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Should you buy a failing pizzeria?: Why do pizzerias fail?

Why do pizzerias fail?

Written by Lloyd R. Manning   
june-2008Last month we discussed how to use your advertising dollars to reach the female buyer. This month, we’ll explore the male buyer, and some key areas that affect decision-making.

Although the Canadian Restaurant Association reported a slight decrease in 2007 sales in restaurants of all classes, including pizzerias, have been on the increase for several years.

Still, many pizzerias are in dire financial straits and can be acquired at fire-sale prices with little capital investment and liberal terms. However, the percentage of closed and bankrupt restaurants that have been successfully turned around is small.

This does not mean it cannot be done, or you cannot do it, just that the law of averages is not on your side. You will need unlimited perseverance, innovation, extensive financial control, people skills, a co-operating banker, and an undeveloped sense of fear.

There are numerous reasons why restaurants fail, the most common given are bad management and under capitalization. Although both hold true in a high percentage of cases, it’s an oversimplification, sometimes true, sometimes not.

Causes for a pizzeria’s failure are many, several of which are obvious even to the untrained eye, while others are well disguised. Some problems are readily rectifiable, others can be corrected but at too high a cost to be feasible, and some are incurable. Accordingly, before contemplating the purchase of a distressed pizzeria it is absolutely essential that you understand why it is failing and what is required to make it profitable.

To this end it could be necessary to develop a new or different concept, renovate the premises, buy new equipment, develop new and innovative marketing techniques, hire a new staff, and have new and better management. It’s all about making winners out of losers.

An extensive study conducted by Cornell University groups the causes of restaurant failure into three distinct categories: external, internal, and economic. There is of course the usual overlap
with some fitting into all three categories.  Still, failure is more often dictated by internal and not external or economic influences. It is the internal problems that are most readily identifiable and correctable.

External Factors
For the most part these are impediments you cannot overcome, or if so at an excessive cost. They would include a poor location such as being too far from the pizzeria’s market, (delivery and pick-up customers will normally patronize the one closest to home), hard to find, hard to see, (a good location is clearly visible from one half block in a built up area and two full blocks when on a highway or main thoroughfare, either of which could be made so by large signs), hard to get to, limited or restricted accessibility, unsafe neighbourhood, changing demographics such as a declining market, a saturated market with excessive competition, etc.

Like Cornell University we are going to classify building deficiencies as an external impediment to success. Although some pizzerias are quite simple with little other than a front counter area, kitchen, and storage areas, others are very elaborate dining edifices, subject not only to location inadequacies, but improper design, structural deficiencies, and deferred maintenance.

 Where they are property related the first step is to clearly identify those shortcomings which can be rectified and those which cannot, and where applicable, the cost of correction, including soft costs.

Soft costs are those that are additional to the basic cost of construction or renovation. And, do not overlook replacement or upgrading of the furniture, fixtures and equipment (FF&E). If it’s a bad location or no off-street or nearby parking, and you cannot acquire the same, the building is inadequate or dilapidated, and so forth, don’t buy.

If acquiring a building needing a major renovation, be careful. You would not be the first restaurateur to spend thousands of dollars upgrading the premises only to do less business than before.

If contemplating a leased property be certain to check out the ramifications of the lease. With most leases all improvements become a part of the building. If the upgrading cannot be amortized during the first lease term either it costs too much or the rent is too high. You can never assume that the lease will be renewed.

For a simple way to determine “Will it pay?” start with the market value of the pizzeria as it is, add the cost of the renovations, and then estimate the value after. If you have not gained more than the cost of upgrading the answer is “No”, it will not pay.

Internal Factors – Mostly Curable
Bruce Flesher, of Edmonton, a highly successful restaurateur who has been in this business for about 40 years and has owned restaurants of all types – including pizzerias – says that the most common reason for restaurant failure is lack of motivation by the owner.

Many lose focus, and they become frustrated and burn out when they discover this is a labour-intensive, low-profit business. Cornell University says that lack of or diversion from a workable concept is the second principal cause. Overextending resources, being overly optimistic, ignoring or misunderstanding competition, relying on short-term and quick fixes, overreacting to problems or not acting at all, lack of product quality and standardization are on the list.

For the most part failure caused by internal factors comes down to lack of management capability, adequacy, competence, efficiency, and experience. These shortcomings are reflected in a poor financial condition caused by poor controls, accounting that fails to provide the necessary data, limited access to necessary information, poor staff control, internal theft, and lack of good managerial advice.

Many pizzerias fail as they are not sufficiently marketed or there is no originality or marketing innovation (who has gone to Mesa, Arizona, without visiting Organ Stop Pizza), too much reliance on existing customers, not obtaining new ones, or adapting to neighbourhood changes only as needed.

Flesher recommends that before you buy a pizzeria you take a tour of the target’s market area. Check out the competition. Don’t be afraid to spend a dollar in a competitor’s pizzeria or talk to the owner.

Compare, compare, compare. How does your intended acquisition stack up? Be honest. They might be better than you could be. If you fool anyone it will only be yourself.

Other common management problems include overextending resources, staff’s couldn’t care less attitude, poor service, bad food, uncompetitive prices, failure to address customer complaints, dirty premises, particularly washrooms, dirty and torn menus, poor maintenance on property and FF&E, none or poor pest control – having a friendly cockroach join in for lunch, etc.

You can do something about all of these, it just takes time, patience, and staying on top of it.

Economic Factors
These are failure reasons unrelated to the pizzeria’s operation.

Lack of capital is always listed as a principal cause of failure, yet more often it is not the amount of capital available but how it is used. Other reasons could be loss of lease, or the landlord increased the rent unfairly, death of the owner, excessive new competition entering the marketplace, partnership or shareholder disputes, family squabbles, spousal separation and/or divorce, inability to attract competent employees due to high-paying non-restaurant competition, a restaurant fire, and changes in the economy.

Next month, in Part 2 of Lloyd’s feature, he will tackle the topic of whether you can turn around a failing pizzeria and make it profitable.

 
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