The Restaurant Economy

21 / 01 / 2020
Category: Blog

I’m upset to report that in the last year two of my favourite restaurants, a curry house and a sushi place, have closed.

To those of you with a knowledge of textbook microeconomics and theories of the firm, I’m sure you realise that this idealistic view of the world is only a loose approximation to how things really run.

I live in a pleasant residential suburb of north London, with lots of food outlets – though not as many as a few years ago. When we moved here, getting on a decade ago, I made a point of trying all the local eateries. Within a five-minute walk you can find sandwiches, cafés, curries, veggie Indian, Persian, Turkish, burgers, Lebanese, sushi, Vietnamese, Jamaican, pizza, two amazing falafel joints and some excellent gastropubs. There are also a few chains, though it is the independents that I’m glad to say dominate.

It doesn’t surprise me that they don’t all survive long-term, though it is personally frustrating that of the four closest outlets to us three are boarded up and the fourth is a chain I tend to avoid.

The restaurant industry is relatively fluid. Barriers to entry are low, though not insignificant: the costs of kitchen equipment, furniture and furnishings are front-loaded, but can often be softened by a few months rent-free negotiated with the landlord.

In textbook theory the industry feels like “monopolistic competition”. In this model, barriers to entry (or exit) are low, and if there is sufficient economic profit (i.e. profits beyond providing a normal return to proprietors) then competitors will join the market, pushing supply up and prices down. Conversely, as is very apparent, if returns are insufficient then establishments will close, leaving a bigger slice of the pie (or pizza) to each survivor.

Monopolistic competition is less efficient than perfect competition, in which products and prices are identical. Monopolistic competition allows for branding and advertising, as well as product differentiation. Although these are obvious features of restaurants, the market settles at cost levels above the minimum, which is, at least according to the theory, considered inefficient.

I mentioned economic profit – let’s explore this idea a bit further.

Where it is relatively easy to open and close, the natural level of economic profit should be zero. All providers of resources wish to receive (and will, in the long-term, need to receive) a fair return. The food suppliers need a reasonable price; the waiting staff must earn an acceptable wage; the landlord wishes to get adequate rent. Who else? Oh yes, the proprietor. Let’s suppose our budding entrepreneur, Hélène, opens a modest café. She needs a fair return on her expertise, not to mention her time and capital. Though as equity owner she gets bottom dips.

Surviving and making a decent return are very different measures of success. Hélène installs a kitchen and furniture, sinking her time, imagination and of course savings into making the place homely and welcoming. As the first paying customers arrive, how many people must she serve to make it worthwhile?

Quite a lot, as it happens. Let’s invent some numbers. Hélène’s café is 150 square metres (1,500 square feet, give or take) in size. Rent may be around £30/sf, with another £10 of business rates, already £1,200 of fixed costs per week. Add a waiter and a chef, even on the minimum wage, and fixed costs climb to £2,500 per week.

Now look at revenue. There’s a wide spread between caviar and cappuccino, but let’s say a typical customer pays £10, with a gross profit margin of 60%. After VAT that’s £5 gross profit per cover.

This means our café owner needs 500 covers per week, 70 a day, to cover fixed costs. To provide any kind of personal income she would need closer to 100 customers a day. And then there’s trying to recover her savings…

Realistically, how on earth do cafés and restaurants survive? As I have seen, many independents don’t. By contrast, the chains have a number of advantages: their branding increases footfall and revenue, their bulk purchasing decreases costs. Even losses can be considered a marketing cost: we have a (big name) ice-cream shop nearby, open throughout the year from noon till midnight. At this time of year, I’d be amazed if they sell more than a few dozen scoops on a damp, grey weekday. Such losses couldn’t be sustained indefinitely by an individual.

This inequality makes it harder for Hélène to survive and can lead to a dreary uniformity of high streets around the country. I recall an episode of The Simpsons in which one by one each shop in Springfield Mall turns into a Starbucks – Bart Simpson goes into one place (“If it dangles, we’ll punch a hole in it”) to get his ear pierced then walks out moments later, latte in hand, to see the new sign already above his head.

It is the small entrepreneurs, the Hélènes, that create jobs in the economy, demand for resources, and supply for hungry locals. It may well be she values her independence as fair reward for a low and irregular income. It may also be that her café becomes the hip local establishment that expands until she makes a multi-million-pound retirement. Though let’s be honest, the former is more likely.

Now, what’s for dinner?

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