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The Anatomy of Restaurant Failure: Dead Man Walking

  • Most restaurants fail quickly, and the seeds of their failure are planted before the restaurant even opens.
  • Due to both personal and external factors, even successful restaurants almost always eventually close.
  • Restaurants are essentially dead men walking, and their initial planning phase should anticipate their eventual demise.

 

The Nature of Restaurants

By their nature, most restaurants have a limited life. An astonishing 60% go out of business within three years of opening, largely due to fundamental flaws in the planning of the operation. But even restaurants that experience years of success almost always face eventual closure. The restaurant business is very hard, and because of both personal factors and external factors beyond anyone’s control, restaurants don’t last forever.

These factors help to explain why the average life of a restaurant is only 8 to 10 years, and they teach us that the planning of a restaurant should contemplate postponing the inevitable and at the same time anticipate its eventual demise. Whether we call the ending a failure or not is a matter of semantics. What matters is whether the closing of the operation is a decision that the owner/investors make on their own terms.

I. Why Most Restaurants Fail Quickly

Various studies estimate that among the 60% of operations that fail within the first three years, 44% failed the first year, 33% within the second year, and 23% in the third year. The causes behind these failures are numerous, and entrepreneurs and investors must realize that many of them are firmly in place even before a restaurant first opens its doors to customers.

Concept Development: Clarity

Success is heavily dependent on the strength of a restaurant’s concept development and the planning of its execution. Unfortunately, most restaurateurs confuse concept with menu.

A restaurant concept is not a menu and a set of recipes. Rather, it encompasses a location, a marketing plan, a service scheme, design, atmosphere, price point, a defined position in relationship to the competition, and almost as important as the food itself, a long-term strategy.

There are two basic strategic choices: You are either the first one to come up with an idea, or the idea is already out there and you plan to execute it better. Being unique is great, but it’s rare. And in our business, a unique idea is rapidly duplicated. Being second, on the other hand, may not be as glamorous, but if done well it can be very lucrative. Think McDonald’s and Apple versus White Castle and Microsoft, respectively. The first two companies in that list have been immensely successful with that second strategy. However, in most markets doing it better than the competition implies that guests will be poached from competitors, and to “steal” these customers you need both a solid concept and superb execution.

A winning concept should be distilled to its very essence and defined in a simple, clear, concise, and highly communicable sentence.

Example: Expression of a concept
West Side Story by Leonard Bernstein – It’s Romeo and Juliet, in plain English, among gangs, in New York City, with music.

This crisp sentence encapsulates the core of the concept, and communicates to the guests, investors, and employees a clear picture of what you’re trying to achieve. It’s a road map for branding and image. If the concept is ambiguous, guests will be confused and employees will develop their own version of the concept. This, in turn, will lead to conflicting initiatives and confusing messages.

What Do You Want to Achieve? Strategy for Survival

What do you want to achieve? When asked this question, most operators explain earnestly that first and foremost they want to open the restaurant. Most of them have trouble thinking of what comes after opening day, and they’re consumed by the immediacy of the tasks at hand (signing the lease or purchasing the building, ordering the equipment, doing the renovation, putting the menu together, etc.). Opening the restaurant becomes the strategic goal, and they fail to anticipate obstacles or put in place the necessary strategy and operational elements for long-term survival.

Success requires strategizing beyond the opening and establishing benchmarks that will strengthen the operation and be used to measure progress. Success also envisages an exit strategy. The operational and exit strategies not only guide the research and planning, but also lead to modifications and refinement of the original concept. They represent the difference between wishful thinking and flawless execution.

Strategies can be very diverse, but consider the following: Do you plan on having one unit or multiple units? Do you want to develop an idea that could later be franchised? Do you plan to grow the concept, sell it, and retire on the proceeds? Are you in this for the money or the glory? Do you have a specific ROI in mind? Do you want to be the first or do you want to be the best? Do you want to own a restaurant because it would be cool to entertain friends or sit at the bar? If so, who is going to actually run the restaurant?  Are you going to be an operator or an absentee owner? If an absentee owner, who will you trust to run your establishment, and what measures should be put in place to ensure that profit will not be dissipated or siphoned off before reaching your pocket? For how long do you anticipate doing this? Should you have a partner, and if so, what skills must that person have?

