The impressive power of online ratings
Historically, the opinions of professional food critics could put an up-and-coming restaurant on a path to a Michelin star – or shutter its doors forever. But over the last two decades, the proliferation of online review websites has greatly democratized this process, letting diners from Boston to Bangkok give instant feedback on their experience – and creating a deep pool of data for potential customers. Research by François Derrien, Professor of Finance at HEC Paris, and co-authors suggests that a high online rating has become much more than a predictor of a good meal – it is also a measure of a healthy business. A strong financial position translates, in turn, to easier access to financing.
“In a world without Tripadvisor, the best restaurants would not necessarily have access to more debt,” says Prof. Derrien.
For their recent article, Prof. Derrien and his colleagues combed through a decade’s worth of reviews of nearly 2,500 Paris restaurants that were published on Tripadvisor, France’s most popular online rating platform. The restaurants selected had received close to half a million customer reviews between 2007 and 2017 – yet there was limited information about the health of their business. By obtaining access to their annual financial statements, the researchers were able to study whether – and how – online popularity impacted their business performance.
Finding a correlation between a restaurant’s popularity and its access to credit may seem intuitive, but it is not so simple to prove true causality. After all, “any relation between debt and Tripadvisor ratings could simply be due to Tripadvisor reflecting higher quality that the bank can observe otherwise,” Prof. Derrien says. To deal with this problem, the researchers took a clever methodological approach: Instead of relying solely on Tripadvisor’s overall, rounded scores – extrapolated to the nearest half-star from thousands of individual reviews – they looked deeper into the raw scores provided by each reviewer. This revealed discrepancies between very similar restaurants that ended up with different ratings due to rounding. The researchers could then compare the financing outcomes for restaurants that fell on either side of a rating threshold to demonstrate a causal relationship. “It’s a cool way to deal with the problem,” explains Prof. Derrien.
Favorable online reviews do indeed create a virtuous circle – attracting new customers and leading to larger and more predictable cash flows.
The researchers concluded that favorable online reviews do indeed create a virtuous circle – attracting new customers and leading to larger and more predictable cash flows. Having a steady clientèle, in turn, makes for a more resilient business that can withstand fluctuations in the economic cycle – as well as sudden demand shocks like a pandemic or other disaster. Restaurants with the strongest customer ratings before the Paris terrorist attacks of 2015, for example, reported higher revenues and cash flows in the two years that followed that event.
“Firms can benefit from an improved online reputation by attracting new customers and improving access to external funds,” the authors determined. Meanwhile, “banks can benefit from paying attention to online customer ratings to reduce information asymmetry in the screening of borrowers.”
Why restaurants struggle to attract investors
Of course, successful restaurateurs are the most likely to invest in growing their business. “We find that restaurants with higher online scores invest in tangible assets instead of increasing dividend payments or improving their cash balance,” the authors write. But like many small entrepreneurs, restaurant owners often struggle to attract outside investors. Most are obliged to commit their personal savings while turning to family and friends for additional support. Many also seek out bank loans to finance their activities – a process that frequently falters amid the challenge of calculating credit risk.
As a business category, restaurants have a reputation for being a bad bet: an overwhelming majority of eateries shut down within 10 years. They also tend to have few tangible assets – they rarely own the space they’re in, for example – which means they often don’t have much to offer banks in terms of collateral. As a result, a restaurant’s capacity to borrow has traditionally rested on its financial statements and ability to demonstrate steady cash flows. What these ledger entries can’t measure, though, is the “special sauce” of a restaurant’s reputation: intangible assets such as the quality of the menu, the talent of the chef, customer service, and ambiance. These are the kind of attributes, the HEC researchers argue, that are best captured by online customer reviews.
“Online ratings provide a reliable, freely available way for lenders to measure those intangibles and assess risk,” the authors write. They added that their findings were applicable to any small, young consumer-oriented business whose online reputation provides insights into future cash flows that can’t otherwise be easily predicted.
