The building blocks of setting up and operating a successful restaurant
This is the fourth and final instalment in a four-part series of articles (4 of 4) focused on exploring the building blocks of a restaurant Business Model. These are what I believe form the foundation for setting up and operating a successful restaurant. In this article I discuss Support Services, Breakeven Point, EBITDA, Financing, Growth, and Effects of Business Model on Design.
Support services, what are they, why do they matter and why did I include them in this article about Business Model?
In a recent project I handled, support services cost the client a closure of 6 months, the loss of revenue, and the near end of their business. Yes, they are important and affect your finances.
I define support services as; “non revenue generating functions within the company”. These include:
- QA (Food Safety)
- Fire & Safety
The company I mentioned was unlucky enough to face two major challenges within a short period. On one occasion, the collapse of one of their servers which led to a hacking of their IT infrastructure. In a separate non related issue, the HVAC (Heating, Ventilation and Air Conditioning) system in one of their restaurants failed and caused major disruptions to the business which led to a complete overhaul of the system.
Both situations were not caused by a single day sudden event, but were because of compiled oversite resulting in a slow deterioration of the systems and their implementation.
These support services are often seen as cost centres and regarded as a nuance. More often than not something not enjoyable for the owner / operator to handle, but they are a necessity.
Whether you opt for in-house, or outsourced solutions, or a combination of the two. Or you appoint internal team members in charge as a side responsibility. These components should be taken seriously, accounted for financially, and included in your organisational structure. Effective support services are ones that you do not feel or notice. I strongly recommend the adoption and use of technology to ensure these functions operate in an efficient and effective manner.
I cannot overemphasise the importance of this metric. Recently, I had a client who was barely making any profits prior to the pandemic. It took us a year of working hard on optimising the business. Now, during these tough times, he turned a positive EBITDA (cash profit) during a low season and in the middle of a world pandemic. There was no magic formula to this. Just a thorough and deep understanding of the breakeven point. A lot of hard work, sacrifices and informed decisions needed to be taken.
To control your breakeven point, you need to take a very close look at both fixed and variable costs, examine ways of optimising and reducing those expenses without sacrificing or jeopardising the customer experience. While it is a tricky balancing act, it is doable. Your aim should be to identify your lowest demand periods, whether a season or a weekday, and figure out what you need to do by reverse engineering the numbers to at least breakeven during those times.
Again, with most other figures, they are best used as management tools, not reporting figures. There is no point in merely knowing a figure at the end of a reporting cycle. You need to have systems in place to track figures almost on a daily or weekly basis. These figures need to become engraved in your team’s daily briefs and language. They need to inform decision making initiatives both for revenue generation and cost saving tactics.
If there is one number, I would suggest you calculate, keep in mind, and use as a quick reference tool for many of your decision making, it is EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation). In other words, this is your cash profit. This is what you end up taking to the bank (theoretically). In our industry, cashflow is king. While there are other factors that can affect your cashflow health and stability, it would be impossible to run a successful business without a positive EBITDA.
As mentioned earlier, you want to avoid paying more to your landlord in rent than you do to yourself in profits. If you are a someone embarking on a new project, my advice is do your calculations accurately (or as close to that as possible) to identify both your potential EBITDA and breakeven points. These two numbers will be key indicators that will feed into your ROI calculations and be your deciding factor in whether to embark on this venture. This is an industry that is driven by passion, but without getting your numbers right, this passion will lead to a lot of wasted hard work and heartache.
If you are an existing business, then I recommend you do a thorough evaluation of your operation by analysing your P&L. The exercise will help you identify areas of improvement to optimise your business and maximise profits. Use this ratio to take daily decisions not only as a reporting tool for end of month cycles. You can use it to calculate required returns on marketing initiatives, the pricing of promotions, decisions on opening times and evaluation of your various revenue centres (in-house and delivery for example).
You want to run a new promotion for a special event you are holding. The marketing expense to promote this initiative comes to $3,000. So in order to run your numbers and set targets, you do a quick calculation:
Assuming you have an EBITDA of 20%, and your average spend per person is $75.
$3,000 (expense) / 20% (EBITDA) = $15,000 (potential revenue required to breakeven on the marketing expense)
$15,000 / $75 (spend per person) = 200 people
This event has to bring in 200 people and above for it to be a success and make you a profit.
Note that we are only evaluating the success of the event through a narrow prism and not considering any PR or community connection benefits. However, this shows you how to use this ratio in everyday decisions. You can then put it on the marketing team to justify how with the $3,000 expense they plan to attract 200 people to the venue. The point here is to always take informed decisions.
Numbers to Consider
The ratios shared in the above table are only indicative. There are multiple variables that can affect these figures. What I am sharing is based on a wide range of projects I have come across.
