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How the Chains Research Restaurant Locations and What You Can Learn From Them

As the old real estate saw goes, the three most important selling points of a property are "Location, location, location."

In the restaurant business, that goes doubly.

Picking the right place -- and time -- to open a restaurant is critical to success for the simple reason that location is one of the few aspects of your restaurant you can't easily change.

And no one does it better than the chains. They are not infallible, in this regard; however, in general there is method to their madness. You don't grow to 25, 50 or 100 units by getting it wrong.

Sure, chains have resources and systems that give them many advantages in site locations because figuring out where to put their next units is integral to their success. Still, independents can learn a lot for their approach process and with the advent of online search tools, for example, can more level the playing field. Hopefully, this glimpse into the location approach and strategy of the chains can help you, as an independent, understand and benefit by employing some of the information and techniques they use.

Requirements Common to Every Operator

H.G. Parsa, Ph.D., FMP, Barron Hilton chair in lodging and professor of hospitality management of the Daniels College of Business at the University of Denver in Colorado, says, "We have all kinds of chains: micro chain, regional chains, national chains, international chains. There are different levels of chains." Each has their own requirements but many of those are common to every operator, including the independent.

When it comes to the major chains, they have entire departments devoted to real estate. Size has its privileges, Parsa says. "With these big corporations, the real estate sales people come to them with all these sites and proposals and things." They have a lot of outside people that are always bringing them ideas on location sites and new development ideas. Add to that important advantage the ability to afford in-house research along with their existing economies of scale, and the larger chains usually get first pick of the best sites for their units.

First, "they do traffic counts; [they ask] where is the traffic coming from?" Parsa says. "Number two," he says, "they look for competition saturation; [i.e.,] how much competition is there waiting for them to get in?"

They also look at concentration. McDonald's used to have a rule of thumb: one McDonald's restaurant for every 30,000 people. Today, the chain has dropped the number to 15,000 or even 10,000. For other chains, the equation is different.

"If you go to a mall you have one Starbucks downstairs and one Starbucks upstairs," Parsa says. "They use density as one of the factors. Then they look at the cost of real estate. Their fixed cost of real estate is the killer; you've signed a 10- or 20-year contract. So what they want to do is get the [rent per square foot] down as low as they can." The goal is to drive down overall rent as a percentage of revenue.

Smaller chains -- players with from five to 20 units -- often rely on commercial real estate brokers to help them find locations, again, with affordability being an overriding directive.

Parsa says the rule of thumb for most of these businesses is to keep real estate costs below 7 percent of projected revenue. "The next thing they usually look at," he says, "is how much it's going to cost to remodel or renovate; and development cost. All of that together should not exceed that 7 percent." Again, they project revenue, and decide if the rent factor is sustainable. If this sounds simple, bear in mind that many don't go through this analysis with sufficient rigor, and suffer the consequences after they open their doors.

So-called micro chains tend to focus on shopping centers for reasons -- again -- driven by containing costs relative to revenue. They don't want to be self-standing because if they are they have got to be in charge of things like parking lots, maintenance, security, and a dozen other expensive and time-consuming tasks. Instead, they find a mall operator to handle it for them. They negotiate a rent, and part of the projected revenue is allocated toward marketing, right off the top line, to drive sales.

For them, location is a matter of finding shopping centers, analyzing traffic and guest counts to see who is doing well, determining how much marketing will be required to drive business, and ultimately seeing if the numbers make sense. You might be seeing a pattern here.

Leaving nothing to chance, particularly when moving into centers, careful operators also see to it that there is a noncompete clause so that a similar operation doesn't open nearby and cannibalize business. For new operators, having a lawyer close by who has experience counseling restaurants is often critical when reviewing leases. As they gain experience, operators know what noncompete terms they need to protect their turf.

How McDonald's Does It

As long as we're looking at what the chains do, we have to examine McDonald's strategy. Not because it is some-thing you can replicate easily, but it is an example of what all operators might wish for, if they could make it happen.

