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Restaurant Failure Rates Recounted: Where Do They Get Those Numbers?

by G. Sidney

For centuries, conventional wisdom held that we live on a flat planet. The Earth was believed to have been shaped roughly like a circle, with the oceans plunging over its edge, creating dreadful currents that would send hapless sailing vessels plummeting beyond the boundaries of the mortal world.

Many believed that when Christopher Columbus set sail for the New World, the explorer and his crew would never be seen or heard from again. The Nina, Pinta and Santa Maria and their crews would simply disappear into the abyss. The rest, shall we say, is history.
start quoteThink about it. Nine out of 10 new restaurants fail in their first year! Could that be possible?end quote
-- G. Sidney
 

One hundred and forty years later, Galileo's proposition that the Earth revolved around the Sun, rather than the other way around, got him into trouble with the folks running the Inquisition. Found guilty of heresy and sent to his home near Florence, he was placed under house arrest for the remainder of his life.

Press "fast forward" to summer 2003. A well-financed, celebrity chef hosts a reality television program titled "The Restaurant" (some believe its proper title should be "how not to open a restaurant"). Millions of TV viewers hear Chef Rocco proclaim that while "90% of new restaurants fail in their first year, he can beat those odds." The ridiculous myth about excessive restaurant failure rates is once again perpetuated and moves from industry scuttlebutt to everyday knowledge. Think about it. Nine out of 10 new restaurants fail in their first year! Could that be possible?

History tells us that commonly accepted "truths" are often little more than idle speculation and hearsay. The truth can be elusive, especially when the data is fuzzy and it's easier to quote rumors than discover the facts. The restaurant failure rate myth seems to fall squarely into this category. There just isn't much credible information. The result: Perfectly intelligent people believe facts and figures that have little relationship to reality, absolutely no documentation, and just plain don't make sense.

It seems everybody "knows" that restaurants fail at an alarming rate. Ask a banker, for example. She'll tell you "we don't make restaurant loans, it's too risky, they fail too often." Ask her to support her opinion with real data, and she'll likely say, "It's common knowledge."

Press her further to find out if she has ever loaned money to a restaurant, and she might state, "Well, no. It's too risky and they fail too often."

That's what you might call a "vicious circle."

The Numbers Game

You might think that a good source of anecdotal information on new restaurant failure rates would be the restaurant distributor sales people. They're on the front line of the battle. When a restaurant "goes south," they feel it in their bank accounts, since most are paid solely on a commission basis. While compiling this article, I interviewed several in-the-field reps who claimed that the new restaurant failure rate was "really high." That is, until they took a minute to review their accounts lists, at which point they invariably adjusted their estimates -- downward. One wine sales representative said, "When I really think about it I can only remember two of the 40 accounts I call on going out of business." One thing they all agreed on, however, is that those who go out of business simply were not paying attention to their business or simply didn't have a "clue" as to what they were doing.

Granted, an informal poll -- "grandmother research," as we say around here -- isn't always statistically valid, and might not be a fair snapshot of the market. But take a look around your community. Of all the restaurants you're familiar with in your area, how many have gone out of business in the past year? How many of the new ones have failed? Is it 90% or some smaller number? In our community, six new restaurants have opened in the past three years and they're all still in business. That may be an exception, but as we tried to find data for this look at failure rates, it appears that maybe it's not so uncommon.

If you're a conspiracy theorist, you'll enjoy the explanation that current restaurant owners promote the myth of excessive restaurant failure rates as a way to discourage prospective competitors. Based on the number of new restaurant licenses issued across the nation each year, this theory is a hoax, or startup restaurateurs don't frighten easily.

Fact-Finding Mission

Precise restaurant startup failure rate statistics don't seem to exist. We find that astonishing, given the size and economic importance of the industry. Surfing the Web sites of several respected restaurant business organizations, including the National Restaurant Association (NRA), were fruitless, as was a telephone call to the NRA research department: "We don't track restaurant failures but you might try Dunn & Bradstreet" said a friendly voice at the association. So we took that advice, but the person in charge of D&B's restaurant database was of little help: "No, we don't track that kind of data," he said. So we thought, perhaps the banking associations have some figures or insights, or maybe the local restaurant associations know something about their local regions. Nothing.

Several years ago, researchers at Cornell University and Michigan State University conducted a study of restaurants in three local markets over a 10-year period. They concluded the following: After the first year 27% of restaurant startups failed; after three years, 50% of those restaurants were no longer in business; and after five years 60% had gone south. At the end of 10 years, 70% of the restaurants that had opened for business a decade before had failed. Those are far different numbers than a 90% failure rate after the first year quoted by our television star chef. Another academic research study concluded that 81.4% of all small business failures result from forces within the control of the owners/managers. The bottom line is that even if the failure rate is a little daunting, failure is not inevitable.

Common Sense Applied

The other research studies on business failure rates seemed too general to apply specifically to the restaurant biz. And besides, they were pretty dated. So we plugged these assumptions into a spreadsheet to see if the resulting curve makes sense. First, it required making some common-sense assumptions about attrition factors:

  • We know that every business, including the restaurant business, has some level of normal attrition. People die, retire, move or simply get tired of what they're doing and go onto something else. They sell their business or simply close it down. It's a fact of life and of business.
     
  • We also know that not every startup business is going to survive. In terms of restaurants, the location isn't right, the menu doesn't work, costs are out of control, volume just never developed, or some combination thereof. The problems spiral beyond the owners' control.

Now lets apply some numbers to these assumptions and test what would happen at different rates of attrition. We plugged in an accepted current number of restaurants. Using NRA statistics, there are 245,885 limited-service units and 224,560 full-service operations for a total of 470,445 restaurant locations. We know from reviewing nationwide municipal records that approximately 42,000 new restaurant business licenses are issued each year.

Let's first assume the normal attrition rate of existing restaurants is 5%. Applying this rate to our accepted current number of restaurants, and applying a 90% failure rate a la Rocco to known new business license holders simply decimates the restaurant industry. At the end of 10 years, using these percentage factors the size of the restaurant industry would be cut almost in half. On the other hand, if we apply a 27% new restaurant failure rate, based on the aforementioned academic study, a more realistic projection emerges. Using that scenario, the restaurant universe actually grows as new restaurateurs enter the market each year, replacing those that disappear because of natural attrition.

Failure and attrition is a fact of life in business. Painting an unrealistic picture of restaurant startups may build drama on television, but it does little to support the hopes and dreams of those wanting to enter and improve the restaurant landscape.

The next time the subject comes up in an elevator, on the street, or at a party about the 90% new restaurant failure rate, do us a favor. Ask the speakers where they got their information. We'll wager that the answer will have as much basis as the premise that the Earth is flat.


Ohio State University Researchers Weigh In On the Restaurant Failure Rate Myth

In September of last year, the online Dayton Business Journal reported that Ohio State University researchers debunked "the common business wisdom that restaurants fail at 90 percent to 95 percent in the first year." According to H.G. Parsa, associate professor of hospitality management at the university, a longitudinal study of restaurants indicated the failure rate for restaurants in Columbus, Ohio, was 57 percent to 61 percent for a three-year period from 1996 to 1999. The highest failure rate was noted during the first year, when about 26 percent of the restaurants failed. About 19 percent failed in the second year and 14 percent in the third year, according to the analysis.




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