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Five Reasons Restaurants Fail

Aug 25, 2017 9:14:00 AM

Much has been written about how challenging the restaurant business is and the supposedly high failure rates in that industry versus the average new business.  According to the National Restaurant Association, 30% of restaurants fail in the first year and 50% fail within three years.  But that’s actually on par with statistics for most small businesses and it doesn’t really provide a sense for whether the majority of the failures were because an owner has a lot of culinary but lacks business skills.

While I may not have run a restaurant, I’ve worked with hundreds of them over the past few years as a packaging supplier. During that time, I’ve seen some patterns emerge and painful lessons learned by clients of ours who put their heart and soul into their café only to see if barely stay afloat financially.  Many of the restaurant owners we work with haven’t taken a paycheck themselves in months.  We hate seeing this and want to help restaurant and café owners avoid common mistakes before it’s too late. 

Just build it and they will come, right? 

The old adage “location, location, location” may have some validity to it.  However, if you’re a restaurant owner with a great location, that just makes it more convenient and more likely a new customer will find you.  It doesn’t mean they’ll keep coming back or that the costs of your great location make up for what might be low margins. Location, just like having delicious food or coffee, is not a recipe for success.  It merely contributes to the potential for success.  

Here are five mistakes commonly made by restaurant owners we see and some ideas for how to avoid them: 

1. Inadequate Capitalization

Whether you’re bootstrapping a new venture or have a nice investor sugar daddy, avoid spending money on anything until as close to opening as possible.  You don’t need to buy the newest, state of the art kitchen equipment or spend too lavishly on décor.  A distributor of restaurant kitchen equipment once told me he had a thriving business on not just selling new equipment, but buying it back for a few dimes on the dollar, often just a few months later from bankrupt owners. Among other mistakes they made, these owners didn’t properly anticipate how much cash on hand they’d need to ramp up the business and how long that would take.

Get creative: many of our clients have signed leases with landlords that allowed them to build out a new site without paying rent for up to 6 months.  If you can demonstrate how your business will add long-term value to a landlord’s property, you might convince him to extend terms like this to you. Don’t blow your capital like you just won the lottery.  

Bottom line: Write a business plan, using input from experienced restaurateurs before you invest any money in a restaurant or café. 

 2. Poor Cash Flow Management

Related but distinct from capitalization, cash flow management has to do with being crystal clear on what your variable day to day costs are versus your sales.  Don’t think you can break all the rules of a highly competitive industry with time tested business models by having costs or prices that are out of line with industry norms.  Find out what the norms are for the type of food you’ll be serving.  For example, a rule of thumb for most restaurants is that food costs should not exceed 30% of sales with the balance split between labor and (typically) razor thin profit.  If you’re just a few percentage points off on budgeting your costs, it could mean the beginning of the end if you don’t correct it quickly.

Don’t underestimate the time it takes to ramp new employees and gain a loyal following of customers.  Have a buffer of at least 6 months profits’ to pay for unexpected expenses. 

3. Lack of Clear Differentiation

Is it clear to your customers when they walk in what makes your restaurant different from all the others?  Customers want a unique experience - tell your story, utilize social media, and create a menu that people remember.  Don’t try to be the lowest cost food option on the street.  If you’re buying local, healthy, or premium food ingredients, don’t be shy about educating the consumer about this and then charging a fair price for it.  People will pay more for quality and a great experience.  

Limit your menu

I’ve seen so many restaurants try to offer something for everyone and in the process, make their employees and customers miserable. Less is more when it comes to food choices.  First, it dramatically decreases food waste, a huge contributor to lost profits when restaurant purchasing managers fail to properly anticipate demand by buying too much. Second, it makes for a much less daunting experience for consumers. 

There’s a reason why places like Chipotle have been wildly successful recently.  One of those reasons is because they offer limited choice of items on their menus, all of which are prepared fresh and efficiently.  It’s better to be great at a few things than mediocre at a ton of things.  

4. Using Marketing Gimmicks to Drive Sales

This means anything you do to crank up revenue without profits following closely behind.  I see a lot of struggling restaurants lured into trying Groupon type services or loyalty cards in which they give free product away for every 5 or 10 visits.  Although these gimmicks are a lot easier to implement than figuring out a real marketing plan, resist the urge to use them. 

There’s nothing inherently wrong with marketing offers.  Before you’re tempted to go after the foot traffic that a Groupon type offer might generate, ask yourself what problem such a marketing effort is solving for you.  If you just want more traffic and aren’t thinking about profits, then you’re just feeding your ego.  If the company selling you a coupon advertising packaging can show data that their offers result in return customers who are profit generating customers then maybe its worth it.  

The same goes for loyalty cards. Many café loyalty cards offer free coffee for every 10 you buy.  If your average gross profit per sale is 30%, then giving that 11th coffee away means you’re forfeiting over 20% of your profits. What is that 20% profit erosion buying you?  If the answer is unclear, consider investing that money elsewhere.  

5. Poor Time Management

Time is your most valuable asset.  Don’t waste it.  As a business owner, you should always be asking yourself what your highest and best use is at any given moment.  That means if you’re spending 12 hours a day cooking or running the register, don’t wonder why your business isn’t growing or that costs are out of control.  The reason is because you can’t effectively manage the business while you’re running the register.  

I also see café owners spending hours a month shopping at wholesale restaurant supply stores instead of just getting delivery of their food and supplies.  Sure it sometimes costs a bit more for delivery but the savings of your time is well worth it.  Spend that time you saved from shopping by negotiating better supplier terms, analyzing profit margins of your menu, hiring and training the very best employees, and getting to know your customers. 

Saving money is important but there are limits before it becomes counterproductive to the interests of running an efficient and profitable restaurant. 

Summary

Several of pitfalls are tightly related to the others. For example, resorting to expensive marketing gimmicks like Groupon is a sign that because the restaurant hasn’t focused energy on providing a unique offering (differentiation), it feels the only way to drive revenue is to give profits away to lure customers. The resulting cash flow problems from these new unprofitable customers probably means the owner will have to pitch in to serve them while neglecting other important tasks.  And the cycle just continues.

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Are you a restaurant or café owner? Do you think these capture the five most common pitfalls of failed restaurant owners? How can aspiring restaurateurs best learn about the many mistakes restaurant owners make BEFORE they make them as well? We want local restaurants to thrive and as an industry, continue to raise the bar of excellence.  

Topics: Restaurants

Ken Jacobus

Written by Ken Jacobus

Ken Jacobus is CEO and founder of Good Start Packaging. He works with restaurants and other organizations around the U.S. to help them find the best sustainable alternatives to traditional plastic take out food containers. When not busy trying to eliminate landfills and plastic, he hikes, bikes, skis, reads, and plays with his family around his home in southern New Hampshire.

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