Essay/Term paper: What are five factors which contribute to the failure of new restaurants?

Essay, term paper, research paper:  Economics

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 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)