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 and start his business.
There are two major type of restaurants, specialized menu and diverse menu. A diverse
menu franchise such as McDonald's has a failure rate of about 2%. (Nathan, 66) This is
because people have a choice in what they eat , and because of the good reputation.
Though these are fairly successful, specialized restaurants such as Cinnabon or Wings to
Go may also be very successful. Their product or specialty could prove to be the only
place around to get it or most likely the best. The failure rate of these specialized
establishments is closer to 40%. (Nathan, 66)
Clearly, it is not difficult for an entrepreneur to miscalculate his venture. It might
be a bad time economically for that particular town to open that type of specialized
business. Starting a restaurant from scratch is not the only option, some say that it
could be just as beneficial to buy a franchise that has already been established. Though
there is still a great amount of risk, wise advice leads toward buying a restaurant that
has weathered three years of operation. Even this type of venture requires research.
Entrepreneurs must investigate their market before beginning a project. Restaurants
depend primarily on their local consumer markets and secondarily on traveling market for
their business. Thus they should study their market by looking at extreme factors such
as both the prime and local lending rates, cost-of-living index, factory lay-off or
hiring, and the general unemployment levels. (Mullen and Woods. 64) What usually
happens is that when a local economy takes a downturn, a flurry of new restaurants
appears which create more jobs and filter out the weaker and more poorly-managed
restaurants over the next two years. (Mullen and Woods, 65)
Some restaurateurs believe that an original and strong concept for a restaurant is most
important. The food is commendable but the way it is presented and delivered is
extraordinary. Some also believe that it is most beneficial if all of these types of
restaurants are lumped together in a town so that people can choose. A case in point is
Brinker Intl., the US's biggest restaurant business. Owner and operator Norman Brinker
believes his insight has led him to look for prime sights. His ideal; Control an
intersection and put a different restaurant concept on each corner. That way, if a
Brinker restaurant loses business, chances are, it will lose to another Brinker
restaurant. (Palmeri, 62)
After an entrepreneur has taken his idea or concept with his restaurant, he must find
people to run his business, that is if he does not run it by himself. Restaurant
managers are a vital part of success. Some of their most important jobs is to control,
oversee and train the employees of the restaurants. This is not an easy task, given that
restaurant help constantly changes and rotates. This workforce is huge. This year the
number of restaurant workers went up from 6.74 million in '89 to 7.24 million in '94.
42% of all women and 31% of all men in the US have worked in foodservice at one time in
their lives. (NRA factbook)
It may be a concern of the manager that there may not be a large enough pool of quality
help to hire. If their establishment is not a solid one, managers must realize that
interested workers must at some point decide if they are interested working for a firm
that is at high risk of failure. (Mullen and Woods, 61) Higher quality
employees may be scarce, thus efficient training must take place.
Low quality training by the manager could prove to be a deficiency to the restaurant.
Poor training equals poor efficiency and service which equals less patrons which equals
low income which equals bankruptcy. Managers must set and keep a company standard. Many
restaurants publish official handbooks which outline the standards. It is up to the
managers to keep the help up to and working toward that standard.
Managers and restaurant operators also must frequently reevaluate their establishments
to direct their goals toward their patrons. They must find out what the people want and
deliver. Fast Food chains such as McDonald's, Burger King, and Wendy's have lured
customers in with selectively lowered prices and bargain meal combinations; by
delivering value, they can offset the damage lower prices do to revenue. (Thorrien, 97)
The restaurants that have not gone beyond the customer's expectations have failed, or
will soon fail, because of mismanagement and ability to change. All cannot be blamed on
the management, individual firm failure could be attributed uncontrolled external
factors. This observation leads to contradict the notion that good management can always
overcome negative environmental conditions. (mullen and Woods, 63)
The numbers which illustrate the success and failure of restaurants may be discouraging
but they show that this business is one of competition and risk. Factors such as
capital, type of establishment, location, labor, and management all contribute to the
success or failure of restaurants. The majority last less than a year, and the fortunate
handful stay in operation for generations, others make their share and move on. This
business is best described by an equation simply stated by Atlanta attorney Rupert
Barkoff, "One third are doing well, one third are doing okay, and one third are having
difficulty." (Hartnet, 67)
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