Why so many businesses fail

August 16, 2011

Comments 23

Many business failures are self-inflicted. Photo: Louie Douvis

Why do businesses fail? The most obvious answer is that a weak economy eventually crunches the cash flow of smaller enterprises and kills them. But a different picture emerges from external administrator reports supplied to the Australian Securities and Investments Commission: too much failure is self-inflicted.

In fact, “poor economic conditions” was not at the top of 13 possible causes of business failure across five industries that ASIC reported on. “Poor financial control including lack of records” and “poor strategic management of business” came much higher as causes of business failure in the construction, services, retail, accommodation and food, and manufacturing industries.

To be fair, the data looks at the 2009-10 financial year, when economic conditions in industries, especially retail, were better than now. So I examined annual ASIC data from financial years 2005 to 2010 to identify trends in causes of business failure.

What’s your view?

Why do you think businesses fail (and don’t say “because they run out of money”!)
Is failure more self-inflicted than the fault of the economy?
Have you been involved in a failed business, and if so, what caused it?
From experience, what is your best advice to safeguard against business failure?
Do you think a higher rate of business will fail in the next six months? If so, why?

Some interesting trends emerged from my analysis. First, poor financial control has risen from being a nominated cause of business failure in about 30 per cent of all external administrator reports to 33 per cent in 2010. Poor strategic management is easily the highest cause of business failure, featuring in about 43 per cent of all external administrator reports and remaining fairly constant over the past six years. Inadequate cash flow or high cash use also ranks high.

Poor economic conditions, although lower than several other causes, has jumped from 11 per cent in 2004 to 26 per cent in 2010, with a big rise in the past two financial years.

Fraud, natural disasters, industry restructuring and disputes among directors barely rated as reasons for business failure. Poor management of accounts receivable also scored much less than expected. The under-capitalisation of businesses, which I always suspected as a key cause of failure, has improved slightly as a reason for business failure.

ASIC’s report is based on insolvency data; it does not cover the many more businesses that spend time in “work-outs” with their banks to stay alive, or the vast number of ventures that technically have not failed but have performed below their owner’s expectations for years.

The takeout from this analysis is simple: if you want to avoid business failure, focus first on strategy. Implement strong financial controls and record keeping, and keep a close watch on cash. That sounds like obvious advice, yet too many small business owners I know don’t have detailed strategies. They often have poor records and weak cash flow controls.

Does your venture have a clear strategy and strong financial controls?

As the Australian economy slows, and United States and European economies stall, it’s worth remembering that bad economic conditions are not nearly the biggest business killer. That might change in the next year or two if the global economy deteriorates further, and it’s true that volatile economic conditions often create “poor strategic management of businesses”. I can’t help but think that too much of the failure is self-inflicted, especially relating to record keeping.

For those who missed the latest ASIC stats on insolvencies, insolvency appointments rose 20 per cent in June, albeit off a low base, and external administration appointments were up almost 6 per cent last financial year. Numbers are still small in the scheme of things, but growing at a faster rate.

My bet, sadly, is on a bigger rise in business failures over the next six months.

23 comments so far

My first attempt at establishing a small business failed simply because I didn't research the market thoroughly enough. I was producing something that a) took a long time to produce (I'm a designer), and b) had a very limited market. Bad judgement on my part.
I am currently setting up a small business, but have learnt from my past mistakes. This time, the market research has been very thorough, and I am offsetting the things that - whilst unique and therefore should prove very lucrative - take longer to produce, by producing items I know will sell quickly and are equally quick to make, at a minimum cost.
I think that more businesses will go to the wall because there is simply very little out there that is unique...many people are slaving away trying to sell things that a hell of a lot of others are selling, i.e., same product, different brand. Consumers will always be looking for something new to the marketplace, and when there is nothing new and/or exciting left to buy, they will simply stop spending.

Commenter

Lynne

Location

Melbourne

Date and time

August 16, 2011, 11:30AM
Remember the collapse of Borders? And Starbucks? The latter entered the market here despite us clearly having a mature coffee (proper coffee) drinking market - the reason they gave for closing most stores didn't admit they got their "data" wrong 5 years earlier, & that their entry was driven by senior & middle management, whose bonuses were based on company expansion. Borders went down not because of "the internet" (the current excuse used by any poorly run business looking for any excuse other than their own ineptitude) but my over-geared investors & too broad a range of merchandise. Neither was anything to do with the external environment.
And if they really were well run businesses, they would have adjusted their businesses earlier. It's about competence & management, not easy whining & blaming external factors.

