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5 big lessons from the Kona Grill downfall

Restaurant operators can learn a lot from the decisions that led the chain to file for bankruptcy, says RB’s The Bottom Line.
Photograph by Jonathan Maze

The Bottom Line

Earlier this week, Kona Grill filed for Chapter 11 bankruptcy protection, a move that was suggested last month and, to be honest, inevitable for a lot longer than that.

Kona largely did this to itself. It overspent and overexpanded. Then it panicked and cut too much, too quickly. All of these are lessons for any operators trying to make it work in the challenging and hotly competitive restaurant environment.

Here are five lessons that restaurant operators and others can take from Kona Grill’s downfall.

Be smart about expansion

We wrote earlier this year that Kona Grill expanded too fast, having doubled in size between 2013 and 2017, to 46 locations from 23. Marcus Jundt, one of the chain’s former CEOs, was blunt in his assessment of that expansion, saying that many of the new units were in markets very different from Kona’s traditional locations in suburbs.

Bankruptcy filings have even more damning information about that expansion. The company spent more than $4 million per location to build those new units, costing Kona $92 million.

The chain’s average unit volumes and traffic began falling in 2015—meaning it kept expanding even while problems began to surface.

Since last year, the struggling Kona has closed 19 units. At least 10 of the locations have been opened since 2013.

Overly aggressive expansion is one of the tried and true ways to run into trouble in the restaurant space. This is just another lesson. Kona is in bankruptcy court just two years after completing that growth.

Don’t panic

Companies that face financial problems often make panic moves. That always does more harm than good.

Based on lawsuits between the company and one of its former CEOs, as well as the bankruptcy filing, problems began emerging with Kona’s finances in 2017.

That prompted the company to stop developing, close units and go on a cost-cutting spree.

In his lawsuit against Kona seeking to be paid severance following his November firing, former CEO Jim Kuhn said his “marching orders” after he was hired as COO in 2017 were to “quickly create cost-saving measures that would increase the company’s overall profitability.”

The cost savings might have helped profitability, but they most certainly hurt sales last year.

You can’t cut your way to prosperity

The panic moves proved, once again, that you simply cannot cut your way to prosperity in the restaurant business.

That is triply true for restaurants with waitstaff, where service is paramount. The company cut restaurant-level support, training programs, culinary innovation and management staffing levels, “which negatively impacted guest experiences and restaurant-level standard-operating procedures.”

This business is too competitive for a service-oriented business to be cutting service. We’ve said it before, and we’ll say it again.

Buybacks are terrible

Maybe the most interesting element in the filing was a note that the company spent $15 million to repurchase shares in 2016 and 2017, which hurt liquidity.

I do not like stock buybacks, but they can lift a stock when executives think it’s more valuable than its trading price. In this case, however, it was a bad idea.

The buyback came at the tail end of a $90 million spending spree. It also came as the company’s finances were clearly a problem. Kona had a $21.6 million net loss in 2016 and negative $6.6 million in EBITDA (earnings before interest, taxes, depreciation and amortization). In 2017, it had a $23 million net loss and $6.4 million in negative EBITDA. It wasn’t exactly flush with cash either year.

Kona clearly needed to preserve cash those two years. And that $15 million buyback did little for the company’s stock price—it fell from more than $16 a share to less than $2 over that time period.

Slow down earlier

Between 2014 and 2018, Kona’s operating profit per store fell to 10% from 18%. Traffic began falling in 2015.

The company had to take asset impairment charges as early as 2016. Yet it did not officially slow growth until 2017.

Kona’s downfall was quick—it really does appear as if the company simply ran off the rails over that period. But something about the company’s expansion clearly wasn’t working back in 2015, and the company should have made changes earlier. Instead, it bought back shares.

This is easy to say in hindsight, of course. But it’s clear that Kona took on an aggressive and costly expansion, and then saw way too late that it wasn’t working. If your new units aren’t working the way you think they should, maybe stop adding more of them.

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