While restaurants may not have the highest failure rate of any industry, they are certainly up there. Depending on timing — before, during or after a major economic downturn — and a number of other variables, experts peg restaurant failure rates at somewhere between 17% and 90% within the first year.
Inexperienced owners with limited capital tend to have very high early failure rates, whereas deep-pocketed restaurant management groups with multi-skilled management, marketing and operations support tend to last a lot longer. Most experts seem to agree the failure rate exceeds 50% within the first three years.
Since almost everything that can go wrong with a restaurant eventually does, we consider a wide range of factors whenever we do a feasibility study. Here is a representative list:
First and foremost, do the owners have enough money to open the restaurant and then get through the first few years? Many times, we find the answer is NO.
A few years ago we helped a serial entrepreneur with over twenty years of restaurant management experience develop his business plan. He wanted to open a seafood restaurant on the west side of Chicago. Our only real concern was money.
He had done a terrific job of lowering his buildout and equipment expenses, but he had very little capital reserve after all the startup expenses were paid off.
The opening went well, but the restaurant soon received a substantial number of negative online reviews about customer service (slow, rude), pricing (too high), portions (too small), time to get the check (too long) over the next few months.
Management systematically addressed all of these issues and reviews began to improve. But when a string of cold winter weather and heavy snowstorms hit, revenues dropped again.
If they had started with a larger cash reserve, the restaurant might have survived for many years. But without that reserve, and no available credit (since the founder refused to deal with banks), the restaurant closed for good within a year after it opened.
Who is going to manage the back of the house? Who is going to manage the front of the house? Do these people have relevant —and current — experience? Is the size of the management team proportional to the scale of the business?
A small restaurant can get by with one person managing the entire business. But that doesn’t work for larger restaurants. Where does your restaurant sit on this scale?
One of my favorite “Frasier” episodes is when Frasier and his brother, Niles, decide to open a fancy restaurant. They hire one of the best chefs in the city, and they co-manage the restaurant.
But Frasier and Niles micro-manage everything, including the chef, and contradict each other’s directives at every turn. They can’t even decide how to manage the kitchen door, so staff crash into each other constantly. Everything goes wrong on opening night, resulting in chaos, and the restaurant shuts down the next day.
Many restaurant entrepreneurs underestimate how many staff they will need, how much they will need to pay (in wages, taxes, and benefits), and how many hours they will work.
Understaffing leads to poor customer service, which leads to bad reviews, which leads to decreased revenue, which leads to failure. Similarly, underpaying your workers usually translates into low-quality service and no loyalty, which means your staff could all walk out when you need them the most.
Do you have an operations plan? Who will set standards for customer service, menu design, marketing, sales, cleaning, cooking, etc.? How will you communicate these standards and make sure staff are following them?
Beyond the operations plan, you’ll need an employee manual which sets out a myriad of customer service and operational details. Opening a restaurant without at least a minimal operations manual is a recipe for disaster.
5. Design and Buildout
Is the restaurant design consistent with the theme of the restaurant and with the demographics of the local area? Is the amount and level of buildout enough, or too much? Do the architects, designers and contractors have the right experience, and are their costs within reason?
These are subjective questions, but they are worth examining. We’ve seen both extremes: over-investment in design and buildout in some cases, and cutting corners everywhere in other cases. Finding the right balance is tricky.
In the case of the seafood restaurant, the restaurant design and buildout were of very high quality, and the associated expenses were well under control. But the restaurant still failed.
Is there enough equipment? Is it the right equipment (both in terms of quality and function)? Many first-time restaurant owners over-invest by insisting on buying new kitchen equipment, when they could save tens or even hundreds of thousands of dollars on gently used equipment.
We usually recommend scaling back on equipment in favor of cash reserves. Once you are operating, it’s easy to add more equipment, or upgrade your existing equipment if things are going well.
7. Furniture and Decorations
Does the furniture match the restaurant style? Is it comfortable? Is it reasonably priced? What about decorations? Do they match with everything else, or are they an unnecessary distraction? By themselves, mismatched or uncomfortable furniture and decorations probably won’t cause a restaurant to fail, but they can be contributing factors.
Many entrepreneurs get hung up on competing with the large cash-rich franchises and chains. They overspend on extras and then fall short when it comes to necessities.
What is the local area like? Is it a high crime area? Is there adequate parking nearby? Are there other high quality or high traffic venues or attractions nearby that will bring people to your restaurant, or will you have to spend a fortune on marketing and outreach so people will find out about you?
The right location is critical to success and the wrong one usually leads to failure. In large, dense urban areas like Chicago, just being on the right (or wrong) side of the street can make a huge difference. In rural or suburban areas, adequate parking and easy on-and-off access to a highway can make a huge difference.
9. Demand, Demographics and Competition
Is there sufficient demand for your new restaurant? How many direct and indirect competitors are nearby? What are the local demographics? What sort of clientele is most likely to want to come to your restaurant? Just looking at population counts isn’t enough; you have to make sure your restaurant is a good fit for the local population.
And it isn’t always obvious what will work and what won’t. For example, a high-end French restaurant in a low-income neighborhood that’s considered a food desert will probably never make it. But a family style restaurant with good quality yet simple fare, large portions, great service, and moderate prices could be a huge success.
