Are restaurants profitable businesses? The answer is yes. But let me clarify the answer: Restaurants can be profitable -- it's the probability of success that's slim.
Restaurants have notorious failure rates: 60% fail within the first year, and 80% are already out of business even before graduating from their 4th year of operation.
And, while many factors contribute to this, one could point out that the restaurant business merely classifies into an intensely competitive industry.
How much is the profit margin in restaurants?
In such an industry, everyone has to kill for market share. There is certainly no shortage of tactics to do this, but it can be boiled down to increase gimmicks (to boost sales), cost reduction (to improve pricing), or a profit margin compromise.
But even if it seems like lowering profit margins is optional -- it actually isn't. In fact, most restaurants can pull all the stops to gain market share, but will still get a poor bottom line.
The average profit margin of restaurants ranges from 2% to 6% (take note, this is pre-tax), according to the Restaurant Resource Group (RRG). And the reason for this dismaying number is a lot of a restaurant's sales go into its "Prime Cost," which is the cost of food and beverage purchases and labor expenses. It's estimated that about $0.62 to $0.68 (almost 70%) account for the Prime Cost for every dollar of sale. Imagine that.
Of course, other expenses have to be accounted for as well, like rent, insurance, utility, and others. And RRG noted that the only way restaurants can be in the green is if it has a favorable rent expense (less than 4% of sales) or the most obvious solution: increase sales.
But, needless to say, improving sales is easier said than done. I've seen food trucks (which have slightly better profit margins than restos but more of that later) employ celebrity endorsements and all sorts of schemes to boost sales because their food can't captivate the taste buds of their customers.
If a product can't sell on its own, then those methods to attract attention to it will eat away the lion's share of the revenue. But then again, this could be a product-specific issue which is remedied by simply throwing out the unwanted product.
Okay, I get that, but why do most new entrepreneurs start food businesses anyway?
I have a couple of theories for this. I think one is the misconception of newbie entrepreneurs that starting a restaurant is easy and that the only ingredients for success are a good location and delicious food.
In other words, as long as there is reasonable foot traffic and cooking is great, there are customers. Again, just a theory.
Another one could be that entrepreneurs push for their USP way too much. Then they pair it with a brash claim, which goes like "what we have is something you have never seen before."
And those never-seen-before spells out a buffet (pun intended) of what people had seen before -- e.g., an affordable price for a luxury dish, a unique blend of cuisines, organic ingredients, and a healthy twist to street food, or a minor adjustment to a mainstream dish like an extra crispier fried chicken.
If that's all it takes to become a successful restaurateur, a lot of people will already be in the game. Wait. I just described reality. Most have the same idea that's why it's a cut-throat battle for differentiation all the way through.
5 PANDEMIC BUSINESS IDEAS
Food Business and COVID-19
Now, when the coronavirus hit in 2020, several industries have been severely hampered by lockdowns and the lack of economic activity -- even killing off several companies. Of course, restaurants have been one of the biggest casualties.
Business Insider even estimates that about 85% of restaurants will go out of businesses by year end. This goes to show that eating out became the least of everyone's concerns because of the pandemic.
No one anticipated that the death blow to some of the businesses in this scarcely profitable industry would come in the form of a virus when in 2018, it was delivery apps that threatened its survival.
Yes, the apps that were conceived to be a wellspring of sales for restaurants became the very thing that took most of it. The high delivery service charge (set at 35%) of apps like Grubhub, DoorDash, and Uber Eats is just too much for most restaurants to parcel out, making these app's proposed benefit more of a paradox.
Restaurants are already clinging on tight margins, and they can't be sustained further if it meant sharing more than a third of revenue per order with the delivery providers, just ask Mulberry & Vine.
But with most restaurants currently operating at half capacity, a lot more people turn to deliveries to get their food. So, when the dust settles, restaurants could end up extinguished by a double whammy of COVID-19 and delivery providers. I'm just curious as to what restaurants will evolve into post-crisis.
Are food businesses profitable in general?
Again it depends. Anyone with the right recipe (again, pun intended) plus with some decent financial acumen and possibly some stroke of luck (this is very important) can make a killing in the food business world. However, the stark reality is that no matter the kind of food business concept, it is inevitably a low-profit margin venture.
AZ Central lays out the profit margin for different types of restaurants. Full-service restaurants are estimated to garner the lowest at 3% to 5%. The second is "catering" with 7% to 8%. Coming at a tie are both food trucks and fast-food restaurants with 6% to 9%.
But what's surprising to me about these statistics is the one for food trucks. Food trucks have low overhead costs and possibly employ less staff than the three other types but still can't churn out double digits in profit margin.
And while in the topic of food businesses, most of the delivery providers mentioned earlier are also remarkably unprofitable -- despite the 35% cut for just delivering orders and the uptick in delivery volume due to COVID-19.
Now, this piece is not to throw shade at food businesses, particularly restaurants. I want to point out that this type of venture is not for the inexperienced entrepreneur. Managing a restaurant is for those who have gone through the headaches of working for one or at least have successfully managed other non-food businesses. And, if both of that is absent, then there's very little chance of that restaurant succeeding -- at least, based on stats.