From 416 to 905 ...: The Restaurant-Failure Myth

The Restaurant-Failure Myth

Research shows that some popular perceptions about the rate of failure in the restaurant industry are just not true

By Kerry Miller

"Do you know me?" asked Rocco DiSpirito in a 2003 TV spot for American Express. "I'm a chef who already runs two restaurants in New York. Now I'm opening a third on national television in a time when nine out of 10 restaurants fail in the first year."

Like many viewers, H.G. Parsa did know DiSpirito from his NBC reality show The Restaurant. The nine-out-of-10 figure was familiar, too. As an associate professor in Ohio State University's Hospitality Management program, Parsa had heard it many times before. But based on his 13 years of restaurant-industry experience, he still didn't buy it.

Parsa says he spent three months trying to track down someone at American Express who could give him a source for the 90% figure quoted in the ad. As it turns out, they didn't have one. "American Express has not been able to track down a specific data source for the statistic," reads a written statement a spokesperson sent Parsa in response to his request.

Urban Mythbuster

Parsa wasn't surprised. He had run several spreadsheet simulations to verify the statistic himself and found that not only is the 90% figure off base, it's practically impossible, given industry growth rates. He decided to do his own research on failure rates, using Health Dept. records to track turnover among 2,500 restaurants in Columbus, Ohio, over a three-year period.

His research—consistent with similar studies—found that about one in four restaurants close or change ownership within their first year of business. Over three years, that number rises to three in five.

While a 60% failure rate may still sound high, that's on par with the cross-industry average for new businesses, according to statistics from the Small Business Administration and the Bureau of Labor Statistics.

Parsa's study garnered serious attention within the hospitality field: Within a year of the paper's publication in the Cornell Hotel & Restaurant Administration Quarterly in August, 2005, Parsa's research had been downloaded nearly 2,000 times, a record for the trade journal. But in the culture at large, the nine-out-of-10 myth has stubbornly defied debunking.

Wary Lenders

While it's certainly not the first urban legend to fly in the face of facts, Parsa holds the banking community largely responsible for perpetuating it. "They are the ones that benefit from the myth, and they use it more than anyone else," he explains, though he's quick to note that his opinion is based on logic, not research.

Because of the belief that restaurants are high-risk investments, he says, many banks won't lend to restaurants at all. Typically, the ones that do require would-be restaurateurs to pay sky-high interest rates or put up significant collateral (say, a house) to mitigate the perceived risk (see BusinessWeek.com, Winter, 2007, "Tapped Out"). Ironically, Parsa's research identified lack of sufficient startup capital as one of the major elements that contribute to a restaurant's failure—making the myth a self-fulfilling prophecy of sorts.

Of course, a lot of restaurants do open and close each year, because opening a restaurant has such low barriers to entry and exit. And because the figure seems true—after all, there's plenty of anecdotal evidence—statistics-quoting experts who don't cite their sources often go unchallenged. The media—BusinessWeek included—adds fuel to the fire (see BusinessWeek.com, 5/19/03, "Cooking Up a Global Empire"). And every "under-new-management" sign in a restaurant window acts as an independent confirmation, cementing the idea that restaurants are impossibly risky further into our collective memory, continuing the cycle.

Franchise Safety Is Overrated

And it doesn't end there. Research shows that a lot of the conventional wisdom about failure in the restaurant industry is similarly faulty.

One widely held belief is that franchise restaurants are much safer bets than independent restaurants. But Parsa found that the three-year success rate for franchised restaurants is actually only a few percentage points higher than it is for independents—about 43%. That's a far cry from the 90% or higher success rates trumpeted by many franchisors.

So far a cry, in fact, that the International Franchise Assn. decided it had to step in to clear things up. In 2005, the IFA issued a letter urging its members to remove from their Web sites or printed materials "any information claiming that the success rate of franchised establishments is much greater than that of independent small businesses," calling the information "potentially misleading."

The IFA specifically called out franchisors for using old Commerce Dept. data that has been shown to be invalid. But because changes in franchise ownership usually remain behind the scenes, Parsa says it's still easy to make franchises look like a much safer bet than they are. "In the Yellow Pages, a Taco Bell is still a Taco Bell," Parsa says—even if it's had five different owners in a year and isn't turning a profit (see BusinessWeek.com, 1/29/07, "Franchise Owners Go to Court"). On the other hand, Parsa's failure-rate statistics are somewhat misleading too, because they count any turnover as a failure, including restaurants that close or change hands while still profitable.

Juggling Family Ties

Given the immense time commitment that goes into owning a restaurant, it makes sense that some owners want out, even if they're making money. And in fact, the number of profitable "failures" is not insignificant. A 2003 report from an economist in the SBA's Office of Advocacy analyzed unpublished data from the U.S. Census and found that one-third of closed businesses were financially successful at closure.

"It appears that many owners may have executed a planned exit strategy, closed a business without excess debt, sold a viable business, or retired from the workforce," the report noted, adding that business-failure statistics might therefore present "much more daunting odds for business success than is actually the case."

Whether failure rates overstate or understate the odds, no one disputes the conventional wisdom that making it in the restaurant industry is no cakewalk. What entrepreneurs might find surprising is just how much a restaurant's success hinges on an owner's ability to keep the pressures of work from affecting life at home.

Parsa says how well an owner juggles the demands of the business with family life is actually one of the most critical factors contributing to a restaurant's success—more important, even, than "location, location, location."

Overcoming Geography

His conclusions were based on in-depth interviews with 20 successful and 20 failed restaurateurs. He determined that "beyond muddled concepts, failure seemed to stem in large part from an inability or unwillingness to give the business sufficient attention, whether due to lack of time, passion or knowledge."

Most of the failed restaurant owners themselves attributed their failure at least partly to competing family demands, including divorce, ill health, and retirement. Some owners voluntarily closed when the family sacrifices became too much, like one owner who said she didn't want to miss seeing her children grow up.

Location, while an important factor, appears to be more of a "moderating variable" than a causal one, Parsa says, ruling that "a poor location can be overcome by a great product and operation, but a good location cannot overcome bad product or operation."

DiSpirito—whose restaurant Rocco's on 22nd Street shut down just over a year after its well-publicized opening—might well have a few moderating variables of his own for the list.

Miller is a New York-based staff writer covering startups and small business. Miller is a graduate of Brown University.