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What are the Primary Reasons for Business
Failure for New Independent Restaurants in the United States?
Richard
Wagner
October 7,
2007
Executive
Summary
The sign on
the door reads “CLOSED” and the parking lot is now empty on what is
normally a busy Saturday evening in front of your favorite local
restaurant. We’ve all probably witnessed this scenario and wondered why
that quaint cozy diner on the corner is now out of business. You wonder,
what went wrong? The food was good, not great, and the service was
reasonable, but somehow they just could not make it work. Practically
everyone has seen restaurants come and go and heard the rumors of why they
went out of business.
Independent
restaurants often operate in a competitive environment. Independents must
compete with franchise and corporate chain restaurants that usually offer
consistency in product and atmosphere, and dominate in the advertising
arena. Independent restaurants often attempt to differentiate themselves
and fill a certain niche by offering a unique dining experience based on
the type of food served and or the atmosphere. Independent restaurants are
also prone to failure.
Failure
studies are difficult to analyze in terms of the common traits of failure
due to limited research in the field and research that is based in
different geographic regions that have their own economic characteristics.
However, research may show some common themes which suggest that effective
management is critical for success
In this
paper I will explore the primary reasons for business failure for new
independent restaurants in the United States. By studying restaurant
failure, the reader can gain a better understanding of successful
practices in the industry.
Failure is
hard to define since it is more of a qualitative term. Researchers Haswell
and Holmes encountered difficulty in defining failure in all of the
literature on restaurant failure that they reviewed (1989). Gaskill
asserted that previous studious of small business failure had resulted in
“fragmented” findings due to the “quality and variety of factors
identified” (1993). A restaurant can cease to exist through closing or
selling it to another owner and researchers have used varying methods to
define failure. However, “failure” in this paper refers to those
independent restaurant operators that ceased operations.
Independent
restaurants have a high failure rate. According to Parsa, Self, Njite and
King, in a 2005 study of discontinued restaurants in Columbus Ohio, the
three-year failure rate was approximately 61%. In a 1996 study of
restaurant attrition in El Paso, Texas by English, Josiam, Upchurch and
Willems, the four-year failure rate was approximately 67%. Parsa et al.
also reported that independent restaurants have a higher failure rate than
the corporate chains restaurants do (62% vs. 57%), and they indicated that
this can be attributed to a lack of financial support and marketing
resources to compete with the chains.
It is often
difficult for an independent restaurant to break into a crowded and
established market. This can be especially true when that market is
dominated by franchises and corporate restaurant chains. Also, just the
fact that a restaurant is new may be an initial obstacle for success.
(Romanelli,1989). Romanelli found that “the liability of newness indicate
that younger firms tend to fail in greater numbers than older firms, given
the same environmental conditions”.
There has
not been a wealth of research conducted on restaurant failure to date. It
is relatively easy to quantify the number of failures, but the qualitative
reasons for failure can provide insight in order to improve success. It
should also be noted that it can be difficult to
collect data on restaurants that are sold or cease to exist since the
owners may not be available to survey why they left the business.
There are
numerous factors both internal and external that may contribute to new
independent restaurant failure. Internally, it most always starts with the
owner. Daniel Lee, a notable stock analyst in the restaurant sector,
boiled it down to ineffective management (1987). Bad management can lead
to a number of problems such as ineffective business strategy, financial
and business planning, human resource management, marketing, or a
combination of all these factors. External factors that can negatively
impact the operations include government regulations, economic conditions,
changes in the economy, local business climate, or the competitive
business environment. While these external factors are important and can
greatly affect the success of the business, this paper will address
internal factors that can be controlled by management. Gaskill noted that
business failure is often characterized by reactionary managers, who can
not plan or makes decisions effectively (1993).
Successful
restaurants almost always start with good food. However, the location,
atmosphere, and service levels are other critical components that often
define these operations. A restaurant can have outstanding food, but it
can fail in the areas of service and atmosphere. The atmosphere is also
critical and includes the cleanliness of the operation. The concept must
take all aspects of the operation into consideration. Additionally, an
analysis of the competitive environment is important and the ability to
differentiate a restaurant from a crowded field is critical.
As part of
a differentiation strategy, the sound business concept should be
developed. In one qualitative study by Parsa et al., it was found that the
failed restaurant owners did not fully develop a
concept of the restaurant further than the type of food that was served
(2005). Parsa et al. also noted that the owner may have good management
experience, a sound business plan and the financial resources to be
successful, but they did not fully develop the total concept.
The dining
out experience is much more than the food that is served. It encompasses
everything the customer experiences from the atmosphere to the
friendliness and attentiveness of the employees. A potential entrepreneur,
who may be a talented chef, may decide to enter the business based only on
their cooking skills. The owner may not have the expertise to fully
develop the concept of the complete dining experience, taking into
consideration financial factors, service and atmosphere. It is usually
more than just good food that brings back the repeat customers that are
critical for success.
In addition
to developing a concept, another reason for failure is attributed to
financial factors. English et al., found that the average initial
investment of franchise restaurants was seven times that of independents
and for corporate chains, it was 12 times independent restaurant
investment (1996). If the financial entry barrier entry is low,
prospective owners may feel that success is fairly easy to attain. As
English observed, “ease of entry is associated with ease of acquiring
small business loans, tax incentives and enticements by local governing
bodies” Owners/managers of independent restaurants often have varying
levels of experience and expertise when they get into the business. It
follows that those with business backgrounds are likely to achieve higher
levels of success.
