5 Reasons Why Restaurants Fail

new entrepreneurs startup Jan 12, 2021
Business and Entrepreneurship Blog

Restaurants have extremely thin profit margins...between 3%-8% (depending on whether it's full-service, fast casual or catering). With these tiny profit margins, it's no wonder why 60% of restaurants don't make it past their first year and 80% don't make it to their fifth year.

We've all witnessed beloved restaurants in our neighborhood disappear overnight and have asked: "What happened? The food was so good, how could it have failed?"

Restaurants fail for a variety of reasons. A simple Google search will yield you countless articles on why restaurants fail. Rather than regurgitating what you can already find online, I'll leverage my experience as a previous owner of a business in the food, dining and events space. I'm going to highlight to you the 5 most important reasons why restaurants fail: 

Reason # 1: Ownership

Most people don't realize how difficult the lifestyle of a restaurant owner actually is. Most restaurant owners usually have to give up their nights and weekends. There are aspiring entreprenerus who think they can meet that challenge. At first, every new business owner is willing sacrifice…that is until they actually go through it for a few weeks or months and then realize they are not happy.

Additionally, hospitality owners need the "people person" gene! They have to be able to handle criticism or negative Yelp reviews, even when the complainer is blatantly lying or is at fault.

"Yeah…it sucks that the customer dropped penne vodka on their pants and stained it because they were using their hands to eat…but dammit…why did you have to make that pasta with so much sauce! Obviously it's your fault."

The most important flaw found in ownership is their management style. Owner's should ask themselves:

  1. Am I a culture creator or a task master?
  2. Am I present on-site, or am I you an absentee owner?
  3. Can I lead by example or will I sit on the sidelines while everyone else is working?
  4. Am I a "know-it-all" or am I open and willing to learn.

The answers to these questions will decide on employee loyalty, morale and turnover...which will also effect the bottom line.

 Reason # 2: Location

"Listen, I get it…you found a perfect location where rent was cheap, the infrastructure and equipment was already in place...and even though the last 5 restaurants there failed, you'll be the change maker...oh, and since it's in a vacant strip mall, you will be the sole tenant…so that means…no competition! Wait, what? There are no homes or businesses in a 5 mile radius? I wonder why no one is showing up?"

Obviously, don't set-up shop in a remote location where no-one will discover you. Additionally, it would be wise not to open in a a location with too much competition, that is unless what you offer is very different and you are able to afford the high rent in that area.

Reason # 3: Failing to Understand The Customer & Demand

Whatever the concept or cuisine is, make sure there is a desire for it. The worst thing an owner can do is assume that people want it and then are left without any sales...resulting in losing all their money and going belly up (pun intended).

The point is, take a lesson from Seinfeld and don't be like Babu Bhatt by opening a Pakistani restaurant in a neighborhood where no-one was asking for it.

Reason # 4: Poor Operations

There are a couple of areas to this question.

First, the business has terrible or no marketing at all, and that includes having zero social media presence. Marketing is key and social media is a necessity today!

Second, the business has bad staffing practices. Owners must hire good, honest workers. Additionally, the business should implement training for the staff. Without strong culture where employees feel they are not valued, the business operations are sure to fail. 

Third, owners should avoid being cheap in the beginning or they will be left to shell out more later on. This could be on renovation, furniture, equipment, maintenance, etc.

Fourth, owners should be mindful of their product pricing and product costs:

It's important for owners to understand their customers purchasing power. Many failing restaurants price their food too high, or too low.

When it comes to purchasing food and ingredients, owners need to have a pulse on the going price for all items entering their kitchen.

Tip: if the owner is not the Chef, make sure the Chef brought onboard knows the cost of food, the cost of ingredients and is on top of seasonal pricing fluctuation.

If overhead is not accurately managed, expenses will rise and profits will decline!

Reason # 5: Starting in a Financial Hole

When it comes to raising capital, most new restaurants owners use either institutional financing (bank loan or SBA loans) or friends and family.

Regardless of where the funds are raised, the biggest mistake I've seen too often is that owners do not account for potential lack of sales in the beginning. Owners should plan to have a 3 to 6 month lead of working capital. This means, if the cost to operate the restaurant is $5,000 per month, then the owner should have $15,000 to $30,000 on hand (working capital) to ensure the doors remain open. 

Owning a restaurant can be overwhelming and stressful…especially when dealing with:

  • Employee turnover
  • Food overhead
  • Equipment breakdowns
  • License and permitting requirements
  • Customer retention
  • Customer reviews
  • Tremendous competition
  • Razor thin margins

It's not easy to operate a restaurant and that's why it is said by many current and former hospitality entrepreneurs: "Only own a restaurant if you truly have a passion for it!"

I will also add: "Only own a restaurant if you have prior experience in the industry." If an owner brings food & operations experience to the table, then they should make sure to bring along a business & sales person (or vice versa).

Tip: Owner's should network with the local chamber of commerce and any other restaurant associations. Building relationships will drastically improve the bottom line.

Be warned, if Jon Taffer from Bar Rescue walks into your establishment, then you know you've messed up!

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