I have seen projects with EBITDA percentages that range from 10% to 25%. Based on my experience, I believe that if you achieve an EBITDA ratio of around 15% and pay your landlord less than this figure in terms of rent, your business is one that you can sustain and grow. This assumes that you do not have a a substantial amount of interest to pay on loans.
Variables that can affect the cost ratios include:
- Type “category” of restaurant you operate, fast casual, café, find dining etc.
- Menu choice
- Service style
- Management setup, having head office overheads or not
- Utilities used on site
- Country / city you are in
- Type of location, whether shopping centre, high street or other
- Sales volumes
- Dependency on delivery business
- Franchise operation or not
- Support services (in house or outsourced)
Perhaps the most important topic an entrepreneur will tackle prior to embarking on a project. Questions that will be brought up and need to be addressed include: To get partners or not? is the project self financed? approach institutional lenders ? does it make sense to lease equipment? potential returns?
Nowadays you can get financed through suppliers. This can be done by negotiating favourable long-term payment plans. Crowd funding is another avenue you can go for. Incubator projects financed by landlords is one more form of easier market entry for up-and-coming restaurateurs with limited access to funds.
To get a project off the ground and maximise your potential at succeeding, get your numbers right from the beginning and try to stick to them as much as possible. Granted, there will be unexpected things that might come up, but these are things you can also allow for. There is nothing worse than running out of cash 30% close to the finish line when setting up a project. Two things can happen. Either the entire project is cancelled or put on hold. Or severe value engineering takes a hold of the project and dilutes the overall vision and you end up far from where you intended to be and risk failing before even starting the project.
You need to consider working capital part of the financial projections of the initial fund raising initiative. Think of it as your safety net and the cash you will need to survive the first few months. Things that go into working capital include (not limited to):
- Salaries for a couple of months
- Utilities for a couple of months
- Spare cash for produce purchases as most suppliers start off with cash purchases prior to opening credit lines
- Rental instalment (first payment due after opening)
- Deposits required for rent and other
- Prepaid expenses: insurance, licences
- Contingency for unexpected cost overruns
If you are new entrant to the market and want to open your first restaurant, I would advise you to think of this from day one. What are your future plans? Any growth and expansion ambitions? While this is a vast topic, I wanted to include this as part of the Business Model article as it should be at the core of what your business is from day one. Doing so will allow you to look at your restaurant as a business and not only a passionate project.
Even if you have no intentions of expanding or having multiple units, my recommendation is to think from day one that you are. From day one:
- Set up the business as if you will replicate your concept
- Think of your business running without the need for you to micro manage it
- Make sure you set up systems that make the business less dependent on a single individual, you
Even if you are not planning to expand, this will provide you with a healthier, more solid business and will allow you room to take a deep breath and extract yourself from the business to take some time off and re-energise. One of the best signs of a great leader is if the business can run without them. Make that your target, even if you plan to have a single outlet and nurture it with love and hard work for years to come.
Key to all this is to establish operating systems from day one. With franchising, for example (not my favourite mode of expansion), people buy a franchise for two main reasons. The brand and the systems.
If ever you decide to either sell, franchise, or expand your business, you would have already accomplished the hardest step, which is the creation of effective and efficient operating systems.
Effects of Business Model on Design
It is important to identify that the Business Model and design of a restaurant are interlinked. The more you identify and enforce this connection, the more opportunities you have to succeed and have a solid business with longevity built into it. Some of the links from the Business Model to design include :
- Outlet Size
- BOH / FOH spatial allocation
- Seat (sqm) ratio
- Type of seating in terms of arrangement (pax)
- Style of seating (comfort levels)
- Volume / surface finishes
- Positioning and level of finishing
- ROI and budget
- Delivery aspect of business (food production and pickup)
- Takeaway aspect of the business
What you can take away from this
Know your business through numbers. A restaurant is made up of varied interconnected parts that need to come together to create a memorable customer experience. That creates loyalty and repeat visitations. With that said, you need to monitor all the different moving parts, see your business through the lens of numbers and fine tune and ensure everything comes together in a way that allows you to turn a profit.
Often when working on new projects with the development teams (designers, builder and suppliers), they all have a target in place which is the opening / handover date. To them, this is when the project is complete. I constantly remind them that is the start date, not the end date of the business. You increase your chances of success as an owner / operator if you take the points mentioned in this article into consideration while creating your new business / concept. Think of it as a puzzle which, if you get right, all the pieces fit perfectly together. If you don’t, you end up trying to force square pieces in round holes.
If you are an existing operation, optimization is a daily task you need to embrace. It is never too late to instil a culture of data driven decision making and strategy formulation in your business. Through daily small incremental improvements, you can reap great benefits. Constant improvement, adaptation and evolution are key to ensuring long-term success in this volatile, risky, yet beautifully rewarding industry of ours.
I hope that all restaurant owners / operators turn profits that are higher than the rents they pay to their landlords and can reap the financial rewards of their dedicated passion to the industry.
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