more expensive than their quick service counterparts, consumers are afforded more natural ingredients and custom meals.

As mentioned previously, Chipotle Mexican Grill is at the forefront of the rapid growth. Chipotle offers made-to-order meals with plenty of options for customization. As consumer habits shift to healthier life choices, ingredients labeled organic, fresh, and non-GMO are associated with higher prices. As a result, the average Chipotle customer spends $11.56 per visit with prices continuing to rise as a result of commodity price fluctuations. However, the sector still maintains high volume sales, indicating that people prefer quality and hygiene over low prices. (For more, see: 22 Ways To Fight Rising Food Prices.)

The Fast Food Sector

The fast food sector contains a number of popular franchises, including McDonalds, Taco Bell (YUM) and Wendy’s (WEN). McDonalds has led the fast food industry in terms of sales and number of restaurants worldwide, followed by Subway and Starbucks (SBUX).

Fast food chains earned much of their success by offering quick, inexpensive meals made exactly the same way around the world. However, over the last few years, fast casual restaurants have continued to eat into the market share of leading quick service chains. While Chipotle’s $3.2 billion in 2013 revenue doesn't compare with McDonald's, Chipotle’s consistently high revenue growth suggests higher investor confidence than found in comparable fast food chains.

The fast food industry considers the growing fast casual sector a major threat due to the shift in customer traffic and higher average spending per visit. It is estimated that in 2014, the fast casual segment witnessed an 8% increase in traffic. An increasing number of guests insist consumers with higher discretionary incomes are more inclined towards health and quality. Likewise, guests of fast casual restaurants average higher ticket purchases compared to fast food chains. This suggests inelastic demand for quality labeling such as organic, fresh, and local, to name a few. As hospitality shifts its focus onto new consumer habits, the quick service industry must become cheaper or adapt to the fast casual model to remain competitive. (For more, see: Commodities That Move The Markets.)

The Bottom Line

As consumers with discretionary income continue to shy away from traditional fast food outlets, the fast casual industry has witnessed rapid growth. Growing at roughly 11% per year, companies operating as fast casual outlets have found success for a number of reasons.

Restaurants like Chipotle promise the fresh ingredients typically absent from a fast food meal. Likewise, customization has become a staple for many fast casual outlets. Building your own burrito, sandwich, or salad appeals to pickier eaters especially.

It is estimated that prices within a fast casual establishment can be up to 40% higher than a comparable fast food chain. Clearly, consumers are willing to pay more for a higher quality meal.

While it is safe to assume the rapid growth rates of the industry will slow down, American fast casual restaurants boasted revenues of $21 billion in 2014. While the individual sales of fast casual outlets do not compare to the likes of McDonalds, major players in the fast food industry have witnessed slowly decreasing sales as a result of consumer preference to fast casual dining.

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