Thursday, 9 August 2012

The worst business model in the world

"Because I'm not as stupid as I look"

I consider myself to be quite a good cook. In fact I would say I'm the third best cook I know (behind a lady who worked at Alain Ducasse in Paris and a chap who was a semi-finalist in Masterchef). So inevitably people sometimes ask me "why don't you go and start a fancy restaurant". And my response invariably is:

"Because I'm not as stupid as I look."

A fine-dining restaurant is probably the most suicidally insane business model devised by mankind. It is the business school equivalent of trying to deep-fry ice-cream inside a chocolate teapot in the middle of the Sahara. As the old saying goes, the best way to create a small fortune is to start with a large fortune and open a restaurant.

Probably the worst business model in the world...

Putting my analyst's hat on there are a number of reasons why a posh restaurant restaurant counts as the World's Worst Business Model.

  • High upfront capex requirement: Villeroy & Boch china? Check. Reidel glasses? Check. Linen tablecloths (and associated recurring laundry bill)? Check. Three million bucks out the door before day one? Check. Put frankly, although it has little or nothing to do with the food the fixtures and fittings for a contemporary fine diner mean you need to stump up a seven figure sum before you've even fired up the oven.
  • High ongoing fixed costs: As a rule of thumb, ingredient costs make up about a third of the menu price in a good restaurant. That's your variable cost. Unfortunately much of the rest is fixed (largely rent). So even after you've fitted out the place and fired up the oven you then have a ridiculously large fixed cost base to cover before you start making a penny of profit.
  • Low volumes: Fixed costs aren't always bad -  McDonalds thrives with a high fixed cost, but that's because they pump tremendous volumes through that cost base (similar to the business model for data-processing companies like ADP or Amadeus). Unfortunately a high-end restaurant doesn't have that scalability - while McDs might turn tables twenty times an hour, you're lucky if you can turn them twice in an evening.
  • Cyclical demand pool: Oh and did I also mention that low volume demand pool is completely hostage to economic circumstance? (there's a reason why cheaper entz like McDonalds or Cinemas flourish in a recession) So which you volume upside is capped by limited capacity, your volume downside is completely hostage to the macro environment. Worst of both worlds.
  • Low leverage: You want to double the size of your restaurant? You need to find twice as much space, source twice as many fittings and hire twice as many staff. Hassle factor - high. Scalability factor - nil.
  • Vast competition, lower margins: You would think such criminally low returns would deter new competition. Unfortunately not - restaurants are one of those eternal "oh I reckon I could do that" propositions which attracts fresh new mugs at every turn (I blame Masterchef). Result - high competition, limited pricing power, low margins.
  • Exogenous risk: One bad review from Frank Bruni at the NY Times or Fay Machler in the London Evening Standard? You may as well pack up now.

Which is a very long-winded way of bringing me to my main topic of discussion, which is the counter-factual - if a restaurant is the world's worth business model then what is the world's best?

Step forward the dullards of enterprise software...


  1. Maybe it is not the best model but it has more potential than the article gives credit providing the owners have sufficient imagination and determination.

    For example PizzaExpress and Wagamama are two businesses that first started out as restaurants fitting the model you describe and now turn over tens of millions of pounds. They have achieved scale yet are distinct from volume brands such as fast food outlets. By being inventive and building their brand through franchising, cook-at-home meals, and takeout. Cook is another fledging business that also has chefs preparing individual meals but for customers to eat at home.

    In another article you lament the state of the European tech firms and express disappointment at the lack of start-ups coming throgh the ranks. The restaurant sector might not acheive the giddy valuations of tech firms but it does possess many 'home-grown' and owned businesses with buldging valuations and there are no shortage of start-ups. Ironically everything you yearn to see in the tech sector!

    1. Hey mate thanks for your comments!

      Heh note I snuck the adjective "posh" into the introductory sentence. I'm thinking more about high end michelin-ish restaurants in this article rather than the Wagas or Pizza Expresses of the world. Those are the guys with the toxic combination of high fixed costs and lack of scalability/low volume.

      re: PizzaExpress and Wagamama I completely agree with you. These are great business models - the difference is they have high fixed costs but also high volume/scalability. A posh resto can only have 1 or max 2 bums on a given seat during an evening service. Wagas can have 10x that.

      In terms of the basic business model I'm not convinced its that different from the volume brands such as fast food outlets. Its still the McDonalds model - you have a big fixed cost but the actual food you sell is very high gross margin (pizza and pasta - raw materials are flour, water, egg). If you can get punters through the door to cover the your high-footfall rent then the margins ramp up rapidly above your break-even point.

      Cook I haven't tried personally but looks like a variation on this model - one central kitchen which can then scale to high volumes distributed through various channels. I guess the complicating factor is the friction costs generated by needed to keep the food frozen through the distribution chain.

      The one thing I would say is that for every PizzaExpress or Wagamama that takes off don't forget there are hundreds of failures. The thing that always occurrs to me about this kind of business is that if its a smash hit its great but its very very hard to create a smash hit. In particular small details matter a lot. You can have we-have-a-big-site-high-rent-and-just-do-chicken joint which doesn't quite take off and another one which becomes Nandos, and the differences might be imperceptable. There's a real gift to getting this right - Russell Norman of Polpo, Polpetto, Spuntino fame seems to have this gift. Alan Yau also struck gold twice with Wagas (tho he sold out early) and Hakkasan, although I note other ventures such as Busaba Eathai and Cha Cha Moon were less successful.

      re: The global competitiveness of UK restaurant sector I both agree and disagree with you. I know what you mean by us having PizzaExpress, Wagas, Pret etc - real home grown success stories. But I also note that these don't always travel well. (Pret I guess has had a degree of success in NYC). Also companies which have tried to really leverage these and take them big such as The Restaurant Group/Clapham House Group have had mixed records of success. The really big global catering franchises from good old MaccDs through Yum Brands and their portfolio are all American. I guess in the tech analogy PizzaExpress may be like the Imagination Technology of the sector by McDonalds is the global-scale Google-type outfit...

      Hope you find that stimulating - as you can see I think alot about the economics of the restaurant industry as well - but every time I dream about opening up my own little restaurant I wake up in a cold sweat!

      All the best


      PS On the subject of trans-atlantic restauranteurs I note NYC legend Danny Mayer (one guy who has cracked how to do mid-range dining in scale) is about to open his first London venture Shake Shack. I look forward to it with anticipation!

  2. A good read, can posh and scale ever occupy the same space, I doubt it, but both can at least deliver quality.

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