Restaurants run on slim profit margins — a mere 6.2%, according to an — suggesting that staying in business and remaining profitable isn't easy. And, in 2020, it got a whole lot harder, with reporting 15,770 restaurant closures as of July, a number that will likely climb before the year's end.
So why do restaurants fail? And how can you prevent it? Explore common restaurant business challenges while learning how to set your company up for success.
7 reasons why restaurants can fail
Few restaurants fail due to a single cause. It starts with a poor decision, such as the wrong location, which causes financial concerns and leads to arguments with business partners or an inability to buy supplies. If one thing is certain in the hospitality industry, it's that you will face challenges. The way to stave off most issues involved with owning a restaurant is by planning and preparing before you hit an obstacle.
1. Not enough money to survive the first few years
When it comes to companies in all industries, money, or the lack of it, is a key reason for failure. It may take a year or longer to turn a profit, so restaurant owners need access to funds to cover restaurant payroll, inventory, and taxes.
Restaurateurs require an emergency fund. Unless you buy all equipment brand-new and under warranty, something is guaranteed to break. From walk-in coolers to ice machines, equipment failure always comes when you can least afford it. Without enough money for repairs, it's easy to fall behind. Before opening a restaurant:
- Put aside enough funds to cover a year of operating costs.
- Look into small business loans, crowdfunding, or business grants.
- Get approved for a line of credit, equipment, or supplier financing.
- Define how you'll address an unexpected expense or extended slow season.
2. Ongoing financial management problems
Many businesses start with a pile of cash and still fail. That's because managing restaurant finances is complicated. Each aspect, from menu pricing to staffing levels, impacts your bottom line. And these numbers fluctuate widely in a new business since you may not get into the swing of staffing until you have some experience behind you.
Plus, huge variations in the cost of raw food products or underpricing a popular menu item can lead to less-than-profitable results. The way to get a handle on your finances is by ensuring clear visibility of your cash flow while maintaining real-time views of your labor, sales, and inventory reports.
Along with daily cash flow statements, use:
- Restaurant technology: Use your point of sale system (POS), accounting program, and other restaurant management systems to run regular reports.
- Inventory management: Track prices, count high-value inventory daily, and create a plan for tracking overages and averaging use.
- Menu engineering: Use menu psychology techniques for proper item placement, easy scanning, and aesthetics.
Don't forget to review all the extra costs of doing business and look for ways to cover expenses, such as additional labor and packaging for delivery or carryout or third-party delivery fees.
3. Poor location selection
Besides insufficient funds, location is a top reason for a high restaurant failure rate. Owners may choose the wrong place or select a site that isn't affordable for the long run. Your location needs to fit your concept and your market.
If you want to capture local business, yet it's tough to get to your restaurant on foot, you're going to struggle. Or, if you select a huge space but can't keep the seats filled, you're going to be paying vast amounts of money for utilities but won't have enough sales to pay the bills.
4. Problems with a business partnership
Partnering with a fellow restaurateur or family member may seem like a great way to bring extra capital or experience to your business. However, there are plenty of horror stories stemming from partnerships — from broken marriages to a partner disappearing along with your bank funds. Set up a business organization plan early in your relationship and clarify how you'll handle:
- Split decisions
- Sweat equity versus investment
- Access to accounts
5. Not enough experience or business skills
There’s no doubt that restaurant owners are passionate. You have to love hospitality and the industry because you're giving up your nights, weekends, and holidays. It's a tough business.
However, having decades of restaurant experience can't make up for a lack of business sense. Along with creating a mouth-watering menu backed by a stellar staff, you need to understand business basics, select an experienced partner, or outsource tasks beyond your expertise.
Few restaurant owners have the funds to outsource everything, though, so many entrepreneurs muddle through and learn on the job. While this can work, it's also really hard to do. When you start your restaurant, you're working non-stop, leaving little time to learn about creating a restaurant website or paying sales taxes.
Instead, enroll in free business classes to boost your business management capabilities, whether it’s accounting, taxes, payroll, or any other skill where it's a learning curve for you.
6. Lots of restaurant software but no long-term plan
Successful businesses often don't rely on spreadsheets to track data because data entry mistakes are common, and it's hard to create the custom reports restaurateurs need for total visibility.
You still may be tempted to buy the cheapest versions of your restaurant POS systems, loyalty programs, or accounting software. While they may offer the features you want, low-cost or free solutions may not be easy to use or customize. Plus, many lack integrations necessary for running a restaurant.
For instance, a POS system that captures all the right data but doesn't let you split a guest ticket or automate custom meal instructions slows down your staff and harms the customer experience.
- Third-party delivery services
- Loyalty programs
- Customer relationship management software
- Online ordering systems
When making software purchases, think ahead to what you may need in the years to come and look for solutions that scale along with you and software that integrates with your essential programs.
7. No explicit differentiation from competition
You know what makes your restaurant different. But if you can't clearly show prospective guests your restaurant's value, it will be tough to stay top of mind when they go to order food or plan a group gathering.
Branding your restaurant isn't just picking a name, logo, and tagline. It involves fleshing out your key differences and brainstorming ways to market those distinctions. During the branding process, you need to go through tons of market research, including identifying your ideal customers, what they want, how much they spend, and even their hobbies.
The more data you have, the easier it is to show your value and create a restaurant marketing strategy that captures attention.
Overcome restaurant business challenges
This list is by no means exhaustive. Restaurants also go under because the business concept and menu failed to change as the market evolved, or a lack of staff and management training led to poor restaurant customer service. Rarely is there only one specific reason.
Owners, consumed with the day-to-day operations in their restaurants, fail to recognize how quickly problems are building, resulting in a landslide of problems all at once.
While nothing in the restaurant industry may be 100% avoidable, starting with a thorough business plan and a risk management and disaster recovery strategy — and repeatedly assessing and revising these documents — helps you make informed decisions.
Rather than asking why do restaurants fail, discover why and how restaurants succeed and emulate those business approaches.