Article

Brave New World
for Independent Operators

Chris O'Donnell is co-owner of Craft Grill Restaurants in the Houston metro area. He filed his paperwork for an Economic Injury Disaster Loan (EIDL) on April 1 and for a Paycheck Protection Program (PPP) loan on April 6. On April 20, he had not received a cent from the government. The day before, the Small Business Administration (SBA) announced the EIDL program was on hold, and Congress and the White House were near a deal that would allocate an additional $50 billion to the program.

In an attempt to "flatten the curve" of the COVID-19 pandemic, the government shutdown of restaurant dine-in service overnight shuttered successful independent full-service concepts across the country for all but delivery and takeout service. O'Donnell is no ordinary entrepreneur. He is a lifelong restaurateur whose emerging Houston brand has received accolades from the food press, was a past board member of the Texas Restaurant Association, and someone whose resume includes executive positions with Brinker International. And he wasted no time hand-wringing or navel-gazing.

Aldous Huxley's classic dystopian novel warns us what happens when we marginalize what it means to be human. The restaurant business represents the best aspects of society, including communal experience and hospitality. It played a significant role in the Civil Rights movement, leading to Title II of the Civil Rights Act of 1964, which prohibits discrimination because of race, color, religion, or national origin in places of public accommodation, including restaurants. In this article, we look to experienced and outstanding restaurateurs, consultants, experts, and strategists to discuss what the future of the restaurant business might look like in the wake of COVID-19, and what operators, the industry, and government might do to preserve its essential role in a truly civil society.

O'Donnell ramped up off-premises sales from 3% of his prior total business to more than 45% of his pre-pandemic sales in a matter of weeks with aggressive social media marketing and signage. No doubt, it is an impressive feat that slowed, but had not stopped, thousands of dollars of weekly cash flow hemorrhaging. While he hangs onto his business like a Texas bull rider, O'Donnell reads reports of large chains such as Ruth's Chris, securing millions of dollars of PPP funding. Even without the government-backed loans, the chains are in a much stronger position than the independent restaurants to weather the pandemic, with private-equity capital and credit lines. Meanwhile, like many independent operators, O'Donnell waited for his share of government- backed SBA loans that could mean the difference between staying in business and closing his doors.

On April 23, 2020, the Wall Street Journal reported Ruth's Hospitality Group, owner of Ruth's Chris intended to repay the SBA loans it received in the amount of $20 million, following the lead of Shake Shack, which repaid $10 million it received. Bowing to industry pressure, a number of other chains followed suit.

Government, Where Art Thou?

The government promised a bail-out. For many of the small businesses that comprise more than 70% of a once $825-billion industry, they felt like the proverbial skeletons at the feast, with their life savings at risk. Before we criticize government response, however, let's consider the CARES Act was quickly drafted and passed in an emergency, and its primary policy goal was to keep people employed. The two primary funds, the EIDL and PPP were never crafted as long-term solutions for restaurant businesses. PPP loan forgiveness required 75% of the amount dedicated to payroll costs incurred in an eight-week period. Independent operators trying to stay afloat with delivery and takeout were not inclined to maintain more than minimal staff, and encouraging the rest to apply for state unemployment benefits.

Thus, without the forgiveness, they were essentially being lured into loans that would only promise a big debt obligation coming out of the crisis. That is if they are able to come out of the crisis at all. Says Allen, "If you are doing $600,000 to $700,000 a year as an average small independent, even with 10% of the loan not forgiven, you might be not be able to pay it off and stay in business."

The EIDL, with a 3.5% interest over 30 years and a $10,000 grant was not a bad deal for operators like O'Donnell, who could use it to refinance his existing debt. And that would have been fine, except the EIDL funds dried up before he could take advantage of them. And in any event, the recovery period for most restaurants will be long. They would need breaks to cover losses and carry them through a long recovery period. And speaking of covering losses, operators with business interruption insurance sued their insurers to cover COVID-19 claims. (Please read "Business Interruption Insurance: Are You COVID-19 Covered?" for more information on this topic.)

