Why Do Restaurants Fail?0



failIn the inaugural issue of Restaurant Startup & Growth magazine in February 2004, our magazine challenged the 90% first-year restaurant failure rate that was being passed off as “common knowledge” inside and outside the industry. RS&G conducted its own research, which suggested that the first-year failure rate was closer to 25%. Not great, but not much different than the failure rate in any sector.

Happily, we learned that an Ohio State University study, spearheaded by H.G. Parsa, Ph.D. confirmed that figure. Dr. Parsa’s landmark study, which was published in Cornell Quarterly did not only attempt to determine the restaurant failure rate, but identify the root causes. Seven years after that study was released, we talked to Dr. Parsa about the study, its “back story”, and what he’s learned since. His advice is still quite relevant to anyone who owns an independent restaurant, or is considering opening one.

If nothing else, it is important for independent operators to evaluate the risk factors for restaurant failure in light of their own businesses, and correct problems before they become fatal.

So, the big question: Why do restaurants fail?

The answer — answers — aren’t at all simple, and may just surprise you.

The reasons are many and varied and, in some cases, not the least bit obvious. While a lack of working capital is most people’s first guess, underlying factors can and often do include anything from a lack of proper planning for slow times or retirement to unrealistic expectations, quality of life issues and even the inevitable passage of time.

It was nearly seven years ago that Dr. H.G. Parsa decided he wanted to know why.

“People always said that 90% of restaurants fail in their first year,” recounts Parsa, at the time, now a professor at University of Denver’s Daniels College of Business. . “Then in the late ’90s the NBC television network broadcast a program titled Restaurant: A Reality Show sponsored by American Express and starring Chef Rocco DiSpirito. Every 15 minutes American Express put on a commercial saying that 90% of restaurants fail in their first year. That puzzled me. I’d been in the restaurant industry for 15 years and I’d never seen anything like that. So I called American Express.”

Parsa reached American Express’ vice president of media communications in New York. “I asked him, ‘Look, you said this — 90% of restaurants fail in the first year — but where did you get the data from?’ He said, ‘I’ll get back to you in a week.’ Well, in a week I got a letter from him: they didn’t have any data.

Parsa, an industry veteran who had worked his way up from the bottom to management positions with companies like Pizza Hut, Wendy’s and Denny’s, earned his PhD in marketing at Virginia Tech, then taught at SUNY Buffalo for seven years. While serving on board of the Ohio Restaurant Association, he came across a fool-proof source for learning exactly how long restaurants remained in business: the health department. “Every restaurant has to be inspected by the health department before it opens, and the license has to be renewed every single year. The only time they don’t renew you is when you’re closed. I thought, ‘Wow, there we go — when a restaurant opens I know it because of the license, and when it closes I know because it’s not renewed.’ The research was done credibly, scientifically. That’s the point.” Data was collected over four years from among 1,400 restaurants. The result: less than a third of restaurants — just 29.6% — went under.

While teaching at Ohio State University in 2005, Parsa published a research study two years in the making called Why Restaurants Fail in Cornell Hotel and Restaurant Administration Quarterly. Additional research was conducted later among restaurants in Columbus, OH, and Buffalo, NY. “With these qualitative interviews,” he says, “we discovered that restaurants fail for reasons other than finance. That’s a fascinating finding.” Follow-up research among 5,000 restaurants in Cobb County, GA, in 2006 and 2007 helped to solidify the findings.

Why Restaurants Fail

According to Dr. Parsa, the factors that can lead restaurants to ruin are several — some are more obvious than others — and include the following:

The number-one reason that restaurants fail, Parsa found, has to do with population density and location. The highest failure rate in restaurants comes about, “believe it or not — surprise, surprise, surprise — in downtown markets,” he says. “As you and I know, the highest number of restaurants per capita is in downtown locations. High real estate costs, number one. Number two, labor — you can’t get the labor. It’s difficult to come to downtown to work, because no one lives there.” But the single most important factor is simply that most downtown businesses operate Monday through Friday for breakfast and lunch. “Very little for dinner,” he notes, “very little for the weekend.” Rainy days.

