According to this local paper, our fair town of Colorado Springs, USA, is divided into two main parts, as far as restaurants go: the downtown area and the Powers Boulevard area. In the downtown area, franchises really struggle whereas on Powers, local restaurants are losing lots of money. Now the franchises might have to just take the fact that they cannot compete, but I think that the locals have opportunities that they might not be taking advantage of.
According to the article, “One of the biggest threats to independent restaurateurs is food costs” (Schniper, Matthew. “Powers struggle.” independent April 30-May6, 2009: 22). These threats can be separated further into four categories: 1. Wage wars from “bulk-buying chains” 2. An explosion of competitors 3. A dramatic increase in rent 4. A strong susceptibility to troughs in the business cycle.
Notice anything in common about these categories? If you realized that they all reflect greater costs for smaller restaurants, give yourself a cookie. In economics, this is referred to as positive economies of scale, and means that much greater profits can be had by growing larger. How much larger? The company should ideally try to produce the quantity that will result in the lowest average cost. In a perfectly competitive market (which should provide a good approximation in this case), this will also be the point in which marginal revenue equals marginal costs of the industry; the profit maximizing point.
One might conclude that this implies that the large companies are guaranteed to corner the market around Powers, but this is not so. According to Mr. Link, an owner of Eastside Grill and ex-owner of a Ruby Tuesday franchise, the flexibility of his new restaurant menu went a long way toward covering the gap because now he can react to what his customers are asking for, which buys him consumer loyalty and is more in tune with customer preferences. In fact, many of the restaurant owners that were interviewed in the article felt that two companies would definitely flourish, simply because their offerings were unique and authentic to their ethnic heritage.
To me, the obvious solution is that this dilemma is to consolidate. Cartels may be illegal, but two shops might find that they can peacefully share a larger building in order to cut down on costs and to cause some advertising due to the novelty. After all, several larger restaurants have done so successfully (such as the Pizza Hut/ Taco Bell that lies down the street from me). If lots of restaurants started “buddying up,” they could reduce the competition; share the cost of rent; and support each other through the lean times. If they share ingredients, they may even be able to cut down on their food costs by buying in bulk and cutting back on spoilage and waste.