If this is a time to consider a new order in the restaurant business, Walchef encourages the industry and lawmakers to examine the minimum wage, the tip credit, and tipping.

In mid-April, President Trump announced executives, economists, scholars and industry leaders would form various "Great American Economic Revival Industry Groups". The representatives of the food and beverage sector included many of the usual industry suspects, including leaders of the National Restaurant Association, The Coca-Cola Company, and the national chains including Chick-fil-A, Bloomin' Brands, Papa John's, Subway, Starbucks, Waffle House, Wendy's, and Yum! Brands. Several independent operators were part of the mix, including Thomas Keller, chef and owner of the iconic Napa Valley concept The French Laundry.

Whether or not independent restaurants have a meaningful voice at the table is still yet to be determined. Former Brinker International CEO Doug Brooks is upbeat and believes the National Restaurant Association is "doing a good job putting pressure on at all levels to update legislators to offer help to operators not just to stem unemployment." In fact, President Trump signed a bill to provide a $484 billion coronavirus relief package, which included another $10 billion for the EIDL, program, and sets aside $60 billion for smaller community banks and credit unions.

Listen to our podcast interviews with Doug Brooks, Shawn Walchef, and other successful operators...

The landscape has continued to change. I spoke to Brooks, O'Donnell, as well as successful young restaurant owner-operator of Cali Comfort BBQ and forward-thinking digital marketer Shawn Walchef, global strategist Aaron Allen, and internationally acclaimed consultant Chris Tripoli. They have thought deeply about this situation and how restaurateurs, the industry, and government might respond.

The End of the World as We Know It?

These experts agree the full-service restaurant market is likely not coming back as we know it, if only because third-party delivery was already impacting the industry before COVID-19. The pandemic has only accelerated it.

All restaurants are in the same ocean, but not in the same boat.

"Restaurants will most likely not reopen at the same revenue levels they were pre-Corona," says restaurant consultant Chris Tripoli. "I hope I am wrong, but the restaurants with which I have been working are looking at a 60% to 75% revenue level. The new normal is going to look like a combination of fewer guests dining in, with more opting for delivery and pick up. In total, it will be less revenue flowing into most concepts. I know, "ouch". But it's real."

According to the National Restaurant Association, prior to COVID-19, independent restaurants comprise 70-80% of units. Allen believes the independent restaurant market will likely experience the same kind of shift the pizza market experienced when chains took off. Years ago, the ratio of independent to chain pizza units was 60/40. Today, it is 40/60.

Not surprisingly, experts echo the early winners among the full-service independent market coming out of this are likely operators who figure out delivery and takeout as a significant supplement to lost dine-in business. The shift has top- and bottom-line implications. Delivery and take-out service models require fewer people.

"The dirty secret" observes Walchef during the transition of his concept Cali Comfort BBQ to delivery and takeout during this crisis is "something we've known for a long time. The full-service restaurant model is broken. Margins are so slim, and we're always asking ourselves how much labor we need to provide a five-star experience."

Walchef has no intent to abandon full-service at his popular family-friendly sports concept. Nevertheless, he has carefully eyed the margins of his take-out service during the crisis, and as he notes, it was difference between a labor cost of sales percentage of 35% and 10%. "I have to consider what is best for my family."

Allen believes coming out of this crisis, will there be a "moon race" in the restaurant industry to find ways to cut labor costs by reducing dependence on labor. Allen notes the restaurant industry has been slow to integrate technology to reduce the need for human labor, compared to other sectors.

The hospitality industry has created employment opportunities. Other industries have diminished them through automation and technology. Guests value hospitality. The question is: how much are they willing to pay for it?

Allen also notes something every operator understands every time he or she pays the landlord. A big footprint at a desirable location can be crushing overhead. Restaurants with a high percentage of takeout and delivery sales will also have the advantage of being able to operate in a smaller footprint with a lower rent factor. The commercial real estate sector will have to retrench in the face of this retooling.

