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It’s never been easy to make money in the restaurant industry. A highly fragmented sector dominated by 70 percent independent owners and operators, the average restaurant’s annual revenue hovers around $1 million and generates an operating profit of just 4-5 percent. A financially sustainable business model for small independents is often elusive.
So when a crisis of the magnitude of the COVID-19 global pandemic forces restaurants to close, and their revenue drops to zero overnight, things get particularly dire. Unlike the oligopolistic airline industry, where a few large firms can easily band together to lobby for government support, the concerns of restaurant owners and the unique realities and concerns of their industry remain largely unaddressed by government programs designed to help small businesses.
Two months into the pandemic, 40 percent of America’s restaurants were shuttered and 8 million employees out of work—three times the job losses seen by any other industry. While some restaurants began reopening in May and June, most featured only takeout, delivery, or outdoor dining options due to local restrictions. The number of diners in June remained down more than 65 percent year over year, and the National Restaurant Association projected an industry revenue shortfall of $240 billion for the year.
Second-order effects of restaurant closures ripple through the American economy, bringing economic pain to farmers, fishermen, foragers, ranchers, manufacturers, and other producers who supply the industry. Equally hit are supply chain partners who move goods across the country.
“IT’S GOING TO TAKE SOME TIME TO RETOOL OPERATING MODELS TO BE ABLE TO SUCCEED IN THIS NEW ENVIRONMENT.”
Coming into 2020, the restaurant industry was thriving. Within a few short months, we now see an industry back on its heels, massively disrupted by an external force so unprecedented it is almost unfathomable.
The severity of this business interruption will continue to endure and be further complicated by the mandate of many local governments that dine-in capacity be limited to 25-50 percent even after restaurants are permitted to reopen. It’s still an open question how skittish the American public will be about returning to one of its favorite pasttimes.
As a result, the restaurant industry that emerges from the global pandemic will likely look fundamentally different from the one that existed in early March. How will the COVID-19 crisis change the landscape of the industry, and what do restaurants need to do to survive? And, what should consumers, desperate to return to their favorite restaurants but wary about whether it is safe to do so, expect?
Stories from the inside
The future of the restaurant industry is especially of concern to us. We collectively share 35 years of restaurant and food industry experience, navigating our way through as waitstaff and bartenders, as managers and senior leaders of restaurant groups and the industry’s primary trade association as well as the food and beverage brands that supply them. We’ve invested in the industry and served as corporate board members and leaders of industry coalitions, and we now, as educators, prepare future founders and leaders of restaurants to operate in this unique industry. We’ve spent the last few years in deep study of the restaurant industry to create and deliver an MBA-level course at Harvard Business School called Challenges and Opportunities in the Restaurant Industry.
Leveraging this work, we virtually convened in April a diverse group of restaurateurs, chefs, investors, and industry leaders to participate in a course capstone panel discussion of the COVID-19 crisis and what it means for the future of the industry.
What we heard was that the restaurant industry was in deep economic trouble and that ill-conceived government bailout plans were not helping to shore it up. However, we also heard that restaurateurs remained steadfastly committed to their goal of nurturing and nourishing people, providing a place of succor and community in a strange new world.
Our conversations with the panel and our field research inform our vision for the future of the industry and the advice to restaurant owners, staff, investors, and patrons that we offer below.
How did it deteriorate so quickly?
Restaurants are universally labor intensive—by any productivity metric they rank among the least productive industries. Labor is required to both produce food in the kitchen and serve to consumers in the dining area. On average, restaurants spend 30 percent of their revenue on labor. With increasing focus on fair wages and legislated wage increases, restaurants may easily exceed that average.
Moreover, restaurants spend roughly equivalently for cost of goods sold (COGS). Independent restaurants typically purchase without the ability to hedge or otherwise lock in pricing, and so are at the mercy of supply-price fluctuations.
A third cost challenge for restaurants is occupancy. Locations are generally leased on a triple net fixed rent basis, occasionally with an additional percentage rent above a specified revenue threshold. Normatively, the industry seeks to spend no more than 10 percent of revenue on occupancy costs, but when entering leases, restaurateurs may well be optimistic about their projected revenue and therefore agree to a fixed rent expense that winds up exceeding that percentage of actual revenue. Other expenses—insurance, credit card processing, marketing, utilities, repairs—mount up.
Assuming adequate working capital upon opening, a restaurant’s cash from daily sales is used to pay for supplies previously purchased as well as for payroll, rent, and other expenses. As a result, restaurants typically operate with modest cash reserves. If revenue is disrupted, accrued payables as well as payroll and rent remain to be settled. When JPMorgan Chase sampled almost 600,000 businesses in 12 representative industries, restaurants had the lowest cash buffer.