Why Restaurants Fail

Editor's note: In February 2004, we challenged the 90 percent first-year restaurant failure rate that was being passed off as "common knowledge" inside and outside the industry. We conducted our own research, which suggested that the first-year failure rate was closer to 25 percent. Not great, but not much different from 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. Parsa's landmark study, which was published in Cornell Quarterly (please follow this link to view the study in its entirety), 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 Parsa about the study, its "back story," and what he's learned since.

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.

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 percent of restaurants fail in their first year," says Parsa, a professor at the Rosen College of Hospitality Management at the University of Central Florida in Orlando. "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 [who, in a commercial that accompanied the show], said that 90 percent 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, and as you can expect I didn't get any answer. Instead, I got shifted around."

Finally, after two months of dogged pursuit, Parsa reached American Express' vice president of media communications in New York. "I asked him, 'Look, you said this -- 90 percent of restaurants fail in the first year -- but where did you get the data from?'" Parsa found that the 90-percent failure rate statistic had become widely accepted, even though there was no data to support it. In other words, it was a myth, and many people and businesses inside and outside the restaurant industry -- even large and sophisticated corporations -- were quoting it.

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 Ph.D. in marketing at Virginia Tech, then taught at SUNY Buffalo for seven years. While serving on the board of the Ohio Restaurant Association, he 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.

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 among restaurants in Columbus, Ohio, and Buffalo, New York. "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, Georgia, in 2006 and 2007 helped to solidify the findings.

Why Restaurants Fail

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 -- 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, No. 1. No. 2, 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 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. 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-written by John T. Self, David Njite and Tiffany King), Parsa wrote 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 said 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 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."

Parsa refers to the well-known story of Wendy's founder Dave Thomas, whose daughter Melinda Lou (Wendy) 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," 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."

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 goes 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 current Iraq war. "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 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. 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,'" Parsa says. "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."

Time. Another potential Sword of Damocles 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 10-15 years.

"I did research on this," he says. "In the 19th century the No. 1 food item in America was steak. By the turn of the century, 1920, 1930, the No. 1 menu item was the hot dog." By 1947-1955, he says, the hot dog was replaced by the hamburger. By 1980 it was pizza. "I told my students, 'Watch out -- by 2020 or 2030 pizza will be replaced by something else, takeout salad or whatever it may be. We don't know." But the conclusion remains: With the passage of time American food habits change dramatically. "Our parents never taught us about eating a burrito for breakfast, but people do now," he says.

Nor does the passing of time affect only taste trends. As decades go by, Parsa says, "a restaurant's décor gets old. Diners experience the same ambience forever so they want to change. If somebody down the street has a better ambience, they go there."

People choose to dine in a given restaurant for three things, Parsa says. "The food, the ambience and the service." But every 10 years one of the three gets old. "Service changes. Habits change. Technology changes. Guess what: People start looking for other things to do. By then you're too late."

Parsa says updating product is 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."

The Right Dream

Parsa says 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 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."

About H.G. Parsa

H.G. Parsa, Ph.D., FMP, is the chairman of the Foodservice and Lodging Management Department, Rosen College of Hospitality Management, University of Central Florida. He holds a Ph.D., MS, MS, and a Food Management Professional (FMP) diploma. He is the honorable editor in chief of Journal of Foodservice Business Research.

In 2005-06, he received a Fulbright Visiting Scholar Fellowship to evaluate hospitality education in India, and recommend to the Central Government of India ways of enhancing the quality of graduate education in hospitality management. He has published/presented more than 125 research papers in business and hospitality journals. He serves on the editorial boards of several academic journals and serves as a frequent reviewer for national conferences including Association for Consumer Research and American Marketing Association. His research has appeared in journals such as Cornell Hospitality Quarterly, Journal of Business Research, Journal of Hospitality and Tourism Research; Journal of Hospitality and Tourism Education, Journal of Restaurant and Foodservice Marketing, Journal of Quality Assurance in Hospitality and Tourism, Journal of College and University Foodservice, and proceedings of the national conference of International Society of Franchising. He has presented papers nationally and internationally including in Canada, Australia, India and China.

Parsa's research was quoted in the national press including Channel 6 (CBS affiliate, Orlando,) The Wall Street Journal, Fortune, NPR, PBS television, BusinessWeek, Chicago Tribune, USA Today and more than 30 regional newspapers. He has extensive consulting experience in the foodservice industry. His clients include independent restaurateurs and chains such as McDonald's Corp. and White Castle Inc. He is a member of the Association for Consumer Research; Council on Hotel, Restaurant and Institutional Education; and the Society for Consumer Psychology. He received the Bradford Wiley Memorial Best Paper Award at the International CHRIE (2001, 2006), and the Best Paper award at the Euro-CHRIE (2005), John Wiley Teaching Innovation Award. Earlier he received the President's Award for Excellence in Research and Creativity presented by the State University of New York -- Buffalo College (SUNY Buffalo). In addition, he won several Best Paper Awards at various national and international conferences.

Case in Point:

Figlio's: Redefining Success

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

"It's open six days a week, but only for dinner," Parsa says. "He very, very carefully has made sure he has quality of life. Everybody asks, 'Hey Peter, why don't you open it for 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 be there; he wouldn't ever go home."

It gets better: Figlio 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 says. "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 workweek.

Danis, Parsa says, "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."