Hospitality is going above and beyond. People want farm-to-fork in an Amazon Prime way. We can deliver it if we package it in the right way.

If this is a time to consider a new order in the restaurant business, Walchef encourages the industry and lawmakers to examine the minimum wage, the tip credit, and tipping. "Politicians talk about the minimum wage and how it needs to be increased," says Walchef, acknowledging the need for restaurant employees to earn livable wages. He is more concerned, however, about the kitchen staff, which he believes are hurt by not being able to be included in tip sharing. Tipping takes care of service staff, and should not be eliminated in his view.

Says Walchef, "servers and bartenders are making $20 to $30 hour. They don't want to become managers. The kitchen crew is running a mini factory. How are they not part of the service?"

For Walchef, tipping is essential to running a full-service operation, if only because of the tip credit, under the Fair Labor Standards Act (FLSA),which allows employers to pay their employees less than the standard minimum wage as long as the employee earns enough tips to make up the difference. The difference in the amount of money between what operators pay their employees and the standard minimum wage is called a tip credit. And it keeps labor costs manageable.

Walchef and O'Donnell observe not only is tipping alive and well in the U.S. Moreover, during the COV- ID-19 shutdown, tippers have become even more generous. O'Donnell has found the average tip has increased from 20% to 28%.

Deliverance Through Delivery?

Third-party Delivery remains controversial in the new normal. As Allen observes, it has gone from independent operators saying "we're being ripped off, to it's our savior." O'Donnell is still in the former camp and is handling delivery with existing staff, rather than having his customers pay what he considers exorbitant fees.

As Allen notes, Millennials and younger have embraced delivery, and in the midst of this crisis, Postmates, an online delivery service is looking to hire 300,000 employees. Full-service operators, says Allen, might learn they can get by with "half as many people as before. The average cost of training a new employee is $1,500 to $1,800," he says. Operators are going to be cautious about hiring, says Allen, adding "like marketing and capital expenditures, hiring will come back slowly". If Allen is correct, with his many years as a restaurant industry analyst, government efforts to get people back to work will be stymied. He envisions something akin to the G.I. Bill to provide job skills training to people displaced by COVID-19.

Allen is also concerned about the debt obligations incurred by operators who receive PPP loans but do not qualify for forgiveness, the amount of which is unclear for businesses that don't meet the requirement of 75% of the loan used for payroll expenses.

As we have seen, a number of independent restaurants have grasped at every dollar of sales they can deliver, going as far as turning their locations into community pantries. Walchef and O'Donnell believe take-out and delivery alcohol are required for restaurants to stay in business. State legislators can do a great deal to help operators by easing their laws regarding takeout and delivery of beer, wine and even mixed drinks. As O'Donnell notes, law enforcement is concerned about people driving with unsealed containers. A container system for the guests to transport the libations to their homes that indicates it is sealed would help justify changes in the law.

Brooks also sees some salvation in selling mixed drinks for delivery and takeout. Alcohol represents about 15-20% of the sales mix for full-service operators. "Restaurants are trying to access mini bottles since the airlines aren't using them." Since these are sealed bottles, one might envision selling the ingredients for mixed drinks with the mini bottle and instructions for making a Bloody Mary or even a signature craft cocktail.

Third-party delivery companies disrupted the independent restaurant market. Now independent operators appear to be in need of a third-party delivery company to disrupt the third-party delivery market.

It is no secret the fees and practices of the larger providers have been under scrutiny since they emerged. Coming out of the crisis, there will be no patience for the host of allegations leveled against them by industry operators and observers. These include pricing that puts small independents at a disadvantage to national chains, overbooking (analogous to airlines that book more seats on a flight than capacity), canceling orders, food tampering, and exorbitant delivery fees.

