More Local Restaurants Struggle As Big Chains Eat Their Lunch
By Shirley Leung
Staff Reporter of THE WALL STREET JOURNAL

CHICAGO -- After more than 20 years in the restaurant business, chef David Schy pursued the dream of many an entrepreneurial American: He opened his own restaurant.

To make his mark, he whipped up American cuisine, with a twist. Caribbean-flavored skirt steak. Big salads tossed with crunchy flatbread. Ketchup blended with jalapenos. Hubbard Street Grill opened eight years ago to gleaming reviews. "Innovative," proclaimed the Zagat Survey. At the restaurant's peak in 1998, Mr. Schy along with his wife and business partner, Debbie, took home a tidy profit of roughly $300,000.

Then came the chains. In downtown Chicago's trendy River North section, upscale chain restaurants started popping up within blocks, hemming in Hubbard Street Grill on all sides. Rock Bottom Restaurant & Brewery. Smith & Wollensky. Spago. Sullivan's Steakhouse.

Against the interlopers, the 44-year-old Mr. Schy (pronounced: SHY) threw everything but the kitchen sink. He held prices steady for several years. He mailed thousands of coupons. He matched rivals' popular menu items -- at one point devising a "Crispy Fried Onion Stack" as a rejoinder to a staple of many of these chains, the deep-fried blooming onion.

But a month ago, with his profit crumbling, Mr. Schy closed down his 200-seat restaurant. "We're a dinosaur," he says. "It's all going to be chains."

Before the economic slowdown cut into business in early 2001 and the Sept. 11 terrorist attacks kept even more people close to home, the restaurant business had been thriving. With today's hectic lifestyles and empty-nesting baby boomers exercising their vast spending power, the business has been growing at about 5% a year in recent years.

Independent restaurateurs should have been eating high on the hog. But there was trouble brewing down the block. Last year, large chains for the first time nabbed the majority share of the $269.4 billion restaurant market, which was once dominated by the mom-and-pops. In 1991, the big chains had a market share of about 46%, according to Technomic Inc., a Chicago food-consulting firm. By last year, that had blossomed to 50.6%.

Much of that growth has come from the explosion of highly sophisticated companies specializing in sit-down restaurants such as Cheesecake Factory (American), P.F. Chang's China Bistro (Chinese), Morton's (Steak) and Olive Garden (Italian). Many of these chains have dozens, even hundreds, of restaurants fanning out nationally. Many are publicly traded, with Wall Street money fueling their initial expansion.

Certainly, sluggish economic times and the tightening of corporate expense accounts have combined now and in the past to force many independent restaurants out of business. But the recent rise of upscale chains, armed with comfort food, economies of scale, chipper waiters and big-budget commercials, has made it harder than ever in the restaurant business to go it alone.

'Wal-Marting' of the Industry

"It's the Wal-Marting of the restaurant industry," says Bill Guilfoyle, a professor in hospitality management at the Culinary Institute of America in Hyde Park, N.Y.

While sales at fast-food chains have nudged up 4.7% in the past five years, the crop of sit-down restaurants -- with dinner entrees starting at between $10 and $18 -- have seen phenomenal sales growth. Maggiano's, 36.4%. Capital Grille, 32%. Cheesecake Factory, 29%.

Their stocks have been stars, too. Over the past two years, shares of such sit-down chains have soared 66%, compared with a 20% gain in the broad restaurant market, according to Salomon Smith Barney's Restaurant Composite, which tracks 50 public restaurant companies.

Even chefs who seem too highbrow to clone are multiplying. New York's Daniel Boulud has three restaurants, Daniel and the more casual Cafe Boulud and DB Bistro Moderne. He is considering opening additional locations of the two lower-priced restaurants. Chef Jean-Georges Vongerichten has 11 restaurants from New York to Las Vegas, most notably four Vongs, a French-Thai concept. And chef-to-the-stars Wolfgang Puck oversees 68 restaurants across the country, including five Spagos, 15 Wolfgang Puck Cafes and 19 Wolfgang Puck Expresses -- some in malls and airports.

"Why only open one?" asks Mr. Puck, whose restaurants rang up sales of more than $200 million last year. "If you train a lot of good people, why not put them into business with yourself rather than with your neighbor?"

