Some Reasons Restaurants Fail

About 5 years ago, Dr. H.G. Parsa, currently the chairman of the Foodservice and Lodging Management Department, Rosen College of Hospitality Management, University of Central Florida studied restaurant 1st year failure rates and also why most restaurants failed.

Even though we’ve probably all heard the urban legend that 90% of all restaurants fail in the 1st year, Dr. Parsa came across a foolproof 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: Fewer than a third of restaurants — just 29.6 percent — went under.  You can read Dr. Parsa’s study here.

Not satisfied with that, however, Dr. Parsa decided to study the reasons restaurants failed. Not surprisingly, the reasons are several and varied. According to Parsa, the factors that can lead restaurants to ruin are several — some are more obvious than others — and include the following:

Location
The No. 1 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, 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 and hard to get labor make operating downtown difficult, 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 says. “Very little for the weekend.”

Rainy Days
Parsa’s second most common reason is one you won’t find in many books. He says 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? Parsa says that entrepreneurs think, “Once I open the restaurant the money will start coming in.” That’s a mistake, he says. “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 says, is that 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,” Parsa says. “I bought myself a grill, I can make my scrambled eggs — I’m a chef. Simple as that. 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.”

Quality of Life
The fourth most common reason restaurants fail, Parsa says, has to do with quality of life. He questioned 50 operators. “Many, many times restaurant owners quit because they can’t take it anymore. They burn out,” he says. 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.”

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,” Parsa says.

Retirement and the failure to adequately plan for it is another potential torpedo. “Restaurant owners don’t live forever,” Parsa says. “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. “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 says, was built “not for a living person, but for a dead person. Nobody lived in that building.”

Restaurants are the same way, he says. “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. 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.”

The Right Dream
The key for anyone considering opening a restaurant, Parsa 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 says. “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 says soberly, that “a restaurant is a living, breathing, real thing. Not a toy to play with.”

If you are a restaurateur thinking about ways to increase sales, increasing marketing, making capital expenditures, or otherwise investing in your business and looking for a restaurant loan, try Advance Restaurant Finance, LLC (ARF). ARF has been making short term business loans to restaurants for almost a decade. Despite the economy, ARF never stopped making business loans to restaurants, and ARF makes restaurant loans up to $1,000,000 per location. If you are looking for a restaurant loan, ARF is one of the first calls you should make. ARF is made up of hospitality experts with financial products tailored to fit your needs delivered by your own personal banking team with no surprises and with over 10 years in business, you know we will be here when you need us.