Failure to
adequately estimate cash flow can certainly contribute to failure. Owners
may not plan for unforeseen emergencies such as replacing equipment or
addressing damage that may occur as a result of faulty equipment or
weather. The amount of inventory investment or projected cost of goods
sold can also be underestimated. Oftentimes owners are not realistic about
their total financial requirements or they have inadequate accounting and
internal controls. In addition
to not having a sound concept or effective financial planning, ineffective
or nonexistent marketing may not create adequate demand. Lee noted that
advertising expense is a common entry barrier in order to effectively
compete against the chain restaurants (1987). The independents have to
compete against the chains national and local advertising strategies. In a
study of restaurant failure in El Paso, Texas, English et al found that
“ineffective financial controls; and marketing strategies” emerged as
reasons for restaurant failure (1996).
Many times,
the independents rely only on word of mouth advertising. While this is
important and personal marketing can certainly help to make a restaurant
successful, it usually takes time to realize a payback on advertising
expenditures. Owners often do not allocate enough money for advertising
when they first open their business. Owners sometimes expect an immediate
return on their advertising investment, and they may not understand that
it usually takes time to realize the return on their marketing
expenditures.
Parsa et
al. noted in a qualitative study that another significant reason for
failure was that the owner did not properly anticipate the amount of time
and effort that goes into operating a restaurant. The owner has a
difficult time balancing their family life cycle with the business cycle
(2005). It may have been because their family life suffered, or they just
worked so much that they burned out. The demands of operating a successful
restaurant are high. In that same survey, Parsa et al. found
that many managers could not find that proper balance and cited family
demands as a reason to get out of the business. All of the successful
operators in that survey were either not married or they established a
life/work balance that enabled them to be successful (2005).
There are
many lessons to learn from these studies and efforts should be made to
increase research in this area and make that information more readily
available. Potential entrants into the industry are wise to learn from
other’s mistakes in order to plan more effectively and also understand the
time requirements that are necessary for success. The responsibility of
operating a successful restaurant requires a significant commitment.
Advance business and financial planning and effective marketing, in
addition to developing a sound concept will go along way towards ensuring
a successful business. The goal of studying failure is to better
understand the underlying reasons for success.
References
English, W., (1996).
Restaurant attrition: a longitudinal analysis of restaurant failures.
International Journal of Contemporary Hospitality Management 8(2),
17-20, Retrieved October 1, 2007 from
http://ezproxy.umuc. edu/login?url=http://search.ebscohost. com/login.
aspx?direct=true&db=buh&AN=4970317&site=ehost-live&scope=site
Gaskill, L. R., Van
Auken, H. E., & Manning, R. A. (1993). A factor analytic study of the
perceived causes of small business failure. Journal of Small Business
Management, 31(4), 18-31, Retrieved October 3, 2007 from
http://ezproxy.umuc.edu/login?url= http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9410211520&site=ehost-live&scope=site
Haswell, S., &
Holmes, S., (1989) Estimating the small business failure rate: a
reappraisal. Journal of Small Business Management, 27(3),
68-74, Retrieved October 6, 2007 from
http://ezproxy.umuc.edu/login?url=http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=5266805&site=ehost-live&scope=site
Lee, D. (1987).
Why
some succeed where others
fail. Cornell Hotel & Restaurant
Administration Quarterly, 28(3), 32,
Retrieved October 1, 2007 from http://ezproxy.umuc.edu/login
?url=http://search.ebscohost.com/login.aspx?direct =true&db=buh&AN=7156558&site=ehost-live&scope=site
Parsa, H.G., Self,
J. T., Njite, D., & King, T. (2005). Why restaurants fail. Cornell
Hotel & Restaurant Administration Quarterly, 46(3), 304-322,
Retrieved September 26, 2007 from
http://ezproxy.umuc.edu/login?url=http://search.ebscohost.com/login.
aspx?direct=true&db=buh&AN=20385702&site=ehost-live&scope=site
Romanelli, E. (1996). Environments and strategies
of organization start-up: effects on early survival. Administrative
Science Quarterly, (34)3, 369-87,
Retrieved October 1, 2007 from http://ezproxy.umuc.edu/login?url=http://search.ebscohost.com/login.aspx
?direct=true&db=buh&AN=4014515&site=ehost-live&scope=site
Bibliography
Miller, K. (April
16, 2007). The restaurant failure myth. Business Week Online, 19,
Retrieved October 1, 2007 from http://www.businessweek.com/smallbiz/content/apr2007/s
b20070416_296932.htm
Sanson, M. (2003)
The 90%
Restaurant
First-Year Failure
Rate is a
Myth. Restaurant Hospitality, 87(11),
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2007 from http://ezproxy.umuc.edu/login?url
=http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=11979334&site=ehost-live&scope=site
Sull, D., (1999) Why good companies go bad!
Harvard Business Review, 77(4), 42-52.
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/login.aspx?direct=true&db=buh&AN=1980078&site=ehost-live&scope=site
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