"And it's a beautiful strategy," Parsa says. "They purchase real estate before it becomes expensive. They know land is cheap now, but that it's going to go up two, three, four years from now," if for no other reason than that the presence of McDonald's has drawn other major players. "When they buy it they know they're not going to make much profit in that particular location, but once McDonald's comes that's an attraction in itself. Other businesses will come, and the other businesses will pay higher rent and real estate than McDonald's." In short, the Golden Arches are like the proverbial Golden Goose. They can quickly improve the value of the real estate.

Parsa says, "When I was working for Wendy's, they asked me, 'How do you think Arby's and other companies find a new location?' [I told them], 'Very easy: Look for where McDonald's is putting its restaurants and follow them,' and that is what they do." This is certainly an easy approach for the independent because it is simply a matter of lo-cating the big players to see where they are building. Then the trick becomes seeing if the concept will match the location the big chains have chosen.

But in spite of its market cache, McDonald's is not arbitrary about its location choices. And here is where you can emulate the chain, albeit on a smaller, less sophisticated scale, if you are willing to wear down some shoe leather.

"I can speak to how McDonald's does it, since this is what I used to do there," says Melanie Smythe, principal of Candacity LLC, a consultancy based in Richfield, Wisconsin. "The regional development team drives the potential market and maps out the trade area. They review demographics of the potential customer base by looking at who lives/works within the boundaries and travels to the area." They then compare surrounding trade areas for existing locations to make sure there is no overlap or, if there is, that it is not detrimental to the nearby locations. They also review the competition within and around the trade area.

"They look out over five to 10 years of development increases or decreases if it is a shrinking market," Smythe says. "They then assign potential sales figures and review the cost of going into business to determine if it is a viable site." If the location does, in fact, meet those thresholds it is then reviewed by committee. If approved, it is offered to potential franchisees.

Sure, most independent operators can't afford teams of real estate specialists hunting for the next great market area. That said, you can hedge your bets to some degree by taking a trip to your town or city planning department and look at the local zoning map.

Perhaps there is an affordable parcel near a large tract of undeveloped land. Is it zoned for high-density housing, single-family homes or commercial use? Ask planning department staff if they can tell you who is eyeing the land.

Anyone can join the local chamber of commerce, Ki-wanis, etc., and attend its functions. Developers and real estate people comprise a majority of these organizations. Don't be afraid to "ask around." You might learn, for example, that a retirement community will occupy that dusty field across from a strip mall in a couple of years, and provide a good stream of future business for your coffee shop concept.

Just as this kind of research can help you spot opportunities, it can help you avoid blunders. A mistake successful chain operators avoid is settling alongside bad neighbors. Independents need to learn the same lesson.

"I would imagine that if you're selecting a location that's right next to a recycling plant that would be a ter-rible thing because of the obvious problems with trucks and possibly creatures," says Angela Phelan, senior vice president of The Clarion Group, based in Kingston, New Hampshire. "You certainly wouldn't want to have a four-star restaurant on a street where a high school empties out right in front of your door." On the other hand, plunking a fast-food restaurant down at a bus stop so that commuters would be lingering right in front of your door -- and perhaps have the impulse to get something to eat -- is an excellent idea.

A mistake successful chain operators avoid is settling alongside bad neighbors. Independents need to learn the same lesson.

A recurring question about site selection centers on whether it's good to have competitors nearby. According to Phelan, the rule of thumb is that you want to be where there are more rather than fewer restaurants. "That's because not everybody makes a destination restaurant their choice for the day. They might say, 'OK, let's go to Joe's.' and when they got to Joe's it's packed." In such a case, those same would-be customers want to go across the street because another restaurant is over there. "If you're standing in front of Joe's and it's packed, and you have to get in your car and drive somewhere else, it might make you less inclined to go there next time." That's one theory. It's also a location rule that if there is not enough population density for the number of restaurants in an area it's almost impossible for the weakest one to stay in business.

