Is the Internet Killing Your Favorite Restaurant?

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Is the Internet Killing Your Favorite Restaurant?October wasn't a good month for the restaurant industry.

Friendly's Ice Cream and Real Mex -- the company behind the El Torito and Chevys chains -- filed for bankruptcy protection from their creditors.

A ho-hum economy and finicky deal-seeking diners are weighing on many dining establishments.

Restaurant failure rates have been historically brutal, though probably not as bad as worrywarts would have you believe. There's an old American Express (AXP) commercial with The Restaurant's Rocco DiSpirito, pointing out that 90% of new eateries fail in their first year. It's a scary number, but it's not true. Studies have shown that closer to 60% of restaurants actually close within their first three years of operations.

Even that number is still a grim statistic. You've probably had many conversations lately where the name of a once popular restaurant is followed by the two words that no restaurateur wants to hear: closed down.

The Groupon Effect

Running a restaurant has never been easy, but it's getting harder to succeed these days if an eatery is too proud to play the social couponing and new media games.

A decade ago, all you needed was a strong concept and healthy execution strategy. If the tables weren't filling quickly enough, running a few ads in the local paper or drumming up some midweek and off-hour specials would do the trick. The Internet has changed the way the marketing game is played.

These days restaurants need to keep Twitter feeds and Facebook fan pages percolating, sprinkling them with the occasional promotion. Owners need to be conscious about what folks are saying on Yelp, even hosting events for the elite reviewers on the site. If the venues are higher-end eateries that rely on reservation requests, embracing OpenTable's (OPEN) electronic reservations book is practically required. Then we get to Groupon, LivingSocial, and the growing number of daily deal upstarts.

Groupon (GRPN) may be generating plenty of IPO buzz at the moment, but it's a mixed blessing for restaurant owners. The model is simple. A restaurateur works with Groupon to offer a discounted dining experience, typically selling a pre-paid voucher for 50% off. The proceeds are routinely split evenly between Groupon and the establishment. In other words, the diner-hungry restaurant owner is willing to sell a dollar in food and drinks for a quarter of their normal price.

It's not an insane proposition.
  • A restaurant will attract attention and traffic through a Groupon promotion, and drawing first-time diners gives them a chance at wooing them for subsequent visits sans discounts.
  • Diners will typically spend more than the voucher's value, so it's really not about trading dollar bills for quarters.
  • Groupon certificates expire within months, and many will go unclaimed.

You'll get both endorsements and horror stories from restaurants that have participated in Groupon promotions. But the problem for restaurants not playing the Internet marketing game is that these promotions, whether successful, are driving real traffic. That means eateries that are doing fine with word-of-mouth traffic are now threatened by rival restaurants that are going the Groupon route. A couple going the Groupon route for a romantic outing may be one less couple at the proud bistro that hung up on the Groupon sales pitch.

As more local newspapers, radio stations, and websites roll out Groupon-like offerings, there's a growing number of consumers that are being spoiled by the discounts, balking at full-priced meals.

Waiter, There's a Fly in the Ointment

OpenTable's model is simple. Restaurants install an electronic reservations book and pay the company a monthly subscription fee of $199. The eatery is then listed on OpenTable.com's popular website and mobile app, where they pay $1 for every diner booked through OpenTable or 25 cents for every reservation that originated on the restaurant's website.

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The math works. Restaurants are scalable enterprises with high fixed overhead and low variable costs. Table turnover separates the winners from the losers. OpenTable claims that just a couple incremental reservations a month covers its tab, and restaurants seem to agree. There were 16,237 North American restaurants on OpenTable at the end of September, a 25% increase over the past year.

Again, you will find restaurants that feel too proud to go the OpenTable route. There are cheaper alternatives, too, including IAC's (IACI) Urbanspoon Rezbook that now has 1,000 restaurateurs on its iPad-based platform. The price for missing out on the networking effect, though, is that they don't stand a chance as more people turn to OpenTable.com or fire up the OpenTable app to make a dining reservation.

Web 2.0: A Second Course

There isn't a financial hurdle to be on Facebook, Twitter, or Yelp. Setting up a Twitter microblog feed or a profile page on Facebook is free. Yelp establishment pages are created automatically by its users, populating it with glowing -- and not so glowing -- critiques.

However, this doesn't mean that it's easy. There's some serious credibility to lose if owners take a lax approach in populating their Facebook and Twitter pages with content and status updates. There's even more care needed in responding to negative reviews on Yelp. It's a delicate balance, but one that is again necessary since gourmet food trucks and forward-thinking restaurateurs are stealing traffic away from the eateries that aren't making social media a priority.

You'll never see a "Put Out of Business by the Internet" sandwich board sign on a shuttered concept, but more often than not that's exactly what is happening these days if restaurants miss the online marketing bandwagon.

Longtime Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of OpenTable. Motley Fool newsletter services have recommended buying shares of OpenTable.



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