What Are Five Factors Which Contribute To The Failure Of New Restaurants?


Darren Atlee
Economics
January 13, 1995


Definition of Business Failure: Business that ceased operation following
assignment or bankruptcy; ceased operation after foreclosure or attaching;
voluntary withdrawal leaving unpaid debts.
It is a common assumption in the restaurant industry that restaurants fail
at an exceedingly high rate, the highest failure rates in the U. S. economy. In
researching this topic, statistics numbers and percentages fly around routinely.
All give somewhat the same concept; in the starting years, most restaurants fail.
The most often cited statistic is the 95/5 ratio. 95% success and 5% failure.
Conversely, another favorite concept exists. Somewhere between 50 to 80 percent
of all new restaurants which open this year will fail within the first 12 months
of opening their doors. The same conventional wisdom also suggests that about
50% of the remaining restaurants will fail in their second year of operation and
another 33% in the third year. This means that if 100 new restaurants were to
open this year, 50 to 80 would fail before their first anniversary. That would
leave 30 restaurants open in the year two. Half of these 30 would subsequently
fail in their second year, and a final third of those remaining would fail in
their third year. As a result, there is about a 90% compound failure rate over
the first 3 years of a restaurants lifespan. (Mullen & Woods, 61)
You are not alone if you feel intimidated by the numbers. They can be
quite blunt and negative which attributes to one simple fact - it takes planning,
research and risk to venture into the restaurant world. There are five major
factors which can lead to success or, in this case, failure of new restaurants:
capital, type of establishment, location, labor and management.
In order to start any business, an entrepreneur needs money or capital.
This capital could include all expenses, such as loans, rent, payroll, and
insurance. Some argue this is what causes restaurants to fail. Given the
information that restaurants are most likely to fail than succeed, it is always
difficult and often impossible to interest bankers in making loans to
entrepreneurs who operate in a high risk industry. Even when loans for
restaurants are available, restaurateurs often must pay higher interest rates or
provide more extensive collateral requirements to secure these “high risk” loans
than might be required for another “less risky” venture. (Mullen& Woods 61)
It is not difficult for a restaurant to fail when it has poorly planned
financially. Many times restaurateurs fail to accommodate the business with
enough cash flow to support the projected three year start period. Some
expenses cannot be avoided nor controlled like raw materials which are essential
regardless if business booms or busts in the early period. Operators must
realize that if business is low, so too should their overhead costs. If there
is no income, there is no money to pay expenses, thus the restaurant goes under.
Some external factors may effect restaurant expenses which owners have
little control over. Government legislation could cause higher taxes and
operation fees which could force some franchise owners, even in large chains, to
sell rather than sign new agreements. (Nathan, 66) With insurance cost at
already high rate for restaurants, new health-care reforms could be an added
burden, especially for independent restaurants. Some sources predict that these
reforms could be so costly that it could eliminate ten percent of the
industry\'s nine million jobs in ‘95. Many factors could lead to ultimate
failure of restaurants due to poor financing and uncontrolled external factors.
The term failure means a lot of different things. Going broke certainly
constitutes a failure, but terminations and nonrenewals of franchises are also
failures in many cases. Selling the store to another franchisee or to the
company could also qualify depending on what motivates the sale. In some cases,
a restaurant in a poor location may change hands several times- each a failure-
yet each change of ownership may go unnoticed because the signage, menu, and
interior decor will be virtually unchanged. (Nathan, 66)
When opening a restaurant, owners must investigate fully the factors of the
type of establishment they want to create and the location of this establishment.
Both are essential in the success of the restaurant. Some restaurateurs aim to
target their patrons, they go directly for what they think they want. Say there
is an overabundance of Chinese restaurants, maybe the people would flock to a
new Mexican restaurant. He will take that risk