In search of a bank loan for your restaurant? Better treat your customers well! Restaurants with good online ratings tend to have more success in securing funding. This results in popular restaurants having more financial debt on their balance sheets. But what are the underlying reasons for this relationship?
The role of customer rating
Never have we been able to measure, quantify and analyze as much about ourselves and the world surrounding us as today. This is especially useful for experience goods - i.e. goods that need to be tried out to evaluate their true quality, such as those offered in the F&B industry on a daily basis. All of us have, at some point, consulted reviews from online platforms such as TripAdvisor, Yelp, OpenTable, Zagat or Zomato while contemplating which food outlet to choose.
Anecdotal evidence suggests that these platforms help service providers such as F&B outlets increase their attractiveness with customers and consequently their revenues. However, in recent years, the downside of this phenomenon has also gradually become apparent. Stories of fake reviews to improve one's reputation or defame competitors have been widely reported in the press. Online clashes between (anonymous) customers and restaurant owners, and the subsequent loss in reputation, have also increased over time.
While all of these direct effects have been widely reported and are known by the public, industry professionals and academia, the indirect benefits of good customer ratings are less visible. Thus, in a recent study, we analyze how customer ratings affect the debt capacity of restaurants over ten years. Overall, we not only provide evidence of a positive linkage between customer ratings and debt, but also of the mechanism underlying this effect and the use of these additional funds by restaurateurs.
Why high restaurant ratings pay off
Restaurants with good ratings tend to have more financial debt on their balance sheets. What is the underlying reason for observing this relationship? Two concurrent effects exist, explaining this phenomenon. First, on average, better-rated restaurants are more popular and consequently more likely to need financing to develop their activities (credit demand mechanism). Second, customers, via their reviews, provide cheap, easily accessible information that allows loan officers to quickly gauge the quality of restaurants, which may otherwise be hidden and not readily observable in financial statements (credit supply mechanism). Informal discussions with bankers confirm they use public information such as ratings to get soft information before granting loans.
We tend towards the credit supply mechanism to explain our findings. For example, due to space constraints in larger cities, it is relatively complex for restaurants to have substantial growth opportunities. We also only find a positive relationship between debt and ratings for bank loans. Other financial debt that mainly takes the form of loans from family and friends or, in the odd case, via crowdfunding appears unaffected by ratings. The link is also much more pronounced for restaurants that are smaller, less expensive or not reviewed by expert food guides. For these outlets, information asymmetries tend to be larger.
Fake restaurant reviews
Fake reviews exist and are a real problem for customers who often have to decide quickly whether they want to eat in a restaurant or go to another one. We find that fake reviews are less of an issue for loan officers. They have more time and resources to examine each case separately and, therefore, should be less prone to fall for fake reviews.
As a consequence, loans are issued to restaurants that (i) display relatively stable ratings through time, (ii) exhibit a broad consensus amongst reviewers and (iii) have been rated by a substantial number of customers. Ideally, these customers should be experienced and not only ever have given one review in their online life.
Restaurant business loan criteria
The main channel through which loan officers decide to grant a loan to a restaurant is twofold. Good ratings could lead to higher profitability and/or reduce a restaurant's inability to reimburse its loans. While we find minimal evidence for the first explanation, risk reduction is at the forefront of the effect.
Good ratings isolate restaurants from witnessing a significant drop in sales or cash flows. They also reduce the likelihood of restaurants witnessing financial distress or filing for bankruptcy. Finally, using the Paris terrorist attacks that hit the Parisian F&B scene very hard in 2015, we show that restaurants with good ratings suffered much less. This was especially the case for restaurants relying on a foreign clientele.
Investing in a better restaurant experience
What do restaurants do with these additional funds? Owners could use the money to channel profits into their or other stockholders' pockets as dividends. They could also build up cash reserves to increase financial stability in case of hardship or improve short-term liquidity. They could also use the funds to invest in the restaurant.
We find that the latter is at work: owners tend to use their additional funds to purchase equipment such as tables, chairs, cutlery and kitchen equipment. Thus, the additional funds are reinjected into the local economy and allow customers to have a better restaurant experience.
A happy customer is a happy banker is a happy corporate owner
While good customer ratings may allow companies to be more popular and increase revenues, it is not the only benefit. Companies wanting to provide a good image to fund providers should ensure they deliver good service to their customers. This guarantees customer loyalty, financial stability, easier access to financing and lower interest payments.
Associate Professor of Finance at EHL Lausanne
