Restaurants Don't Fail Any More Often Than Other Businesses

I recently saw someone say that 90% of restaurants fail in their first year.     I wrote about the topic of Misleading failure rates on small businesses a few years ago and later Business Survival Rates  in which I pointed to actual BLS data on the topic :  Chart 3. Survival rates of establishments, by year started and number of years since starting, 1994–2010.    All of that discussion was about failure rates of small businesses in general.   But are restaurants that much more prone to failure?   I mean it seems like a bit tougher business and we often see restaurants opening and closing... so maybe.

Turns out that, no, restaurants don't really fail much more than any other small business in general and the failure rate is nowhere near 90% in the first year.


I found two pretty good sources on the topic with similar numbers on the topic :

Bloomberg article The Restaurant-Failure Myth says that research from H.G. Parsa  an associate professor in Ohio State University's Hospitality Management program, "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."

Forbes article Restaurants Don't Fail, Lenders Do
"According to the National Restaurant Association 30% of new restaurants fail in the first year, and of those that survive, another 30% close in the next 2 years.  Sure that is significant but according to the Small Business Administration’s Office Of Advocacy the two-year failure rate for all small businesses is 31%, and after five years the rate increases to 49%."

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Business Survival Rates

You've probably heard someone cite a statistic like "X% of small businesses fail in the first Y year[s]".    It seems that every time I hear someone cite that 'fact' the numbers vary.   I've talked about these varying and potentially misleading numbers before.

A while back Joe over at Retireby40 cited such a statistic and I asked him if he had a source.   Turns out he did and he pointed me to the data from the BLS :

Survival rates of establishments, by year started and number of years since starting, 1994–2010, in percent


That site has a chart showing the % of businesses which survived between certain years.    The rates vary depending.   For example 80% of businesses started in 2000 were alive 2 years later, but only 74.4% of the businesses started in 2008 lasted 2 years.   I assume that shift is related to the rough economy during the recession.

While the numbers vary from year to year we can draw some general observations from the data:

About 50% of businesses last 5 years.
Roughly 1/3 of businesses last 10 years.

Those aren't exact but close enough.    In fact the 5 year survival rate ranged from 49% to 55% and the 10 year rate varied from 34 to 37%.


I'm not really sure what the BLS does to measure survival of a business.    If a business doesn't survive that doesn't necessarily mean it failed.    If I retire and sell the business does it survive?  I wouldn't think so.  What if I move out of state?    What if my business is bought by another business?   
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10 Reasons Small Businesses Fail

An article from the New York Times carried by Yahoo titled Top 10 Reasons Small Businesses Fail
gives this list of 10 reasons:

1. The math just doesn't work.
2. Owners who cannot get out of their own way.
3. Out-of-control growth.
4. Poor accounting.
5. Lack of a cash cushion.
6. Operational mediocrity.
7. Operational inefficiencies.
8. Dysfunctional management.
9. The lack of a succession plan.
10. A declining market. 

The article goes into more depth on each point and elaborates on their meaning.   Its quite a good list if you ask me.  If you're thinking of starting a business or if you are already running one then I think it would be good to make sure you're not vulnerable to any of the items.

Here's my thoughts on them.

1 and 5 are basically business plan items.   You need to make sure you have a product people will buy and that your capital will last.   This kind of failure may start from day one and could be insurmountable no matter how much of a genius you are at handling customers or other facets of running the business.  

2,4,6,7,8  all seem like items that are basically flaws or weaknesses of the business operators themselves.   If you don't do a good job running the business then it may fail.   Some are more understandable like #7 "operational inefficiencies" which any business has to keep an eye on.  But others like #8 "dysfunctional management" really translate into failure by the people running the show.

#3 is a sign of your own success.   If you grow too fast you can fail.  You do a perfectly good job managing a small retail shop with 5 employees.  But if you then decide to expand to a regional empire with 25 locations and 125 employees you may realize you're not capable of handling that kind of thing and it may all collapse. 

9, 10 are items that seem more like things that even good businesses may be vulnerable.    You might do a wonderful job running a business for many decades and then end up failing due to one of these.   Small businesses in particular are often ran primarily by a single person.  When that person retires or otherwise leaves then thats a key transition.   A very successful business may fail eventually simply because the world changes.  Just look at the New York Times themselves.   They and other print newspapers are on the path to failure if current trends continue.  They need to adapt to the new media or they will fail.

I don't run a small business myself unless you want to count our rental properties as a business which it is in a way.

Misleading failure rates on small businesses

It seems to be common knowledge that 80 or 90% of small businesses fail in the first year. I've heard this statistic enough times that it seems as if it must be a fact proven multiple times and written in stone somewhere. But the problem is its not really a fact.

I mentioned a while ago that Matt at YFNCG posts in Statistics Shmatistics about the wide variation in statistics cited about failure rates of new small businesses.

In his article he cites several sources with statistics on the small business failure rate that are all over the place.

Matt cites sources with failure rates as high as 95% and as low as 25%:

“Nearly half of small businesses fail within a year…90 to 95 percent of small businesses fail within five years.” - Acording (sic) to this wisegeek.com article, the stats come from the Small Business Association, but they don’t say what reports were used or who in the SBA reported them."

versus

"In an article on Small Business Trends Scott Shane presents stats from his book that show only 25% of businesses fail after the first year and 50% are still going strong after year 5."

I just found another source myself from Dr. Gregory B. Murphy a professor at the college of business at University of Southern Indiana where he explains why the numbers might be so far off:

"Conventional wisdom regarding small business failure rates is based on the assumption that if a small business can be identified as new in a given year and cannot be identified five years later, it’s a failure."

So if the business is in a list one year and not on the list the next year they count it as a failure.

"Just because a small business is no longer listed in a given source doesn’t mean it is no longer there. A number of sources that list small businesses are based on compiled yellow pages. Other sources require the small business owner to pay a fee and/or provide company information to be included in their listings. So what happens if a small business is no longer listed in a source because the owner no longer wants to pay the listing fee or provide the requested information? You guessed it. If that source is being used to track the small business, it probably will be counted as a failure — even if nothing else about the business has changed."

So part of the problem may just be poor quality data.

Other reasons why the 'failure' rate data isn't necessarily good is what they call a failure:

"If an entrepreneur successfully starts and grows a business and then sells it to another company at a nice profit, should that business be counted as a failure because it no longer exists as a separate entity? Clearly not. If a near-retirement professional starts a consulting company to cap off his or her career and does so successfully and then retires, closing the business four years later, should that business be counted as a failure? Ironically, very successful small businesses may be mistakenly labeled as failures."

So if you sell a business then it could end up in the 'failure' bin. Clearly that's not right.

The high numbers in the 80-95% range don't even pass a sanity check. Think about how many businesses you know of in your town. Consider all the restaurants, bars, barbers, furniture shops, car dealers, and all the other small businesses. Then think about how many of them went out of business in the past year. Is it anywhere near 80-90%? I'd bet its almost always not nearly that high.

If you hear someone say that 80 or 90% of businesses fail in the first year then take it with a grain of salt.