Thorough research and strategic soul searching improve planning, sharpen the concept, and fine-tune operational elements to improve chances of success. 

Due Diligence: Market and Location

A strong concept starts with thorough and unbiased research on the size of the market and the general economic condition of the neighborhood. Next comes a thorough analysis of the competition: direct and indirect, their price points, their strengths and weaknesses (the latter of which may present a competitive advantage for you). I emphasize thorough research because many operators frequently make two mistakes: their understanding of the competition is limited and their market analysis is shallow.

Example: Limited understanding of the competition
“Restaurant XYZ does over $6 million in business, but their food is not very good.” If a restaurant is doing over $6 million in business, management is doing something well. Six million dollars is nothing to sneeze at. Find out what the business does well and why it appeals to guests.

Example: Shallow market analysis
“There are no restaurants/good restaurants in this neighborhood. This is an untapped market.” Too often the reason for this scenario is that the neighborhood simply won’t support the restaurants. And another pitfall to watch for: when multiple restaurants have occupied the considered location and all have failed, chances are that something is wrong with the location. A similar argument applies to neighborhoods.

While there isn’t enough room to walk you through a complete market/location analysis, I will point out a few key items of which you should be aware.

Could zoning laws or restrictions interfere with the business and its expansion? Is parking adequate? Is the parking area you’re relying on an empty lot that might be redeveloped in the future? Is there an urban renewal plan that may impact your establishment in subsequent years? Is the neighborhood deteriorating or on the upswing? While a neighborhood on the upswing is a good sign, it may paradoxically lead to the demise of the restaurant. Property values are likely to increase, thus raising real estate taxes and forcing the landlord to increase rent to a level that may no longer be compatible with your concept and price point.

Now consider the build-out cost, and take great care not to underestimate it. If the restaurant is already built, does the equipment allow you to cook your menu efficiently? If you need to retrofit the establishment, consult with architects and designers who have experience with restaurants and can provide reasonably accurate cost estimates. On many occasions we’ve seen construction costs outstrip the established budget, forcing operators to dip into the cash reserve set aside for working capital. This often leads to dire consequences down the road.

Due Diligence: The Menu

A good menu is a balancing act between too many versus too few items, high-priced versus low-priced items, a broad selection of diverse items versus a limited selection based on a specific theme, and trendy versus classic. There are no hard rules as to what works and what does not work – I’ve seen menus that were very successful in New York City fail miserably in Chicago. What really matters is whether the menu fills a need in the market or presents a significant advantage over the competition. Above all, be pragmatic and avoid the “Purity Syndrome.”

Example: Purity Syndrome
The chef deems an item unworthy because it’s too pedestrian and not fashionable enough. He does not put it on the menu. Alternatively, the chef places a terrific item on the menu that may not appeal to your core market because it’s too exotic. In both cases the offerings do not match client expectations.

While there are no hard rules for successful menus, there are five common types of menu mistakes:

1. Schizophrenic: A little bit of this, a little bit of that, with nothing to tie it all together. The concept is diluted due to the false belief that an eclectic selection will attract more customers.

2. Too broad:  This creates unforeseen inventory and production problems, confuses guests, lengthens the ordering process, and leads to inconsistent quality and/or frequent menu-item outages.

3. Too narrow: This limits the menu’s potential to attract a larger customer base.

4. Very trendy: Food trends have a limited shelf life. When a trend goes out of fashion, customers tend to seek different restaurants that are perceived as more hip.

5. Too ambitious: Such a menu may be too complicated to appeal to the target market, it may be beyond the skill level of the cooks and the product availability in the area, and it makes it difficult to deliver consistent food quality.

At the same time, successful menus have several elements in common (see our article on menu engineering.)