Diners, in short, want to go where the action is. They may be willing to travel way off the beaten path for a favorite destination restaurant, Phelan says, "but [if they do] it's probably not going to be a chain." There are plenty of chain units at convenient locations. Whether you plunk down your business among chains or apart from the chain, as an independent, you have to make sure you differentiate their food and service offerings.

Said another way: You can't complete with IHOP by emulating IHOP. If guests want that experience, they will gravitate to IHOP, regardless of whether you are next door or across town. You have to offer something special they can't get at a chain -- in terms of atmosphere, menu or service -- to make the cut.

Internet Resources

For the independent, while they may be unable to afford the high-dollar searches, getting inside information about the demographic makeup of a market area has been made considerably easier in recent years by the Internet and a variety of companies that specialize in such information. There are, Phelan says, organizations that "do all kinds of demographics; that will tell you what the per-capita income is for a given location. And of course all the real estate companies do that." Remember, they are sales organizations and as part of their sales they supply information that will help them make the sale.

Phelan says that for an operator looking at opening a new store in, for instance, Greenville, South Carolina, and who wanted to know who lives in Greenville, they could get that information from the local real estate board. "You can also obtain detailed data from organizations Trulia (www.trulia.com), which will do the demographics down to block by block and tell you how much money everybody makes who lives on that street," she says.

For the independent, while they may be unable to afford the high-dollar searches, getting inside information about the demographic makeup of a market area has been made considerably easier in recent years by the Internet and a variety of companies that specialize in such information.

Trulia (and other similar services) also helps those, like Phelan and her husband, looking to relocate. "My husband and I are in the process of buying a house now. You hit Trulia.com and wherever in the country you want that house to be and they will tell you what that demography is, down to the block. Who lives on that street? Sometimes some of them actually do it with names. You can find out if they're old, if they're young, what the per-capita income is for the surrounding community." As we all know, the Internet has changed the way business and people research all types of things, including where you might want to locate your independent restaurant.

This is the heart of the matter -- the keys to the kingdom, if you will -- for restaurant operators looking to expand. "You've got to know the demography, the ethnicity, and whether or not you want to take a chance on something because the demography says it's a young group and they all go to college at these 10 colleges. You want to know age, ethnicity, and even topography. Is it a location that's easy to get to on foot or bicycle?"

Use your imagination regarding what you want to know about the market to make your location an appealing choice for your target guests. The chains are doing it. And for the most part, they are doing it well. Independents wanting to compete need to employ some of the same systems.

Trust the Wisdom of Your Gut

Phelan learned lots about researching chain locations in the 1980s while she was working on tenant development for the South Street Seaport in lower Manhattan. When this historical site opened, 20 different chain restaurant operators had to be there. For most, she says, their decision was based on, "'Where is the hot location in town?' Everybody thought that would be a good thing."

The person who gave Phelan the best lesson on the power of intuition to choose a location -- "and it has been borne out over the last 25 years," she says -- was Louis Kane, then the president of Au Bon Pain. "The reason I got to know him was that his first store was in Cambridge, right on Harvard Yard, and that did very well. Then he decided he wanted to come to New York. Like a lot of people, he thought that the South Street Seaport would be a very good place to be." Kane opened his store in a second-floor location, one in which Phelan didn't feel he was going to get enough traffic to survive.

Gut instinct might be an important factor in selecting any location. Says Phelan, 'Operators crunch all the numbers and look at how many people are going to walk across that sidewalk a hundred times a day.'

"I always loved his products, and I couldn't understand why he wasn't doing well," she says. "Since my job was to understand how the operators could do well I spent a lot of time watching and staring and looking at traffic patterns and whatever. Finally I called him up and I said, 'You don't know me Mr. Kane, but I'm in charge of tenant relations and I think your store is in the wrong place.'