Allen has observed that at least one major third-party delivery company will accept all orders, even if it is unable to find a driver to pick up and deliver a percentage of them. Meanwhile, the food waits at the restaurant -- and waits. Industry observers speculate independent operators who survive this pandemic will not tolerate this.

Brooks cites examples of third-party delivery companies trying to ease the strain on operators in this environment, including Doordash, by cutting its fees. In San Francisco, local government got involved and placed limits on what third-party delivery companies can charge. "They're trying to help the consumer."

And What About Hospitality?

While a large segment of society clearly doesn't feel the need to visit a bricks-and-mortar retailer for everything from electronics to clothing, the question remains if the human touch is a competitive advantage in a restaurant market in which everything is delivered, like pizza, or picked up like a quick-service drive-thru.

According to Walchef, certainly every operator will want a high-traffic location that supports drive-thru, or at least an easy pickup. He is revamping his systems with a new delivery platform to process and stage orders more efficiently and effectively. For him, that is merely logistics to avoid unhappy customers. He believes there is still a place for hospitality, although it might look different than we remember.

"Customer service is bullshit," says Walchef. "That's just treating someone like a human being. Hospitality is going above and beyond. People want farm-to-fork in an Amazon Prime way," he adds. "We can delivery it, if we package it in the right way."

Walchef promotes what he called "digital hospitality" and the winners going forward are likely to be those who leverage "digital touchpoints" National full-service casual chain Chili's is already doing this. How can it work? For example, the crew at the restaurant could record a quick friendly video on an iPhone and send the video via email to the delivery customer. "We have so enjoyed preparing your meal tonight," says the chef with the hubbub of the kitchen around him/her. "We hope this evening is special, and please let us know if we met your expectations." The person delivering the food can be particularly friendly and hospitable, bearing an unexpected added-value, such as a free dessert sample and a direct phone number to voice complaints or compliments.

Whether chain or independent, the strategy for survival is conserving cash, says Brooks, explaining for a public company like Brinker International that means no longer issuing dividends and cutting salaries. Communication with employees is critical, he adds, citing his experience as a Chili's executive when Hurricane Katrina hit the United States in August 2005, with an estimated 1,833 people dying in the hurricane and the flooding that followed, and the millions of others who were left homeless along the Gulf Coast and in New Orleans.

"Then, we couldn't send emails or cell phone calls," he recalls. "We asked managers to contact key staff," noting you need to do this even if they are now working for Amazon. The message: "We are family." Adds Brooks, "You have to ask how many of them will come back."

Brooks is taking a wait-and-see position, as consumers will drive changes in the business. And that is the way it has always been.

"What are the things that might be different going forward?" he asks about the future of full-service dining. He envisions the end of salt and pepper shakers on the table, with disposable menus and more stringent cleaning and sanitizing procedures, including asking guests not to use cell phones at the tables."

"Consumers might be cooking at home. The restaurant business might not be as robust. People might remain nervous about infection. Third-party delivery and takeout might further accelerate." Certainly, he is not the first person to ask these questions. Brooks was responsible for the success of 1,600 Chili's units. He knows a thing or two about adapting to changing market forces.

You need to listen.

The Future of Fine Dining

The future of fine-dining is uncertain. As Doug Brooks, former CEO of Brinker International asks, "Are we going to have social distancing guest limits in full-service restaurants? Will we take the temperatures of guests when they walk in the door? Will servers wear masks and gloves? Will table-side ordering and transactions end, with an iPad on the table for ordering and bill paying?" He wonders if a COVID-19 vaccine will return full-service dining to normal.

In the meantime, he says, "The parking lot is now our dining room." Large foot-print and fine-dining operations might find salvation in catering and banquets. Competition in this sector will fade; however, people will still want weddings, bar mitzvahs, and other large group gatherings' perhaps more than ever. These events can be done at the facility and at people's homes, so they represent either banquet or catering.

In catering and banquets, there might be greater acceptance of precautions to take guest's temperatures, glove- and face-masked servers, and heavy sanitation procedures because they are group events rather than serving 200 individuals.

