Why Restaurants Fail

Hint: They are destined to.

Last week I wrote about why packaged food brands fail. 

TLDR: Packaged food has low Gross Margin (GM). Because we humans have evolved to mate and procreate. So we only pay high money for things that make us look good outside. Packaged food can’t do that. You can’t flaunt it. It can’t buy you social status. Hence, low GM. Hence, death. 

But what about restaurants? Why do restaurants fail? So often and so spectacularly? 

Restaurants, after all, have great Gross Margins. 70-90%! And that’s understandable. We flaunt the restaurants we go to. It’s a legit status signal. Plus, eating out is an experience, not just a product. So one can charge up for it. 

Yet, restaurants have the highest mortality rate of any industry in the world. 60% restaurants shut in Year 1. 90%  shut in <5 years. 9 out of 10! Why?

And yet, everyone wants to quit their job and invest their life’s earnings into opening a restaurant. Even in the face of such daunting odds. Why o why!

Also, btw, even amongst restaurants that survive, very very few scale. Barring imported chains like Dominos and KFC, how many profitable, Indian restaurant chains with over a 100 outlets can you think of? Haldirams. Theobroma. And?

Why?

Side note: a few cloud kitchen brands are scaling. Rebel foods & EatFit being the top two. But neither is profitable (yet). Even at 1000Cr+ scale. Why?

Before I present my answer, allow me to accept - I’m much closer to the packaged food industry than fresh food (restaurants). My time at REBEL foods, and my extreme curiosity as I view this sister industry from the sidelines, are my only credentials. This might be both, a weakness and a strength. Because I am looking at it like a marketeer, not a restauranteur.

Disclaimer done. Let’s get to it. 

The simple, surface level answer to all these ‘whys’ is operating costs. Running a restaurant is costly business. 

Even before you’ve spent over a crore building the restaurant of your dreams, you start paying rent. The biggest cost on any restaurant P&L. And rents in Indian metros are just too high. With a PPP (purchasing power parity) that’s one-fifth of New York, Mumbai’s per sqft rents are just half that of NY. Or higher. Simply unaffordable. 

The industry used to offset this by paying minimum wage in a country known for cheap labor. But even that is changing. If you want a server who can explain your sea urchin artichoke crème brûlée panacotta to a guest, you need extremely trained staff. And that staff ain’t cheap. 

So yea, we could settle for the simple answer, that high costs kill restaurants. 

But high costs are not an unknown. Most restaurants price that in. 

I mean, food and drink ain’t cheap nowadays. Paying 800-1000 bucks for a cocktail is quite common now in Delhi, Mumbai & Bangalore. That’s $12. That’s 80% of NY prices. Clearly, I’m paying your rental with my Mojito. Then why don’t you survive (live beyond 5 years)? And why don’t you thrive (scale beyond 10 outlets)?

Answers to both are different. Let’s answer the easy one first. Scale. 

Restaurants don’t scale because the best ones are made with love. With soul. And soul doesn’t scale. It shouldn’t either. 

Within restaurants, those serving Indian fare deserve a special mention. Unlike pizzas and burgers, Indian food isn’t modular. It isn’t one patty, one circular piece of tomato and onion, one slice of cheese and two squirts of our special sriracha mayo inside a factory made bun. It’s 10 different veggies and 20 different masalas stirred in a large pot and sautéed and simmered and brought to a boil and salt added ‘swaad anusar’.

Indian food is complex. And it doesn’t scale linearly (garam masala in Shahi Paneer for 50 people being cooked in a large pot is not 25X of home cooking for two people). Same is true for many other complex cuisines (usually from old civilisations). Chinese, for example. No 1000 outlets chains. Just doesn’t scale like American food. Japanese is worse.

But forget scale, why don’t restaurants survive? Even at the count of one?

First, yes, costs are a big reason. Especially because both rent and salaries are an input into revenue. High rent locations lead to more sales (hopefully). Better and more staff is needed for great service. So even these seemingly fixed costs are actually a variable that impacts both top and bottom line. 

