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Why A Restaurant Is The Worst Business Idea

It is no secret that owning a restaurant seems like the hottest entrepreneurial idea lately. 15 years back, by restaurants, we meant Wimpy, Xindian, Malancha and the likes. Now, there is no shortage of fancy restaurants of all forms serving all sorts of cuisines. Yet, every other day a new one pops up, with a seemingly new idea or a new twist to a cuisine. Everyone wants a crack at this “money-making” venture.

The truth, unfortunately, is that a restaurant is regarded as one of the worst businesses you can start. That is according to many reputed sources such as Forbes, American Express, Business Collective, etc. In fact, in the United States, the restaurant is the industry most likely to make their investors lose their entire investment. There are not that many reasons to assume it is very different in other regions of the world.

So naturally comes the question – why is a restaurant such a bad idea?

Mostly, it is because of fierce competition. The number of restaurants in places like Banani, Gulshan, Dhanmondi, and the likes is increasing exponentially, ready to occupy every single nook and cranny. Yet, the population in these areas is not exploding to create that demand. It is just simple logic: a new restaurant in your neighborhood is not giving birth to 100 new customers. It is simply taking away 100 customers from the restaurant next door. But when you have 10 new restaurants fighting for that same 100 customers, you can imagine just how difficult it can get to stay in business!

Why did Pathao succeed so well? It is because it started a ride-sharing business when there were already 20 in the market? No, because it was among the first to introduce this concept in Bangladesh. Before Pathao, the market was almost empty, devoid of any supply of bike sharing. So it was that much easier for Pathao to dominate the market before competition could creep in.

Thus in business, it is always advised to enter “blue oceans”, meaning markets which are free from competition, instead of “red oceans”, which are markets bloody with fierce competition. This is precisely why companies like Uber, Amazon, Netflix, and Facebook, etc. have done so well. Even local startups like bkash and Sheba.xyz are so successful simply because they started something “new”, instead of copying existing ideas.

But why is competition so bad, you ask? Competition can be good for consumers, but not for business owners. Because the more competitors you have, the more price wars there will be, thus eroding your margins. This is another reason why restaurants globally have very poor net margins. Please don’t believe your uncle who insists food business have “200% margin” (which does not even make any sense). On average, successful restaurants can expect net margins of 3-5%, which is very poor when you consider all the hard work that goes into running one. According to Indian restaurateur Vimi Singh, owner of Vintage 31:

“Though our restaurant was praised for its food and garnered a following, for a year-and-half we were forced to put in Rs 1 lakh or so every month from our pockets to sustain the business. Only for the last five months were we breaking even. We thought this market will pick up but have come to the conclusion that it never will. Even if we start making some profit, it is not likely to be much. What is the point of running a business 24x7 but making virtually no money?

“We wouldn’t advise any one to enter the restaurant business in India.”

To put it into perspective, tech businesses have net margins from 30% to even 50% and beyond. (for example, bdjobs)

According to Peter Thiel, a successful entrepreneur, and renowned thought leader, companies that do very well (like Google, Facebook, etc.) do so because they have great profit margins, and make healthy profits; they can thus put money on research and innovation that make them even better as time goes on. It is another simple logic, really: when you have profits coming in, you are relaxed, and you can tinker with your business, build it to become great, invest in assets and innovative ideas, etc. But when your margin is very poor and you have to constantly worry about paying your employees’ salary, you no longer have the frame of mind to do much other than cutting costs and desperately trying to stay afloat. By the way, Thiel also considers restaurants to be one of the worst businesses to start. And he also considers competition to be very bad for business in general.

What makes restaurants so hyper-competitive, though, is that everyone seems to think they can run one. It has incredibly low barriers of entry. You don’t automatically assume you can start a plastics manufacturing business, or a cement producing business because you don’t normally know much about plastic or cement. But you eat food every day, three to four times a day. You visit restaurants a lot, and you like to believe you’re a “food connoisseur”. You helped your family with the monthly bazaar, so you have an idea how much potatoes cost.

“Wow, 1 kg of potato costs 25tk, and they are selling French fries for 200tk? Damn, there must be so much money to make in restaurants!”

Sadly, when 500 other people have the same thoughts running through their heads, that is what creates a bloody, destructive market.

Because food is, unfortunately, a small part of running a successful restaurant. It is, first of all, not very easy to consistently maintain great food taste. Secondly, even if you do, there is not the battle won, because 70% of the challenges lie in other areas such as procurement, forecasting demand, storage, handling of wastage, reducing theft, managing off-peak hours, pricing, calculating gross profit of each food item, keeping salaries to a certain percentage of sales, etc. There are so many crucial elements that you have to successfully navigate day in and day out just for that 5% net margin that you will soon begin to wonder if it’s worth all the effort!