We often use surveys, interviews, and/or focus groups to decide whether or not a certain type of restaurant will be in high demand. In other cases, someone else has already done most of the research, and we only need to compile the results and analyze them.
10. Menu and Pricing
Does your menu make sense? Can people understand it without studying it for 15 minutes? Do you have too many selections, too few, or somewhere in between? Are your prices within reach of the local populace? Can you make a profit based on the prices you plan to charge? Will you offer liquor? If so, what types and brands?
Designing a menu is not as easy as one might think. Franchises and national brands spend hundreds of thousands of dollars on menu testing and design.
Fortunately, you don’t need to spend anywhere near that kind of money, but you still have to put some thought into it. Most successful restaurants have a few signature items they are known for — Whoppers and Big Macs are obvious examples.
I stayed at an eco-lodge in Costa Rica several years ago, and their signature dish was a “molten chocolate torte” (pretty appropriate since they were near a volcano). I have probably tried a thousand different chocolate desserts in my life, and this was — hands down — the best I have ever had. Someday I hope to return to that lodge, and I hope they still have that same dessert.
What will your signature dish (drink, dessert, appetizer) be?
Another common problem is pricing. We recently worked with a high-end steakhouse that served a large slice of chocolate layer cake. People loved it and the restaurant had begun to develop a reputation partly based on the cake.
But it was enormous, probably close to 1,000 calories, and the price was relatively high for the area, around $7.00. Despite the fact the cake was delicious and people enjoyed it, they did not sell very well. A simple change would have boosted sales and increased profits: cut the size of the slice in half and reduce the price by 35%.
11. Customer Service
Even if you get everything else right, if you don’t pay attention to customer service, your restaurant will probably fail. What are your plans when it comes to customer service? Just saying “We will have great customer service” doesn’t make it so.
The single best way to drive great customer service is to reduce the distance between feedback and response. Your servers are your single best source of real-time information, so you need to listen to them and empower them.
What else will you do to gather customer feedback? When you get positive or negative online reviews, what will you do with them?
The restaurant business, more than almost any other, is subject to fads and trends. These days, more and more people are looking for healthy, sustainable, local foods. Just ten years ago most “experts” dismissed this trend and insisted it would go away. Instead, the demand for healthy, sustainable, locally grown foods has increased dramatically.
As one food researcher put it, “people actually want to eat their veggies now.” The result is an explosion of “local,” “organic,” and “healthy” items on restaurant menus, along with a smaller, yet substantial backlash movement with huge portions, lots of meat, salt, fat and sugar.
Are there any social trends that could have a major impact on your restaurant over the next few years? Will your restaurant, benefit, suffer, or be immune to such trends?
13. Marketing and Branding
What’s your plan for marketing? It’s easy to throw money at marketing and advertising without getting a decent return on investment. Are you putting your marketing dollars into the right channels? Is your budget high enough? Is it too high?
Have you put any thought into building a brand? Branding can be very expensive, but if done well, it doesn’t have to be.
The main ingredient is consistency; your restaurant should say something, and all your marketing materials, menu items, events, signage and services should be consistent.
Unless you really know your way around marketing and branding, don’t wing it. Hire a professional firm and listen to them.
Do you actually have a plan, or did you just modify a template with the name, location and a few other words replaced? Are your financial projections reasonable, current, and conservative, or are they internally inconsistent and wildly unrealistic?
We often see financial projections with optimistic revenues and ridiculously low expenses. They look great on paper, but they rarely perform as well in real life.
The steakhouse we mentioned earlier projected revenue of $3 million in their first year, but came in at closer to $2 million. The restaurant had a smart management team, a talented chef, and was well funded. A top-notch consulting firm (not Ground Floor Partners) developed their financial projections, yet they still missed their target by roughly 30%.
If they hadn’t been so well capitalized at the beginning, they would have failed before the first year was out.
15. Risk Management
Do you have a good business attorney with restaurant/food experience? Do you have adequate business insurance (to cover accidents, unemployment, fire, water damage, lawsuits, etc.)? Do you have a backup plan in case your most important supplier goes out of business or can’t deliver due to extreme weather or some other catastrophe?
It’s the Economy, Stupid
While most politicians and restaurant industry pundits praise the rapid growth of the restaurant industry over the past decade, there is reason to believe the industry has entered bubble territory. The share of the American food budget going toward restaurants doubled from 25% in the 1960s to 50% in 2016, and restaurant jobs have grown much faster than the population since 2012.
When the economy slows down again, large numbers of restaurants could go under, plunging more workers into unemployment, leading to even more restaurant closings, leading to more unemployment.
Most restaurants have pretty lean profit margins, so they depend on banks for working capital. Yet, in 2008, when the Great Recession began, banks started calling business loans even when business owners were paying on time. They were particularly tough on small businesses, so many restaurants were hit hard. The same thing could happen again.
The bottom line is that restaurants are tough. They have a high failure rate because almost everything can go wrong, and eventually, it probably will. All the money in the world can’t guarantee success in the restaurant business, but it certainly won’t hurt.
Before you open your restaurant, think it all through as best you can. And start with more money than you think you’re going to need, because you’re probably going to need it.
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- Recession Proof Your Business - February 9, 2019
- Interview with David Johnson - January 7, 2019
- Sell Your Business For More - December 5, 2018