Continued: Forget the free bread and drink refills

When a restaurant like Ike's Food & Cocktails sells more than 10,000 steak and seafood dishes a year, even a slight increase in meat prices can hurt.

So when wholesale beef and fish prices shot up by 20 percent this year, chefs at the downtown Minneapolis restaurant got creative. They curbed helpings of more expensive fish, like sea bass and swordfish, and replaced them with more bountiful portions of cheaper fare, such as wasabi mashed potatoes and jumbo shrimp.

And now, to keep up with inflation, Ike's this fall will do away with prices of some featured fish and steak dishes on its menu and allow them to fluctuate daily. "We change the menu three times a year, but that's no longer enough," said owner Chip Isaacson.

Restaurateurs like Isaacson are being squeezed from all sides. Costs for basic food items, from beef to poultry to eggs, have soared. Meanwhile their ability to raise prices without turning away customers has eroded as tightfisted consumers cut back on eating out.

Last week, the parent company of Bennigan's and Steak & Ale restaurants filed for Chapter 7 bankruptcy liquidation and shut its doors. Many others are struggling and some experts predict an industry shakeout.

Rising food costs, however, are not the sole cause behind the current slowdown, say analysts. The real problem, they argue, is that many large chains overbuilt at a time when Americans were starting to pull back on restaurant spending.

Now, unable to raise prices to match rising wholesale food costs, so-called "menu makeovers" have become increasingly common. Restaurant chains are swapping expensive dishes with humbler food items and cutting back on gigantic portion sizes. Free refills of soda and bread are less common, as are those "Happy Hour" specials.

The goal is to make small changes that save big dollars, while going unnoticed by restaurant patrons. But analysts say it's a dangerous game. The nation's $558 billion restaurant industry is mired in one of its worst downturns in decades. One wrong move and a once-healthy chain can find itself out of favor with consumers -- and bankers. The Bennigan's chain was roundly criticized for upscaling its menu earlier this decade without improving the quality of its food or service.

"There are no quick fixes in this kind of environment," said John Owens, an equity analyst who covers the restaurant sector for Morningstar in Chicago. "A company that cuts back too much [on serving sizes] may lose customers that will never come back when the economy rebounds."

For decades, women were among the key drivers of growth in the restaurant sector. Historically, they have been the primary meal makers in American households, so their entry into the workforce compelled more families to eat out or grab their meals on the go at fast-food restaurants, said Harry Balzer, a vice president at the NPD Group, a market research firm in Port Washington, N.Y.

But for the first time in half a century, the percentage of women working outside the home hasn't increased for several consecutive years. Restaurant meals peaked at 211 per person in 2001, and have been dropping ever since, hitting 207 last year, according to the NPD Group.

Fewer meals, more restaurants

At the same time, the number of eating and drinking establishments has increased 45 percent to 523,965 in 2006 from 360,691 in 1990, according to the National Restaurant Association in Washington.

Many of the casual, family-oriented chains like Applebee's, Ruby Tuesday and Chili's expanded rapidly but failed to differentiate themselves, analysts said. "We had an over-supply issue even before oil prices rose and the housing sector collapsed," said Destin Tompkins, a restaurant sector analyst with Morgan Keegan & Co. in Nashville.

This glut has created an intensely competitive environment. Greeted with a rash of like-themed restaurants with similar menus and service levels, many people show very little loyalty to a particular chain.

Because of the competitive environment, restaurants are being forced to swallow much of the increase in food costs. For the first six months of this year, restaurants have increased prices 4.1 percent, while the producer price index rose 8.2 percent over the same period. Supermarkets have been more aggressive than restaurants, raising prices 5.6 percent during the first six months of the year, according to the Bureau of Labor Statistics.

"Restaurants are doing the best they can to keep prices down," said Malcolm Knapp, a restaurant consultant who does industry forecasts for the National Restaurant Association.

Thriving in tough times

Despite the difficult environment, chains that appeal to young adults appear to be faring the best, said John Hamburger, president of Franchise Times, which publishes the Restaurant Finance Monitor. That includes Golden Valley-based Buffalo Wild Wings, which has seen its shares gain 40 percent this year with a simple menu of 50-cent wings and beer. With no debt, Buffalo Wild Wings has been plowing money back into its 521 restaurants, adding high-definition television sets and a redesigned menu.

"Beer and sports are about as recession-proof as you can get," said Jeffrey Farmer, senior vice president at Jefferies & Co. in New York who covers the restaurant sector. "It's perfectly positioned in the current economic environment."

But investors are treating many restaurant stocks like yesterday's fast-food leftovers. Shares of Famous Dave's have plunged 40 percent this year, and the Eden Prairie-based barbecue chain said last week that it may be forced to write down the value of some of its underperforming restaurants and scale back development plans.

Others have fared worse. Buca Inc., which operates the Bucca di Beppo chain, said last week that sales at its established restaurants (those open at least a year) fell 5.1 percent in the second quarter. Shares of Buca are now hovering near 30 cents and are down 67 percent this year.

There's a possibility that restaurant stocks could drop even more, as commodity price increases filter through the industry, said Owens of Morningstar. Many large chains buy their food products on long-term contracts, which means the full impact of this year's price increases at some chains won't be felt until next year, he said.

One way to counteract the impact of rising prices is to substitute more expensive ingredients with cheaper ones. Earlier this year, the pizza chain Chuck E. Cheese began using a "reformulated" high-moisture mozzarella pizza cheese to save money. Others are dropping smaller, less-pricey appetizers off their menus.

Tim Murray, owner of Murray's Steak House on South 6th Street in downtown Minneapolis, estimates that his wholesale cost of strip sirloin beef has increased about 10 percent over the past year. Yet he's only increased the price of his famed "Silver Butter Knife Steak," a 28-ounce cut recommended for two people, by 5 percent to $89.50 from $85 a year ago.

He contemplated plans to "market price" his steaks -- that is, to allow them to fluctuate daily based on the wholesale price of beef -- but decided against it out of concern that it would upset some of Murray's longtime customers.

"Every time I raise prices, I feel like we're pushing another few people out of here," he said. "In times like this, you need every customer you can get."

Chris Serres • 612-673-4308