If all these haven’t scared you yet, consider another aspect of restaurants: they have incredibly low life cycles. People naturally have the habit of trying something ‘’new” when it comes to eating out, so they always flock to the newest restaurant. However, once they have visited there once or twice, majority stop going as they look for the next hot new restaurant, which will always be there as every tom, dick and harry are always trying to get into this business. So what you are left with, after a few months of opening your own restaurant, are very few remaining customers, and little idea on how to get the other ones back. You can spend intensely on marketing, but that will wither away whatever tiny net margin you had to begin with. It’s a lose-lose any way you look at it.

The problem here is that most of us are victims of “herd mentality”. It is defined as when we do something not because we are convinced of it through our logic, but because we have seen a large number of others doing it. It is a mental decision-making shortcut that helps us well in certain situations. For example, you are walking down the street, and you suddenly find 10 people running towards you, panicking. It would not be wise for you to stand there and carefully analyze the situation before you make a decision about what to do. If there are some crazed goons in helmets behind them, beating up every person they find, by the time you understand the situation you may find yourself surrounded. So a better decision for you is to just run with the others, and then later figure out what’s up. Herd mentality is an excellent instinct when it comes to running away from predators or natural disasters, but not so when you are considering dumping your life savings into a venture. Unfortunately, that is precisely what makes people open certain businesses, like restaurants, travel agencies, digital marketing firms, etc. People do not try to understand if this particular business is a solid idea on its own. They take the mental shortcut of “if so many people are doing it, there must be lots of money to make!”

Elon Musk, perhaps the most visionary entrepreneur of our generation, talks about this exact phenomenon when he asks us to assume that “everyone around you are idiots”. This might sound derogatory, but what he means is that the worst decision you can make as an entrepreneur is following the herd because the herd is almost always wrong. Mark Cuban, billionaire entrepreneur, and star of “Shark Tank”, echoes a similar sentiment when he says “if you are looking where everyone else is looking, you are looking in the wrong direction”.

Musk stresses that when it comes to making any decision, business or otherwise, you try to gauge whether the decision on its own has logic. You look at the numbers. You look at the facts. You separate all mental fallacies and decide whether the decision has its own merit. That is sound advice not just for business but for life in general.

Yet another problem with restaurants, or food in general, is that it is a commodity business. A commodity business is defined as a business whose products are basically indistinguishable from competitors. If I bring you tagless t-shirts from three different outlets, say Ecstasy, Artisan and Taaga Man, and ask you to properly identify which is whose, you will probably fail. If I bring burgers from 5 different restaurants and tell you to do the same, you will similarly have a very hard time getting them right. Both clothing and food are commodity businesses.

An example of a non-commodity business is cellphones. You can always tell them apart, even if there is no branding. So, since the restaurant is a commodity business, it is very difficult to establish a competitive advantage. The only way to do so is by building a brand. And brand as a competitive advantage is notoriously difficult to develop, as it takes a long time of sustained great performance. In the restaurant business, the only way to build a brand is by delivering extremely delicious food day in and day out, for many years! And even then, if your food quality drops even for a month, you can lose customers left and right. It is a competitive advantage that is very hard to gain, but quite easy to lose!

In the end, to sum it up, if you are thinking of opening a restaurant, think very long and hard about it. Don’t just think about how you will survive in the first year; think about how you will survive in the first 5. And consider the fact that people, many people, around you will keep opening restaurants in the coming years. If the market seems glutted now, it will choke in a few years. Consider whether it is worth it to fight so hard to survive in such choking competition. And please, do not look at isolated success cases like Star Kabab or Takeout to justify entering this market. Every single industry has its stars; looking at them to rationalize entering those industries is another dangerous “mental shortcut” you shouldn’t take.

Instead, you might be better off with a business idea that might seem less sexy but has less competition and would actually help you make money.

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About the author: Muhammed Asif Khan is a BBA graduate from IBA (University of Dhaka) and is currently working on his own venture Alpha Catering. He has always been fascinated by the intricacies of business and loves exploring and sharing new thoughts and ideas. He can be reached at muhammed.asifkhan92@gmail.com.

Cover photo: Photo by Sarah Lee on Unsplash

Muhammed Asif Khan is a BBA graduate from IBA (University of Dhaka) and is currently working on his own venture Alpha Catering. He has always been fascinated by the intricacies of business and loves exploring and sharing new thoughts and ideas. He can be reached at muhammed.asifkhan92@gmail.com.

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