Operating a string of restaurants gives Mr. Puck muscle in the market, spreading fixed costs over several properties. A master sommelier can earn as much as $150,000, plus benefits, so it was only when Mr. Puck had five fine-dining restaurants that he could afford to hire his first one to select wines. Each of Mr. Puck's 12 fine-dining establishments contributes between $10,000 and $80,000 to create a $250,000 public-relations and advertising budget. That's an unheard-of sum for a single operator, who would be lucky even to have a marketing budget. By having multiple restaurants, the closely held Wolfgang Puck Fine Dining Group saves about 30% in business-liability insurance costs, or about $12,000 per restaurant annually.

The rise of the sit-down chains has independents banding together. In Arizona, the recently formed Arizona Independent Restaurant Alliance is a consortium of about 120 restaurants buying collectively and extracting better prices on everything from fish to linens. Cafe Terra Cotta, which serves Southwestern cuisine in Tucson, saves at least $100,000 a year from the alliance, estimates Don Luria, the restaurant's owner. "For us to get $100,000 to the bottom line, we would need [to add] 30,000 customers in a given year," he says.

Some 20 independent restaurants in Kansas City, Mo., recently began kicking in $90 a month each to take out ads in the Kansas City Star. It's the first time in nine years of owning his own place that independent restaurateur Tom Macaluso could even consider the expense of running an ad in that paper. The group's ad features the names and numbers of all the restaurants with slogans such as "Local Food Served with Local Flavor."

Mr. Macaluso says there are at least five chain restaurants within a 10-minute drive of Macaluso's, his white-tablecloth Italian place, where the average check is about $40 a person with drinks. "All our money is made locally and stays locally," says Mr. Macaluso. "We don't have a mother ship."

Surrounded by Chains

Restaurateur Peter George is trying to beat the chains at their own game. In the decade or so since he moved his fine-dining establishment, Peter's, to the north side of Indianapolis, at least seven chain restaurants have surrounded him. He says chains have found better locations and attracted patrons with large portions. Ultimately, they have made Peter's unprofitable three years out of the last 10.

When Sullivan's Steakhouse moved across the street in 1996, Peter's saw a 15% drop in business, Mr. George says. In addition to steak, Sullivan's offers a jazz trio, so Mr. George quickly bought a $15,000 piano and hired a pianist who sings show tunes and other songs on request. When Houlihan's and other chains opened, Mr. George had to raise wages by as much as 20% to keep dishwashers and prep cooks from defecting. "We had to compete with the Joneses," he says.

Back in Chicago, Hubbard Street Grill worked hard to beat the odds for eight years. There were four previous restaurants in its space. Each lasted less than a year, including a venture called Steven Seagal's Restaurant named after the martial-arts movie star.

Mr. Schy got his start in the business as a summer dishwasher in a steakhouse in Northbrook, Ill., when he was 13 years old. He went on to study at the Culinary Institute of America and then worked as a chef at various restaurants in California. He returned to the Midwest as a corporate chef at Chicago-based Lettuce Entertain You Enterprises Inc., which has developed more than 70 restaurant concepts, some of which have been sold and expanded nationally.

After seven years there, Mr. Schy thought he could cook circles around cookie-cutter chain restaurants. He always was thinking of new dishes and would often spend time in the kitchen before and after hours concocting three or four different versions of the same dish.

Like other independent restaurants, Hubbard Street Grill budgeted enough to hire a public-relations firm -- about $20,000 -- to help get the word out when it opened in March 1994. After that, there wasn't much money for advertising. That made reviews critical. "You need to get a good review in the first six months," says Mr. Schy. "You can't afford to advertise."

A small ad in the monthly Chicago magazine can cost $2,000 to $3,000. The free Where magazine, which is distributed in Chicago hotels, can cost an advertiser $2,000 a month. Slim profit margins -- 5% to 10% -- make it hard to recoup the costs, says Mr. Schy. Meantime, chains such as Smith & Wollensky with eight restaurants and Olive Garden with 490 locations can herd diners into their restaurants with ads in national magazines or splashy network TV spots.