As anyone in the banquet and catering space knows, these events are more pro?table than full-service dine-in, and they are promotional platforms for other business, including take-out and catering.

The current tax code allows for 100% deduction of expenses for company-wide events. The IRS might consider more liberal deductions for all business entertainment expenses at restaurants, whether banquet, catering or dine-in.

How does a fine-dining operation do delivery? Assuming not everyone wants quick-service or fast casual fare for every restaurant meal, fine-dining operations could promote "date night", "happy birthday" and other special-occasion dinners for two, four or more, with wine.

Upscale operations' guest email lists likely include people who had visited the concepts for anniversaries, birthdays, marriage proposals. Delivery could go as far as a well-dressed server (whom you can tip) comes to the home with a fancy dinner for $150+.

The restaurant might be able to enter into a deal with a luxury car dealer who loans a high-end sexy car for the server to arrive in at the destination, in exchange for promotional consideration. Businesses that promote luxury consumption will have to fight harder than ever going forward.

If you had grandparents who lived through the Great Depression, you know how it affected their thinking about spending money and conserving resources.

Dear Legislators…

If you are a federal or state legislator, no doubt, you have a favorite local restaurant owned by an independent small business person. If you hope for independent restaurant operators to have a meaningful resurgence in the wake of COVID-19, here are some ways you might be able to contribute.

First, please remember, restaurants drive tourism and contribute to the quality of life in every city and town. With online retailing, restaurants are critical to the value of commercial real estate and to attracting customers to commercial centers and venues.

Bear in mind, the average restaurant is subject to numerous federal, state and local regulations regarding public health and safety, employment, taxes and others.

Given the size and economic importance of the restaurant industry, perhaps it is time for regulations that help the operator.

• The CARES Act funding was no more than a BAND- AID® for many independent restaurateurs, if they could get access to the money, much of which was distributed to national chains. Moreover, the policy basis for the Economic Injury Disaster Loan and Paycheck Protection Program loans was to keep people employed. When state governors shut down full-service restaurants, there was no need for fully-staffed operations, and most employees were better off applying for unemployment benefits than being on the payroll of a business that could not use them. Consider additional longer-term low-interest loans to bona fide independent small businesses, similar to the EIDL, with appropriate forgiveness provisions. This recovery will have a long tail.
• Business entertainment is an important source of revenue for full-service restaurants. Consider changes to the tax code that provide even more generous deductions for business meals purchased at restaurants, whether for on- or off-premises dining.
• Alcohol sales comprise 15% or more of sales for many full-service restaurants, and are profitable. State legislators, consider relaxing restrictions on take-away and delivered beer, wine and mix-drinks. Work with your state's restaurant association to determine how to do this, while still protecting public safety.
• Given the critical importance of these services to the distribution of food and beverage in a market in which demand for delivery has accelerated, consider state regulation of third-party delivery. This includes fines for tampering with food and no-shows by the service, service standards and training of delivery drivers; and consistent, equitable, and reasonable fee structures. San Francisco has regulated third-party delivery fees.
• Business interruption insurance was created to cover losses due to unforeseen physical damages. State legislators have the power to impose reasonable regulations of insurance contract language to protect insureds. Consider working with state insurance regulators and the insurance industry to examine restrictions on business interruption policy exclusion language.
• The tip credit is vital to full-service restaurants. Tipping is an established custom in the U.S. and shifts some of the cost of hospitality to the guest in a business that is competitive and has relatively low margins in the best circumstances. We agree kitchen workers are often underpaid, yet they are critical to the quality of the guest experience. By keeping the tip credit and allowing every staff member to participate in tip pools, we can keep minimum wages in check for full-service operators, and yet allowing all restaurant staff to share in the generosity of guests. We have seen tipping increase with the recent COVID-19 crisis. Guests appreciate hospitality and will pay for it in addition to food and drink.