1. They have signature items that will help establish reputation, provide PR opportunities, and expand the geographical market. A typical restaurant draws the majority of its clientele from a three- to four-mile radius, but a signature item may expand this radius and put the restaurant in the enviable position of being a destination restaurant.

2. The menu items have been tested several times with the goal of making them better or easier to produce, and these tests include comparisons to the competition. If an item is not better, the recipe must be improved or the item eliminated. Objectivity in this effort is essential.

3. Each menu item has a precise recipe and specs, which means that the portion size, garnish, and accompaniments are clearly defined. The precision of the recipe ensures long-term product quality and consistency.

4. The menu mix is monitored daily for changes in sales patterns, and items are introduced and/or removed regularly.

5. All menu items have been costed, and their pricing is based on what the market will bear and on the competitions’ pricing. If the item is priced above the competition, its quality must justify the price difference. A frequent mistake is to price an item to compete with immediate competitors regardless of portion size or the quality of the ingredients.

6. Menu items from all categories (drinks, appetizers, entrees, desserts, etc.) are priced to encourage the purchase of items in addition to an entree. If entrees are too pricey, guests may not be inclined to purchase a dessert or an appetizer. Note that alcohol, appetizers, and desserts present excellent opportunities for increased profitability because of their low food cost.

7. Above all, the pricing strategy must be consistent with the concept and conducive to the financial goals.

Due Diligence: Pro-forma Financial Statements — In God We Trust. For All Others, Show Us the Numbers

People tend to go into the restaurant business because of their love for food rather than their love of numbers. The bottom line is often an afterthought, and even when it isn’t, some operators rely on back-of-the-envelope projections that often lead to disastrous financial consequences.

The purpose of the pro-forma financial statements is to figure out the cost of opening the restaurant, prepare a sales forecast, create a yardstick with which to measure the operation’s progress, and arrive at an estimated bottom line. The pro-forma answers two questions: “Will the concept make enough money?” and “How fast can the investors be repaid?” If the answers to these questions are not acceptable, the concept must be modified or in some cases abandoned.

Regarding the issue of how fast investors can be repaid, we cannot stress enough the need to pay off debts as soon as possible. In the event of a recession, the drop in revenue can create a cash crunch that interferes with the debt repayment schedule, and the payments may mean the difference between positive and negative cash flow. Keep in mind that the average profit margin in the restaurant business is about 4%, so there’s not much room for error.

Unfortunately most operators lack the skill required to generate, objectively evaluate, and spot inconsistencies or erroneous assumptions in a set of financial statements. If they lack this skill, they must seek it out elsewhere. It may be a pricey investment, but it will significantly improve the chances for success and look like a bargain compared to the financial losses incurred when a restaurant fails. As for the expert, it’s important to ask for the advice of an investor, a consultant, or an accountant familiar with the Uniform System of Accounts for Restaurants (USAR), who can offer financial insights before the opening, and who can provide helpful information once the restaurant is open. Having or obtaining the proper expertise is critical, as we often see financial statements that offer little in the way of useful information that can improve the business.

Most pro-forma statements overstate sales, average check size, and seat turnover; they underestimate capital needs and working capital (cash reserve) amounts; and they overlook some expenses. Not surprisingly, this combination leads to severe cash flow difficulties as aggressive sales forecasts cause revenue shortfalls that cannot be covered by the insufficient cash reserve.

Examples: Unrealistic sales forecasts
• A frequent mistake is to overstate seat turnover and occupancy levels: Fridays and Saturdays are usually busy nights, but what happens on Tuesdays and Wednesdays?

• Another mistake is to assume that all customers are going to order a drink, an appetizer, an entree, and a dessert. This optimistic assumption leads to an average check projection that will never materialize.

Due Diligence: Systems and Procedures

Opening a restaurant is a project management exercise, and the objective is to be as error free as possible from the start. This is where systems and procedures come into play, as they let everyone know what’s expected of them and provide a benchmark for periodic performance checks. Unfortunately, most operators are too busy putting out fires and getting through the day to put the systems and procedures in place that will protect their business in the long run.

