CREJ - Retail Properties Quarterly - September 2015
In a 2003 American Express advertisement, celebrity chef Rocco DiSpirito claimed that nine out of 10 new restaurants fail within the first year. Unfortunately, that was not the first time I had heard this ridiculous claim, but coming from a celebrity chef, and on national television, really? Since 1994 I have been battling, begging and even pandering to lenders for funding for restaurant projects, tenants and buyers. Then, thanks to nationwide advertisements like the one from American Express, my job become even harder. I always estimated the restaurant failure rate to be similar to the retail failure rate in general. Slowly I began educating lenders, at least the few that would listen, about false claims of high restaurant failure, based on my professional experience and the very low failure rate of our restaurant clients. The “90 percent first-year failure rate” of restaurants already had grown to mythic proportions, though, and it was hard enough to debunk the myth itself, let alone American Express and chef DiSpirito. Thankfully, I found an article written by Jeff Grabmeier from Ohio State University titled “Restaurant Failure Rate Much Lower Than Commonly Assumed,” which referenced research by Dr. H. G. Parsa. The study focused on 2,439 restaurants in Columbus, Ohio, using health department data over a three-year period (1996-1999). According to Parsa’s research, the highest failure rate was in the first year at 26 percent, about 19 percent failed in the second year, and 14 percent in the third year. Parsa’s research showed that the cumulative failure rate for the three-year period was only 59 percent – a far cry from the 90 percent first-year failure rate claimed in the American Express advertisement. Parsa focused on health department licenses that showed a change of ownership, which, in my opinion, is more accurate than other studies that rely on bankruptcies or database listings. However, a change of ownership does not necessarily mean the restaurant failed. Some of the restaurants in this group sold and continued to operate. Therefore, using this data, the true failure rate is considerably less. It is important to note that restaurant failure rates vary by state and by trade area for many reasons. An article published in Cornell Hospitality Quarterly, entitled “Why Restaurants Fail? Part IV: The Relationship between Restaurant Failures and Demographic Factors,” referenced more of Parsa’s research. The study was conducted in Boulder from 2000 to 2010, and failure rates were calculated for the first few years. The data showed that the first-year failure rate was 24.95 percent. So why is the legendary 90 percent failure rate so easy to believe? The answer is simple; think about how you, as a consumer (not a landlord, broker or lender), relate to retail businesses in general. What is important to you? What can you live with and what can you live without? Now try to remember how many retail businesses have closed in the last few years, specifically how many restaurants have closed? If you are like most people, you remember more restaurants closing than other businesses, so you reason that the failure rate for restaurants must be higher. This misconception is easy to understand. Think about the last restaurant that you remember closing. Maybe you were going to meet a friend for dinner and drinks and discovered the restaurant you chose was closed. What happens next is very interesting, as you start remembering all the reasons why you liked that restaurant. Maybe it was the amazing homemade pasta, the cute bartender who made a great martini, meeting a friend for the very first time or maybe a memorable date. You had a personal connection to the restaurant and, therefore, its closing becomes a memorable event. Now think about shopping for an item, for example, a new pair of shoes. Perhaps you have a favorite store and you drive to your local retail center and discover that the store has gone out of business. You can search for another location, or maybe just glance across the parking lot and see another shoe store. Either way, your shoe problem is solved and it is not a memorable event. Restaurants are a bigger part of our lives. You probably can name all the restaurants within walking distance from your office, but can you name every retailer? When restaurants close it is big news and many relate to it. Just like Heather Locklear in a Faberge Shampoo commercial from the 1980s, “I told two friends about it and they told two friends and so on and so on.” The 90 percent failure rate isn’t the first urban legend to contradict fact, but it is one of the most widely distributed and believed. Sure, we can blame the media, the statistic-quoting experts that do not cite their sources or even American Express for this fallacy. However, I believe that banks play the biggest role in perpetuating the myth. After all, they have the most to gain, as it is much easier to ask for additional collateral and higher rates and fees for a high-risk or discouraged industry. You can call the 90 percent first-year failure rate a myth or an urban legend, but I prefer simply to call it false. So please, start spreading the news!