The two sides of our consulting business:
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- launching new concepts and
- fixing/improving existing concepts.
These have given us a unique perspective on what makes restaurants successful …or not. It’s widely known, or at least surmised, that the restaurant business is risky…too risky for most. What makes them so?
Is it cost of goods? Not really. Margins on a plate of food generally land in the 67% to 73% range whereas margins on an average retail item sold at Home Depot or Staples land around 50%.
Is it Labor? Maybe… labor in a retail store lands at around 15% of sales while restaurant labor (management + hourly) lands at around 28%. But on balance, Prime Costs (COGS + Labor) for restaurants beat retail by 5 or 10 percentage points.
Shrink? Sure, employees at a restaurant feel entitled to the inventory in the form of “free food” and Home Depot doesn’t have that problem. Customer theft is a big deal in retail (hence the guy at the door at Best Buy that checks your receipt before you leave). But comps are much higher in restaurants due to complaints, re-cooks, or employee errors and inventory is perishable. Due to the more straight-forward approaches available to manage retail shrink, retail generally beats restaurants at the shrink-management game.
Operating costs can be more expensive in restaurants as the fit and finish of guest spaces is more important in restaurants…however, that’s more about the one-time design and construction expense than ongoing maintenance. Retail probably edges out restaurants on efficiency there too.
All in, however, restaurants and retail operations are similarly risky, where restaurants of a certain size (we find 3,500sf to 6,000sf to be the sweet spot) can easily out-perform similarly sized retail operations when operating with discipline. If the areas where restaurants CAN beat retail are mismanaged (COGS and labor), then the business will suffer. If the food is not tuned to the tastes of its targeted audience or if the brand, in general, does not resonate with its customers, it will suffer.
We find that the most successful restaurants are the ones that launch with enough funding on the front end to create something exciting to their target audience while holding enough in reserve to cover expenses while customers try the new restaurant and convert to it. The individuals who are behind these projects are almost always (heck… darn near always) from business segments other than restaurants who made their fortunes elsewhere, then decided to fulfil a dream of finally owning their own restaurant. Those high net-worth individuals (HDWIs) usually have no interest in the hard, repetitive work of actually running the business, but prefer to hire managers to do that work for them. The problem is that the employed manager rarely has the experience and/or skill to CREATE the systems that will keep the business running. There is a gap between what they know how to execute and what they know how to implement. The salary of individuals with enough smarts and experience to set business strategy and create systems to deliver the brand is generally out of reach to make sense for the restaurant to pay …and that person is also usually not interested in the rote work of managing a restaurant. In other words, if you’re lucky enough to find a restaurant guru to take a job managing your place, they’ll cost too much and get bored after a few months. So HNWIs historically blow it by funding beautiful restaurants, then giving the keys to a hired gun, mistaking that person’s years of experience for an ability to set strategic direction AND mind the store daily. Indeed, HNWIs should wonder what’s wrong with the individual that takes the job claiming to have those skills. Restaurants launched this way tend to cycle through managers and have no strategic rudder…eventually failing once the owner tires of throwing good money after bad. This also pulls the owner closer to daily operations than they intended to be, so their presence becomes a source of pain for them and the manager.
On the flip side, individuals with the talent, experience, and skills to set strategy and run a disciplined operation are often coming from W-2 careers in operations, having traded their time for wages while raising their families. They were not in private equity. They weren’t owners of a construction company or medical supply company. They were not investment bankers. They did, however, become experts at operating a disciplined restaurant, but they don’t have access to the right level of capital to put a competitive product on the market. In short, they’re talented but broke. When they find a way to finally open a restaurant, they push their modest savings into the kitty along with whatever they can cobble together from their support circle (friends, family, and ex-customers) which often means they don’t go into it with enough cash reserves. Because their careers have been focused on operations and not on business building, they lack the business acumen of HNWIs and therefore, they fail to create a detailed launch budget. These restaurants open on a shoestring and can’t weather the first or second storm, so they often fail.
Neither scenario has anything to do with the mechanics of the business…and everything to do with the best way to achieve operating discipline. The most successful restaurants can marry the operating discipline of a seasoned operating team with the funding capabilities of a solvent investor. Some HNWIs and investment groups get lucky and find the right individual to run it, but there’s no getting away from that restaurant sitting low in the water with the high salary until they can spread that salary across two or three more units. That takes a lot of patience and focus…and success usually hinges on the owner’s effort and leadership, not the manager’s. A sensible alternative is to outsource the management of business strategy and operating discipline to a qualified management company. In this scenario, ideal managers are strictly responsible for executing the playbook that the management company develops and enforces and can be selected based on demonstrated capabilities…not aspirational ones. The cost is generally 5% to 6% of net sales and, by virtue of the management oversight being outsourced, the management company’s prime objectives become profitability and growth. The alignment of goals and incentives will generally deliver greater profitability that outpaces the management company’s cost while relieving the owner of daily operational stresses. When the business succeeds, the owner succeeds, and the management company is motivated to grow the business. Perhaps most important, the owner recoups bandwidth to create and launch new units or new concepts while the management company provides guardrails to make sure that what the entrepreneur dreams up will be scalable and successful.
In summary the formula for restaurant success is: Sufficient/Significant Funding + Operating Discipline = Restaurant Success. Restated for the ideal organizational profiles: HNWI or Investment Group + Management Company = Restaurant Success.