Prior to opening the restaurant, outline the timing, processes, and procedures that will ensure proper staffing, quality control, and consistency. Prepare a staffing plan (by days and by meals), write job descriptions, and outline training routines for both front- and back-of-the-house employees. Choose a person to interview candidates, specify the qualities you’re seeking in an applicant, and create an ideal-candidate profile. Prepare a thorough presentation of your concept so that you can effectively convey it to the employees, and consider how knowledge of the menu and salesmanship abilities will be assessed.

The procurement side of the business as well as the receiving and storing of merchandise is often ignored. For instance, in the absence of precise food specifications indicating grade and portion size, food purveyors may be inclined to substitute one product for another, and the person receiving the food may not be aware of the substitution or its impact. Another issue to consider is theft, which is a common problem in our industry. It’s easy to steal a small amount of food, and employees often justify theft by pointing to what they perceive as insufficient compensation. To mitigate the possibility of food theft, in cases where the ordering and receiving are not handled by the owner, it’s important to separate the ordering function from the receiving and the invoice payment.

Example: Receiving and checking
A daily purchase sheet or a purchase order that includes specs, price, and quantity must be provided to whoever receives and checks the food deliveries. The checker can confirm prices and quantities delivered, and the food must be physically examined for quality and weighed. Any discrepancy must be noted on the invoice and proper credit obtained.

Once the restaurant is open, the daily monitoring of sales patterns, guest satisfaction, employee productivity, inventory usage, cash, and other factors is essential to make certain that revenues flow to the bottom line.

Due Diligence: Marketing

While marketing tends to be a longer-term contributing factor in a restaurant’s failure, it can’t be ignored. Restaurants should have a marketing plan in place for the period prior to opening and after opening. Before opening, retain a web-development firm to design your website and a PR firm to produce stories for the local press and to manage the various social media outlets that have become so ubiquitous. It’s foolish to think that word of mouth will be sufficient in this day and age.

Consider the opening: Will there be a soft opening (not advertised), and if so, for how long? A grand opening may be best, but how will it be advertised? Also, consider a post-opening calendar of promotional events that you can base on food or alcohol promotions. Beyond this, other events and sponsorships must be designed to foster community relations, and they can be tied to community and civic events such as the town centennial, the Fourth of July, and other occasions.

Don’t be fooled by the early crowd coming to the restaurant. This is only half the battle. If you do not do a good job when guests first come in, they won’t come back; if you’re not consistent, they’ll leave; and if you don’t bond with your customers, they’ll connect somewhere else.

Due Diligence: Should You Hire a Professional? Can You Afford Not To?

Most people underestimate the complexity of the restaurant business. In a traditional business an individual retails a product that someone else manufactured. The restaurant business, on the other hand, requires that the manufacturing and distribution (service) elements of the business be under one roof, and these two functions presume various aptitudes that are rarely found in one individual. This is why the hiring of a professional consulting group makes sense. (Don’t worry about a conflict of interest here. I’m no longer in the consulting business and am a full-time academic.)

A professional can guide new owners through the planning process and serve as devil’s advocate in the vetting of concept and location and in the recommendation of basic management procedures. For restaurateurs with some experience in the business, I would recommend that they hire a consultant to address those elements of the business in which the restaurateur has limited experience. Consultants are not a guarantee of success, but provided that their advice is heeded, employing them will increase the chances of success and may enhance the ability to raise funds for the project. While the cost of the professional may appear steep at first, it will pale in comparison to the cost of a failed operation.

Can you afford not to hire a consultant?
• Cost of a consultant: $75 – $300 per hour (or project based)
• Cost of a restaurant failure: Much higher

I’ll stress that you should listen to the consultant’s recommendations. The use of consultants within the industry is not uncommon, but it’s common for clients to ignore their advice. As we’ll see in the next section, the ability to listen is not ubiquitous.


