What Are Five Factors Which Contribute to the Failure of New Restauran

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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...
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