Parsa’s second most common reason is one, he reflects, that “you don’t see in many books,” and it’s this: most entrepreneurs and restaurateurs “have enough capital to open the restaurant, but not enough capital to survive for three to six months of the slow days, the rainy days. So insufficient capital is the reason.” Why so ill prepared? Entrepreneurs “believe that ‘Once I open the restaurant the money will start coming in,'” says Parsa. “No, no: they need capital to survive for three to six months without a paycheck.” How much they need depends on the concept. Size. A third factor, Parsa found is that, as he puts it, “size matters. We found that the highest rate of restaurant failure happens in the smallest restaurants, the mom and pops.” Why? Because such small operations tend to carry with them relatively low entry and exit barriers. In other words, it is easier for anyone to get into the business and easier to get out when fortunes wane.

“Say I’ve got $70,000,” says Parsa. “I bought myself a grill, I can make my scrambled eggs — I’m a chef. Simple as that. Remember, restaurants have low fixed costs and high variable costs. Because of the low upfront investments everybody tries to get in, because it’s easy. Nobody thinks about opening a book store or a movie theater because they have high fixed costs.”

In the Cornell Quarterly article (co-authored by John T. Self, David Njite and Tiffany King), Parsa noted that, “In addition to the age of the firm, research has found a correlation between size and survival. In this regard, the larger firms are more likely to remain in business than small operations.”

Quoting L. Richardson’s article The Mechanics of Failure in the November 1991 issue of Asian Business, Parsa pointed out that “both suppliers and bankers are prejudiced against smaller firms. They tend to take longer to act against a slow-paying… large enterprise than they do against a smaller firm, because they equate bigness with safety and security. That said, small firms tend to be positioned for growth, but if that growth occurs too rapidly, a restaurant’s propensity to fail actually increases because of the ensuing financial stresses. These financial stresses include a high cost of goods sold, debt, and relatively small profit margins.” Quality of life. The fourth most common reason restaurants fail, Parsa maintains, has to do with quality of life. Of 50 operators questioned, he reports, “Many, many times restaurant owners quit because they can’t take it anymore. They burn out.” Dollars, of course, play a role even here.

High variable costs mean high maintenance, or more specifically “high management,” he says. “That means somebody has to closely watch what’s happening. Because of that they have to be in the business every day, seven days a week. They can be married to their wife or husband or their business, but not both. That’s reality.”

Parsa refers to the well-known story of Wendy’s founder Dave Thomas, whose daughter Melinda Lou spoke publicly about her childhood after her father’s death. “She complained loud and clear that her dad was never there when she was growing up. Dad was never home; he didn’t even know what school they went to. He was always working, working, working. Because of that the kids were practically raised by his wife, Lorraine. People get married to their businesses instead of their spouses.” Retirement. Yet another factor is ill health — that of the owner or a family member — leading to retirement. “Because of this they find they can’t stretch the time between the family and the business, so they leave.” Retirement and the failure to adequately plan for it is another potential torpedo. “Restaurant owners don’t live forever,” Parsa reveals. “At some point they have to retire.” Too many, though, have no “transitional plans. Most restaurant owners never, ever have transition plans. They think they’re going to live forever.”

The day inevitably comes when they have got to get out due to age or infirmity “but they don’t know how,” Parsa says. “They’ve never planned for it, so what do they do? They sell it, or the restaurant go down because they can’t commit — they’re not that motivated anymore to be there, so they let it go. They don’t know what to do, they don’t know what they do know at that point, and the restaurant suffers. The employees all take advantage, so the restaurant loses money and he tries to get out by selling it.” Parsa likens the scenario to the U.S. war in Iraq, from 2003-2011.

“We got in, (but) we don’t know how to get out. Same thing with restaurants: most restaurateurs never have a plan to get out. There is no exit strategy.”

Taj Mahal Syndrome

Another factor that contributes to restaurants going “belly up” is what Parsa, who was born in India, terms the Taj Mahal Syndrome. The famous landmark, he explains, was built “not for a living person, but for a dead person. Nobody lived in that building.”

Restaurants are the same way, he explains. “People want to build but that’s it; they don’t know what to do with it once it’s built. Restaurant owners most of the time have a dream of opening a restaurant, like the Taj Mahal, but they don’t know how to do the next level, managing it and building it beyond. They thought that once they opened things would happen automatically. They don’t. They never realized it’s more about what happens after a restaurant is built. Before is easy. It’s what I call entrepreneurial incompetence. They are competent enough to come up with the idea, but totally incompetent when it comes to taking it to the next level. That’s why they fail.” Another telling analogy: people who are dating. “They always think in terms of, ‘I’ve got to marry this person,'” says Parsa. “They’re thinking of the wedding, not the marriage. That’s why most Americans spend so much money on weddings. No — we should spend more money on the marriage.”