Due Diligence: Know Yourself (The 49% – 51% Rule)

John Buchanan, the president and founding partner of the Lettuce Consulting Group, has opened dozens of restaurants and hired hundreds of managers. He’s a great believer in Lettuce’s 49% – 51% rule, which refers to the mix of technical skills and emotional intelligence that an operator must possess. Technical skills can be acquired with proper training. Emotional intelligence, on the other hand, is difficult to teach because it involves personality traits, such as the practice of introspection, the inclination to seek other opinions, the ability to be flexible, the willingness to accept criticism, tenacity, and attention to detail. The best concepts are unlikely to be successful in the hands of somebody who lacks emotional intelligence, and unfortunately it is common to find such people in the industry.

The restaurant business is not static, and above all it requires leaving one’s ego at the door. Often operators are too emotionally invested in their own concept to accept the need for a different path, and the singular focus that allowed them to open the restaurant may also be the characteristic that leads to their downfall. Ironically, while hiring a business partner can possibly compensate for a lack of emotional intelligence, its absence can lead owners to choose the wrong partner.

Dead Man Walking

Unfortunately, many restaurants never get past the hurdles noted above, and the seeds of their demise are planted before they even open for business. Sales peter out after the initial opening as guests have not fallen in love with the establishment and differentiation from the competition has not been established through food or service quality. The tepid business leads to insufficient cash flow and a breakeven point that remains elusive, compelling the owner to sink more money into the business in the hopes of buying time.

The dire situation hinders management from engaging in employee development and community outreach, and worse, management is too arrogant to recognize mistakes and change course. Cost control is inadequate, food production inconsistent. “We had an off night” is heard often as an excuse, and as key employees jump ship, lapses in service become common. Management shifts to a reactive mode as it deals with constant crises and puts out figurative fires. The goal is no longer to improve the operation; it’s to get through the day.

II. How Successful Restaurants Extend Their Lifespan

For the minority of restaurants that make it past the initial years of operation, the work is far from over. The goal is now to make the customer fall in love and stay in love with the establishment.

Relentlessly Pursuing Perfection

To keep customers coming back requires a plan of seduction and continuous improvement. Operators must evaluate, adapt, correct, and elevate, and they must focus on food quality, service, and value. Good enough is not good enough. All the details that will make the guest experience memorable must be worked on and perfected. If you make a spectacular rack of lamb, how do you make sure that it’s made the same way every time it’s served? How do you make it even better, because surely someone is going to imitate your recipe?

Data collection is essential to fully understand the nature of your business. For instance, you must consider weekly sales patterns, repeat business (a number that’s frequently overestimated by operators), and menu and cost analysis. Regarding your menu: What works … and what doesn’t work? If a menu item does not sell, what’s the reason? Can the item be tweaked, or should something else be substituted? Is your menu too ambitious for your staff or clientele? Adding or eliminating a menu item takes a lot of confidence because all owners can think of a few customers who appreciate the item and we don’t want to lose these guests.

Standard operating procedures are critical, as the pursuit of perfection includes reducing costly errors so that you can take more of your revenues to the bottom line while solidifying guests’ loyalty. Accordingly, the training of employees through modeling, role-playing, and demonstrations must be continued and elevated, selling skills refined, and errors corrected.

While many operators fine-tune costs, the better ones understand that they can grow the bottom line more efficiently by growing sales. Community relations and customer loyalty are essential to this goal. You want your guests to come back to your establishment because they “had a good time.” You want to become an intricate part of the community you cater to.

The relentless pursuit of perfection establishes and reinforces a culture of excellence and adaptation that will serve you well in stretching out the life expectancy of the restaurant.

Balancing Change and Continuity

The French are fond of saying “The more things change the more they stay the same.” The rules of success are timeless: quality, value and service. Nonetheless, we must not overlook the element of style and evolving trends. While trends don’t last, they do have an impact on the market. Successful, long-lasting restaurants have been able to embrace new trends while remaining faithful to their strategy and core values. For instance, Shaw’s Crab House in Chicago, which started as a crab house/oyster bar, has successfully incorporated into its concept an ample sushi/sashimi selection. The owners have harnessed both innovation and continuity, which are the yin and yang of the modern consumer psyche.