While chains often get a bad rap for their food quality, Mr. Schy clearly borrowed some of their innovations. He theorized that chains had done enough focus-group research to identify popular food trends. When California Pizza Kitchen, just two doors away, offered a Thai Chicken Pizza, Mr. Schy devised a Thai Chicken Wrap. And when Buffalo chicken wings took off, Mr. Schy began offering Buffalo chicken salads (minus the bones).

"All we can do is beat the chains with food," says Mr. Schy. "You take an idea and make it better."

Beefing Up the Steak Menu

When the fancy steakhouse chains rolled into town, Mr. Schy extended his line of steaks to six cuts from four, adding a veal chop and a rib eye. But the steakhouses offered a clubby ambiance he couldn't touch on his limited budget. When Mr. Schy opened his restaurant, he didn't spiff up the loft warehouse space that housed it -- except to paint a mural on one wall and get a new sign. He didn't even buy new tables and chairs, using ones left by the previous restaurant.

"People are coming out for a $3 million [decorating budget] with lousy food because the decor matches people's outfits," he complains.

But Mr. Schy counts other victories. After a few years, his neighbor, California Pizza Kitchen, moved to another downtown location because he says it couldn't sustain a dinner business. (California Pizza Kitchen, for its part, says it moved because it found a better location.) The chains also never really ate into Hubbard Street Grill's lunch business, which had been pulling in $4,000 a day in sales serving 300 customers. Lines were common at lunchtime and the bar counter was often lined with to-go orders.

Mr. Schy thinks Hubbard Street Grill, which had an average dinner ticket of $25, thrived for as long as it did because he tailored the menu to his regular customers. Many of them were women who worked at the nearby Merchandise Mart, a massive mix of office, design showrooms and retail space. After discovering that more than 50% of the orders were salads, Mr. Schy began expanding his salad offerings. In time, Hubbard had over 22 salad options, from a Caesar Salad with Grilled Calamari to a Flatbread Cobb Salad with Crab Cake.

Staying Home

Mr. Schy saw the beginning of the end in December 2000, when the economy was slowing. He estimated that the chains had already gobbled up 25% of his dinner business over the last several years. His clientele from the suburbs seemed more comfortable staying close to home and eating at Olive Garden and Red Lobster than spending a night in the city. Because of the competitive environment, he couldn't raise prices, keeping entree salads priced at about $10 and an entree such as a skirt steak at about $14.

The Schys aggressively trimmed expenses by doing everything from removing tablecloths (savings: $3,000 a month) to switching suppliers to get a better deal on dishwashing soap (savings: $300 a month). Some ideas backfired. The switch from extra-virgin olive oil to virgin olive oil, at a saving of $30 a week, was short-lived. "We returned it," says Mr. Schy after tasting the salad dressing made with the cheaper oil.

To ensure a strong summer, the Schys sent out 8,000 mailings to neighboring offices and residents offering free vodka tastings and hors d'oeuvres. But Hubbard Street Grill's business fell further after Sept. 11 when business travel dropped and expense-account budgets shrank. Hubbard Street's dinner business fell 35%.

After struggling all last year, the Schys managed to scrape together a profit from Hubbard Street Grill that looked like a white-collar salary: $100,000. With both of them working 60-hour weeks, it hardly seemed worth the effort. Luckily, Mr. Schy had a fallback. On the side, he bottles and sells his "Ketchapeno," a concoction of ketchup and spicy jalapenos. He says that business is taking off, and he made nearly as much selling Ketchapeno over the Internet and to grocery stores and restaurants last year as he did running Hubbard Street Grill.

With the lease up at the end of May, the Schys decided to call it quits.

Having a reputation as more of a lunch place, Hubbard Street Grill didn't even open for dinner during its last week in business. Customers still streamed in for lunch, many of them regulars who wanted to say goodbye and have one last meal there. "The decor stinks, it's too loud, you can't hear," offered Hubbard regular Charlie Besser, a 50-year-old Chicago TV-sports production executive. "But the food is good."

Write to Shirley Leung at shirley.leung@wsj.com

Copyright 2002 Dow Jones & Company, Inc. All Rights Reserved