Another problem is the simple passage of time, Parsa says. “I don’t have the whole proof yet, I’m still working on it. My research is unpublished; it’s coming down the road. But every single restaurant — take my word for it — has only 10 years of life. Period.” His proof? The historical record shows indisputably that American food habits change every 10 to 15 years.

“I did research on this,” he says. “In the 19th century the number-one food item in America was steak. By the turn of the century, 1920, 1930, the number-one menu item was the hotdog.” By 1947 to 1955, he continues, the hotdog was replaced by the hamburger. By 1980 it was pizza. “I told my students, ‘Watch out — by 2020 or 2030 … we don’t know.” But the conclusion remains: with the passage of time American food habits change “dramatically. Many of our parents never taught us about eating a burrito for breakfast, but people do now.”

Nor does the passing of time effect only taste trends. As decades go by, Parsa notes, “a restaurant’s décor gets old. Diners experience the same ambiance forever so they want to change. If somebody down the street has a better ambiance, they go there.”

People choose to dine in a given restaurant “basically for three things, and only for three things,” Parsa maintains, “the food, the ambiance and the service.” That said, he adds, “Every 10 years one of the three get old. Service changes. Habits change. Technology changes. Demographics change. (Consider the influence of the millennial generation on preferences.) Guess what: people start looking for other things to do. By then you’re too late.”

Parsa calls updating product a “very, very touchy” affair. “I teach menu engineering, and there is a way to do it. Most restaurant owners don’t know how to do it; that’s why they fail. They’ve got to know how to do menu engineering and they must do it every three months. That tells you which items are selling and which aren’t; which to keep and which to take out. And of course they keep on testing new products.”

Additional Sources:

The National Restaurant Association’s 2015 What’s Hot Culinary Forecast

The Right Dream

Parsa admits that before he started his research he’d been “puzzled about what to expect. All the accounts, and Dun & Bradstreet, all say that capital is the reason restaurants fail. No, it’s not capital. It’s quality of life. It’s lack of planning. It’s the Taj Mahal Syndrome. It’s entrepreneurial incompetence. It’s more of a managerial issue than a financial matter.”

The key for anyone considering opening a restaurant, he says, is to realize that his dream should not be opening a restaurant, but having and operating one.

“Opening is the first step only,” he emphasizes. “Do you have enough money to survive? Do you have the managerial skills to run it? Do you have plans for somebody to (care for) your family? Can you take time off and be involved in your kids’ lives? Do you have a life plan so that the restaurant is a part of your life, not your life itself? Most restaurant owners don’t think in these terms. But if you’re reading this article before you open your restaurant, really think it through — location, the concept, the finances.” A restaurateur must remember, he concludes soberly, that “a restaurant is a living, breathing, real thing. Not a toy to play with.”

Case in Point: Figlio’s — Redefining Success

One operator interviewed by Parsa for his study was Peter Danis, a successful corporate attorney with a degree in accounting who had represented the Wendy’s chain. He retired and opened his own restaurant, Figlio’s, in Columbus, OH, with family money.

“It’s open six days a week, but only for dinner,” Parsa relates. “He very, very carefully has made sure he has quality of life. Everybody asks, ‘Hey Peter, why don’t you open it lunch?’ He says, ‘Nope. If I open for lunch I won’t have any life left.’ He is there every dinner, five nights a week. Once he opened for lunch he’d always there; he wouldn’t ever go home.”

It gets better: Figlio’s is one of the few restaurants that closed on New Year’s Eve of 1999. “It was the end of the millennium and every restaurant was jam packed,” Parsa recalls. “He closed the restaurant, not only for himself but for all of his employees. He says it’s worth making less money so the families can enjoy their time together. He still does not open for lunch. He opened his third restaurant, but still works a five-day work week. Danis, Parsa concludes, “may not be rich — there is a lot of revenue potential that he has given up — but that’s the price you pay to have a life. It’s balancing the life. Money is not everything.”

Additional Sources

In a 2003 American Express ad, celebrity chef Rocco DiSpirito claimed that restaurants have a 90 percent failure rate. The statement left some industry watchers and owners wondering where he got that statistic. Lenny Russo, James Beard Nominee, Chef-Owner of Heartland Restaurant and Barry K. Shuster, Editor of Restaurant Startup & Growth, magazine discuss on Minnesota Public Radio.


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