Mature operations are, by definition, no longer as fresh or tempting as before, and their guests are vulnerable to the appeal of new restaurants. No customer is immune to that appeal. However, if you stay true to your mission while embracing the changing trends around you, these prodigal customers will come back to you, appreciating more than ever the intrinsic qualities of your establishment.

III. Why Most Successful Restaurants Eventually Fail or Close Voluntarily

Assume now that you have successfully survived the initial years and have been operating for four to six years with satisfactory profits. As noted earlier, the trick is to now preserve what you have and extend the life of the restaurant. Unfortunately, this is a tall order, and for a variety of reasons most restaurants that reach this stage eventually fail or close voluntarily.

Personal Factors

1. Burn-Out. The most common personal factor is burn-out. The restaurateur has worked very hard for many years. The long hours and constant demand on one’s time are starting to take their toll. In many cases restaurateurs start to weigh profits against the time commitment. They contemplate this trade-off and its impact on their personal life: the Little League games missed, the Christmases and other holidays spent away from home, and the stress on relationships that can lead to divorce. Under these circumstances, it’s difficult to preserve a culture of innovation and the energy necessary to implement needed changes.

In a sense, too much rested on one person’s shoulders, and there wasn’t enough depth at the top of the management hierarchy. The sacrifices are too great, and the thrill is gone. The restaurant is no longer profitable enough to justify the time commitment, and it’s not profitable enough to sell. The only logical outcome is to close the doors and liquidate.

During the initial planning stage, the operators did not consider the eventual need to bring in a partner to share the workload and contribute new ideas, nor did they anticipate the need for a succession plan.

2. Complacency.  The second most common personal factor is complacency. One of the most difficult things to do in business is to stay on top. The ability to add a spark to the concept, transform it, and sometimes reinvent it completely is a rare quality.

In this case the restaurateur is the victim of his or her own success and is no longer working hard at seducing the customer. Arrogance sets in, and luck in business is confused with talent. The novelty is now gone, and the operation has become routine. The restaurant may be facing some headwinds but they’re ignored. The restaurateur has a difficult time finding the motivation to adapt and elevate the concept. The restaurant is falling behind simply because the owner is standing still, leaving the establishment more vulnerable to the negative impact of external factors.

External Factors

In other cases, external circumstances precipitate the decision to close: a steep increase in rent prompted by neighborhood gentrification, the arrival of a worthy competitor, or an unforeseen change in the neighborhood. Battling with new competition may require updating or remodeling, and the owner isn’t willing to make the capital investment given the limited profitability of the operation. Also, a decline in the immediate physical surroundings can preclude any future investment, and that doesn’t bode well for future sales. In other cases, the concept no longer fits the changing neighborhood – a fact that the operator may have ignored.

Closing Thoughts

The ability to succeed in the long run necessitates thorough planning, clear vision, changes, and adaptation. It also requires both flexibility and humbleness, as owners are in charge – but only to a certain point – and early successes are no guarantee of future success. I found it remarkable that of the handful of restaurants that have been open for several decades, few are critically acclaimed. They seem to provide a satisfying product and excellent service day after day, year after year, and decade after decade, and they’re deeply anchored in their respective communities. At the risk of being an iconoclast, I suggest to aspiring chefs and restaurateurs that they study these establishments. Flexibility, a relentless pursuit of excellence in all stages from planning to testing to operating, and a deep connection with the community are often better assurance of long-term survival than critical acclaim.

September 2013

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About the author

Christine Letchinger received a B.A. in history in her native France before earning an M.B.A. from Southern Methodist University. She began her hospitality career by overhauling financially troubled operations and in 1988 began teaching at Chicago's Kendall College. Her teaching focus is on accounting, cost control, and finance, while her interests encompass feasibility studies, financial sustainability, and the reasons behind restaurant failure. She received the United Methodist Church's Exemplary Teacher Award in 1990 and the Kendall Outstanding Student Commitment Award in 2009. Until recently she served as Interim Dean of the Hospitality Management program at Kendall College.

Chris can be reached at Kendall College:

  • Email: chris.letchinger@kendall.edu
  • Phone: 312-752-2402