Restaurants Face Lean Times in the Economic Downturn

As the credit crisis and the economic downturn begin to bite on Main Street America, restaurant row is in for a shake-up. For the first time in nearly two decades, the $550 billion restaurant industry has suffered stagnant sales this year, creating painful cash-flow problems for restaurateurs who can't get credit lines to cover investment and operating costs even as food and labor costs have risen sharply. That's made it harder for chains and independent eateries alike to upgrade equipment, hire new staff and renovate facilities. "The credit crisis is having a devastating effect on nearly every segment of the industry," says Aaron Allen, CEO of the Quantified Marketing Group, an international restaurant-consulting firm. "This is the death knell for a number of restaurant chains."

Beyond the already bankrupt Bennigan's, Steak and Ale, and Village Inn, Allen expects a rash of closures in the American restaurant industry. Ruby Tuesdays, Chili's, TGI Friday's and other full-service casual-dining restaurants are "in desperate times," says Allen. Restaurants are struggling to find banks' support to cope with short-term cash crunches caused by double-digit price increases for commodities ranging from wheat and flour to rice and corn. And the tightening of credit also precludes many restaurant chains from undertaking direly needed overhauls. Those creaky bar stools, cheesy pennants and outdated waiter outfits just keep getting staler, leaving those unable to finance the revamping of their facilities and menus contemplating oblivion in the face of the challenge from "fast-casual" rivals.

The growing success of the waiter-free fast-casual brands, such as Panera Bread, comes at the expense of higher-cost casual chains, from which cash- and credit-strapped consumers are trading down. Industry analysts expect the fast-casual sector to explode from $12 billion in revenues this year to as much as $100 billion in a decade. Instead of spending $18, on average, at T.G.I. Friday's, they're happy to spend $9 at Panera or Chipotle, with no tip and faster service. McDonald's and other fast-food outlets are also positioned to gain from the decline of the $170 billion casual-restaurant sector. Backed by deep pockets, Mickey D outlets have been able to spring for thousands of espresso machines, even as other chains hunker down with their old-fashioned coffeepots.

Hudson Riehle, an economist for the National Restaurant Association (NRA), says this is the most challenging period for restaurant operators since 1991. In a recent NRA survey, 53% of restaurant owners cited either the faltering economy or rising food costs as their primary concern.

"We're going to see a dramatic change in the landscape of the restaurant industry as a result of the economic crisis," Allen says. He expects fast-casual restaurants to gradually replace many of the aging chain spots that populate America's suburban sprawl. Tom Forte, restaurant-industry analyst for the Telsey Advisory Group, an independent research firm, notes that in recent years the abundance of restaurants in the U.S. has grown more rapidly than Americans' appetites for eating out: While the average American's annual number of dinners out remained constant at 22 a year between 2001 and 2007, the number of restaurants grew by 14% over the same period. This year's takings are down as people pare back their discretionary dining spending, and that, together with surging food prices and tight credit markets, suggests a shakeout in the industry may be inevitable.

Aside from those chains headed toward bankruptcy, Forte says those shifting from direct ownership of outlets to franchising them are the most likely to face turmoil going forward. Yum Brands, which owns Pizza Hut and KFC, DineEquity (Applebee's) and Brinker (Chili's) all will be tested as potential franchise owners face increasing difficulty getting credit.

The chains that manage to survive the downturn may even find it has certain benefits. A global slowdown inevitably reduces commodity prices, which may ease food and gas costs. Even the closure of aging chains may have a silver lining, giving upstart eateries new room to expand as cluttered strip malls see old anchors shut their doors. But for the industry as a whole, that would be a bittersweet dessert.