The pair met, and before long Phelan suggested a new location, and asked Kane to come take a look at it. According to Phelan, he told her, "When I'm doing a deal, no matter how good the numbers look, if I don't have that gut instinct that it's the right place then I either have to move it or I don't go there in the first place.'"

Gut instinct might be an important factor in selecting any location. Says Phelan, "Operators crunch all the numbers and look at how many people are going to walk across that sidewalk a hundred times a day." Kane told her it had to feel right to him, including being on the "sunny side of the street."

Kane's store ultimately moved to a location down on the main level, in a much more obvious traffic pattern. That said, he took the time to evaluate the new location personally.

At that point, Kane was an experienced chain operator; but his lesson holds great wisdom for all start-up and growth operators. Even if you have little experience in the restaurant business, you and your partners, family and friends have experience dining out. You know where you would travel for a given dining experience.

Remember the age-old management axiom: "When all else fails, trust your gut. It will never intentio

Words of Wisdom: Restaurant Real Estate Insights

H.G. Parsa shares these insights on restaurant real estate:

Be careful where you put down your business -- it's a long-term commitment. "Real estate is like marriage," Parsa says. "You're in, you're in for good. And divorce is painful. A real estate divorce is painful. It's a long-term contract, it's messy, and you end up paying a lot of bills."

Chains can leverage bad locations in ways independents might not be able to. Some chains can afford to keep real estate costs down by locating their units off the beaten path. A good example is to be found in Ohio, where a good friend of Parsa's once worked for White Castle. "Even though White Castle is a big corporation, they will look for land as cheap as they can get. But White Castle's customers are so loyal they're willing to drive to them."

A too-steep rent factor can turn even good eateries into little more than dead weight. "When you see restaurants constantly failing in the same location, that's the reason why. Sometimes the rent is so high that the place may be attractive, but they can't make any profit."

Be careful about going head to head with a chain unit, because even if your place is better, the chain can outlast you. One strategy when choosing locations is to use real estate as a weapon against competitors. Starbucks, Parsa says, has mastered the technique. "What they will do on purpose, intentionally, is to veto the competition. They want to put the competition out. They know they're not going to make any profit in a particular location, but they put it there for marketshare, not for profit. Big companies will open a unit, and then another same unit down the street. That's the marketshare game they play. It's not a profit game. In some cases, we can't beat them; they have deep pockets."

Words of Wisdom: 6 Key Location Factors Every Restaurant Needs to Heed

1. Access. In only a few rare cases is going to a restaurant an impulse trip. Most dining out is a destination trip. Exceptions to this rule are restaurants at shopping centers, along highways, and in densely populated urban areas with much pedestrian traffic. In these cases, people are more likely to eat on impulse. For everyone else, ease of access is critical.
2. Parking. Again, most dining excursions are destination trips. Available and convenient parking is critical. If guests know that parking near your restaurant is hit or miss, they will forgo your business for a competitor, even if they prefer your food and service.
3. Visibility and Signage. These two factors are grouped because they both relate to your advertising. Restaurants that are tucked away from view or have limited signage due to overly restrictive sign laws or otherwise, are at a serious marketing disadvantage.
4. Zoning. You need to know the kinds of structures and businesses likely to spring up around you. Will it be office space and retail or light industrial? The type of development in your area can affect the number of potential guests on any given day, or the willingness of guests to drive to your location.
5. Demographics. These are corollary to the issue of zoning. Make no mistake, the chains carefully study the current and projected demographics of a region. You can immediately tell more about the character of a town by its chain restaurants and big-box retailers than almost any other visible evidence. Are there enough office spaces in the area to attract the affluent working professionals who are likely to visit your hip, upscale bar and grill? Are there enough families with kids to make a themed pizza operation successful?
6. Labor. Restaurants need access to labor and labor needs access to you. Most restaurant jobs are near or at minimum wage, and very likely a percentage of your workers will need public transportation to get to you. Otherwise, you may have to pay a premium to fill certain positions.