ARCHIVES  :: SEPTEMBER 2002 :: ENTERPRISE

Bottom of the Food Chain
Entrepreneurs Struggle as Big Companies Take Control of the Restaurant Industry

By Shirley Leung
Staff Reporter of The Wall Street Journal

After more than 20 years in the restaurant business, chef David Schy pursued the dream of many an entrepreneur: He started his own restaurant. His Hubbard Street Grill in Chicago opened eight years ago to gleaming reviews, and at its peak in 1998, Mr. Schy, along with his wife and business partner, Debbie, took home a tidy profit of roughly $300,000.

photograph: Andreas Larsson

'All we can do is beat the chains with food,' says Mr. Schy. 'You take an idea and make it better.'

Then the chains came.

In downtown Chicago's trendy River North section, upscale chain restaurants started popping up within blocks, hemming in Hubbard Street Grill on all sides. Rock Bottom Restaurant & Brewery. Smith & Wollensky. Spago.

Mr. Schy tried everything he could to compete. He kept a lid on prices, mailed thousands of coupons and matched rivals' popular menu items. But a month ago, with profits tumbling, Mr. Schy closed down his 200-seat restaurant.

"We're a dinosaur," he says. Soon, "it's all going to be chains."

Last year, large chains for the first time nabbed the majority share of the $269.4 billion restaurant market, which was once dominated by the mom-and-pops. In 1991, the big chains had a market share of about 46%. By last year, that had blossomed to 50.6%.

'Wal-Marting'

Much of that growth has come from the explosion of sophisticated companies specializing in sit-down restaurants such as Cheesecake Factory, P.F. Chang's China Bistro, Morton's and Olive Garden. Many of these chains have dozens, even hundreds, of restaurants fanning out nationally. Many are publicly traded, with Wall Street money fueling their initial expansion. The rise of these upscale chains has made it harder than ever in the restaurant business to go it alone.

"It's the Wal-Marting of the restaurant industry," says Bill Guilfoyle, a professor at the Culinary Institute of America.

Even chefs who seem too highbrow to clone are multiplying. Chef-to-the-stars Wolfgang Puck oversees 68 restaurants across the country. "Why only open one?" asks Mr. Puck, whose restaurants rang up sales of over $200 million last year. "If you train a lot of good people, why not put them into business with yourself rather than with your neighbor?"
Operating a string of restaurants gives Mr. Puck muscle in the market, spreading fixed costs over several properties. Each of his 12 fine-dining establishments contributes between $10,000 and $80,000 to create a $250,000 PR and ad budget for the group. (An independent restaurateur would be lucky even to have a marketing budget.) By having multiple restaurants, the closely held Wolfgang Puck Fine Dining Group saves about 30% in liability insurance costs, or about $12,000 per restaurant annually.

In some markets, the independents are similarly banding together. In Arizona, about 120 restaurants have formed a coalition to pool their purchases and extract better prices on everything from fish to linens. Cafe Terra Cotta in Tucson saves at least $100,000 a year from the alliance, estimates owner Don Luria. In Kansas City, Mo., some 20 independent restaurants recently began kicking in $90 a month each to take out ads in the Kansas City Star, featuring the names and numbers of all the restaurants.

Back in Chicago, Hubbard Street Grill worked hard to beat the odds for eight years. Like other independent restaurants, Hubbard Street Grill budgeted enough to hire a public-relations firm -- about $20,000 -- to help get the word out when it opened in March 1994. After that, there wasn't much money for advertising. That made reviews critical. "You need to get a good review in the first six months," says Mr. Schy. "You can't afford to advertise."

A small ad in monthly Chicago magazine can cost $2,000 to $3,000. Slim profit margins -- 5% to 10% -- make it hard to recoup the costs, says Mr. Schy. Meantime, chains such as Smith & Wollensky with eight restaurants and Olive Garden with 490 locations can herd diners into their restaurants with ads in national magazines or splashy network TV spots.

While chains often get a bad rap for their food quality, Mr. Schy did borrow some of their innovations. He theorized that chains had done enough research to identify popular trends. For instance, when California Pizza Kitchen, just two doors away, offered a Thai Chicken Pizza, Mr. Schy devised a Thai Chicken Wrap. "All we can do is beat the chains with food," says Mr. Schy. "You take an idea and make it better."

When the fancy steakhouse chains rolled into town, Mr. Schy extended his line of steaks to six cuts from four. But the steakhouses offered ambience that he couldn't afford. When Mr. Schy opened his restaurant, he didn't spiff up the warehouse space that housed it -- except to paint a mural on one wall and get a new sign.

Small Victories

Mr. Schy counts some small victories. The chains never really ate into his lunch business, which had been pulling in $4,000 a day in sales serving 300 customers. Lines were common at lunchtime, and the bar counter was often lined with to-go orders. Mr. Schy thinks Hubbard Street Grill, which had an average dinner ticket of $25, thrived for as long as it did because he tailored the menu to his regular customers.

But Mr. Schy saw the beginning of the end in December 2000. He estimated that the chains had already gobbled up 25% of his dinner business over several years. His suburban clientele seemed more comfortable staying close to home and eating at Olive Garden and Red Lobster than spending a night in the city. Because of the competition, he couldn't raise prices.

So the Schys aggressively cut costs: Removing tablecloths saved $3,000 a month. Switching suppliers saved them $300 a month on dishwashing soap. But business fell further after Sept. 11, when business travel budgets sank.

After struggling all last year, the Schys managed to scrape together a profit of $100,000. With both of them working 60-hour weeks, it hardly seemed worth the effort. When their lease expired in May, the Schys decided to quit.

Luckily, Mr. Schy had a fallback. On the side, he bottles and sells his "Ketchapeno," a concoction of ketchup and spicy jalapenos. He says that business is taking off, and he made nearly as much selling Ketchapeno over the Web and to grocery stores and restaurants last year as he did running Hubbard Street Grill.