Second, restaurants are a catchment businesses. Unless you’ve really created a Michelin star, one-of-a-kind experience, chances are 80% of your guests come to you from within a 5km radius. Which means that after being in this area for (say) 2 years, everyone who had to hear about you and try you, has already done so. 

In FMCG terms, your penetration has maxed out. To grow penetration, you need to grow mental reach (more people know of you) and physical reach (more people have access to you). You’ve topped out on both in your catchment. The rate of acquiring new users will now be very, very slow. Which brings us to the real kick in the nuts.

Restaurants, by their very nature, are anti-loyalty. 

When you buy your tea, or biscuits to have with your tea, your mind goes ‘let’s get the one we’ve always been getting. We don’t want to take a chance’. But when you think of going out, your brain goes ‘aaj kuch naya khate hain’. Let’s try something new today.

By definition, if I’ve been to your restaurant once, my brain is now working against you. I don’t want to repeat. Not very soon atleast. 

Now, just like every brand, every restaurant is a leaky bucket. Even to maintain revenue, you need a constant stream of incoming new users, to compensate for the people who continue to leak out of the brand/restaurant. 

But, because it’s a catchment business (you can’t increase distribution beyond a certain radius), the rate of water flow from your tap is capped. And destined to decline rapidly after 1-2 years. And because of ingrained variety-seeking, your leak rate is high, and destined to go up with time. 

A double, double whammy. 

This, I believe, is the core reason why restaurants fail. Because structurally, they can’t recruit new users at a higher rate than they (are destined to) lose old ones. 

One might argue, why not make food that is so good I want to come back to you again and again. And yes, some folks are able to do that (10% do survive remember :)). But it’s damn tough. 

Consider this. If you want to charge high prices (to offset high costs), you’ll need to make something bespoke (a Peruvian restaurant, say). But bespoke stuff, by definition, doesn’t lend itself to regularity (you’ll go here for the novelty, then move on). In this case, you might make very high GM, but the leak rate of your bucket will be exceptionally high (unless of course, you are sooo good that I’ll drive 20km to come to you). 

That’s how the cookie crumbles.

You start. You’re the talk of the town. The ‘it’ place with a week long waiting list. You’re chatting up patrons late into the night. You’re making good money.

But the bucket is already leaking. Far faster than it can fill.

18 months in and, suddenly, you’re never house-full. Cool people have tried you and moved on. Flaunt value has dropped. More emptiness follows. You haven’t even recovered your (more than) one crore yet. Now you don’t feel like investing more in upkeep. The ceiling starts dripping. The chairs start creaking. The ghost town look is complete. The last few patrons also stop patronising. A vicious cycle sets in. You struggle for a bit. You’re emotional about this place. It has your heart in it. Another year passes. Nothing changes. You’re approached by someone who wants to open an Ethiopian restaurant here. You see the same sparkle in their eyes. You sell and cut your losses. You wish them luck.

Funnily for restaurants, making lower GM seems to be a better play. Keep costs low. Make comforting, homely food that I can order thrice a week. And don’t price it very high. Make less money per order. Since your penetration is capped, ensure high repeats. 

Look around you. Many restaurants that have survived, do this. I don’t have data, but my guess is that mortality amongst high-end restaurants is much higher than the Shiv Sagars and Udupis of the world. 

And lastly, if you survive, don’t get over-ambitious and try to scale. Many good restaurants die not because one outlet wasn’t making money. But because they opened one too many.

PS: One interesting exception seems to be Cafe chains. Blue Tokai, Third Wave, Chaayos, Starbucks -  all are scaling and getting close to profitability too. Why? In a future post :)

PPS: That’s me devouring Artichoke Pizza in NY. Boy, that pizza had soul! No wonder, when we got greedy the next day and went to a different store of this ‘standalone outlet turned chain’, it turned out to be shit. Sigh.