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

SPECIAL REPORT

Getting Started

• From Startup to Success Story
• The Restaurant-Failure Myth
• What the Turnaround Ace Knows
• Take Two Yields One Speedy Startup
• The End of a 1,400-Year-Old Business

Rocco DiSpirito’s restaurant, Rocco's on 22nd Street, shut down just over a year after its well-publicized opening Getty

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 Getty

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." Getty

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"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.