Commenter

Mark

Location

Sydney

Date and time

August 16, 2011, 12:09PM
With many small businesses I know there are often external shocks cupled with taking too much out that have killed them. I have a hotel and we just experienced a 17% increase in electricity which equates to another $1700/month. How do we pass that on? As it is we are selling beer now cheaper than we were in 1997 when we bought the place. However it must be said we have invested nearly $1m and now have pokies and extensive food facilities and function rooms. However, the ekectricity rises and the rest to come will be straight from the bottom line. There is a limit.

Commenter

Terry

Location

Udaipur

Date and time

August 16, 2011, 1:19PM
@Mark - spot on.

Commenter

Dan

Date and time

August 16, 2011, 2:50PM
Irrespective of the accuracy of this article, it's nice to see someone trying to grapple with the nitty gritty of small business. It also seems to attract a serious and informed readership and plenty of useful insights into the experience of running a small business.
Awfully tempting to try to get a long free ad published here, as I run a small business based on advising small business customers how to get a better deal from the service providers they rely upon - will resist the temptation and see if I can add something useful.
My best advice for success in small business, given the small taste of it I have had so far, is to get out of bed at 6am (yeah, yeah, I know you get up at 5 and run 5 miles before you swim to work...) but for me this was emulation of all the really successful men I have met - get started before everyone else has had breakfast.
So - tip one - work hard.
That's it, really. You can pay a lot of money to have someone tell you to "work on your business, not just in it", but if you are at a desk reading emails at 7am it's those two hours before the phones start ringing that really give you time to think - which is the basic element in coming up with a strategy - sit and think.
Anyway, they only value my advice to the tune of this many characters - hope it helps!

Commenter

Colin

Location

Sydney

Date and time

August 16, 2011, 4:28PM
It's true "the internet" is partly a furphy fuelled by Swanny who is trying to talk up the nearly lifeless domestic economy. But it's also partly true and one thing the internet really has over shopfronts is - zero rent! If no small business had to pay rent, probably none of them would ever go out of business except by a gross miscalculation. So forget all the theories, the real killer is rent. Look no further than Frank Lowy and AMP for proof, who own half the malls in Australia. Rent coupled with off-a-cliff recession conditions is quite enough to sort the weak from the strong.

Commenter

bg

Date and time

August 16, 2011, 5:59PM
About three years ago I analysed all the small businesses I had reviewed over 20 years. These were not businesses that had failed, but were not performing as well as they could have.
Usually they were businesses started by people with good technical skills, so it was not surprising that lack of financial and marketing skills were prominent problems.
But the major problem for almost all was the lack management information. They just didn't have the information available from which to make sound management decisions.

Commenter

AdamG

Location

Yamba NSW

Date and time

August 17, 2011, 7:25AM
I have had my current business for more than 15 years now. It gives me an income and the flexibility to have other interests.
Plenty of businesses fail, just look at how many retail shops come and go. Running your own business can be fun and rewarding, it can also be exhausting and consume all your time if you let it.
If you have a passion for what you do thats a great start, but often people fall in love with an idea of what they think their customers want rather than what there is demand for.
You don't need to have some brilliant new idea for a business, very few succesful businesses are new ideas, you just need to supply a product or service that people want and to do it well.
No need to re-invent the wheel, just check out which businesses are doing well and why.
Running a business is not an intellectual excersise, stategy is important, but so are client relationships and marketing.
Keeping a close watch on costs is important, high overheads like rent can be a killer while trying to build a business.
There is always an element of risk in any business, you give it your best shot and it flies or it doesn't. You can do everything right and still fail, you can be hopeless and the business succeeds, I've seen it happen.

Commenter

Andrew

Date and time

August 16, 2011, 11:06PM
A lot of it is simple psychology, for example:
http://en.wikipedia.org/wiki/Overconfidence_effect
and
http://en.wikipedia.org/wiki/Optimism_bias
Let's face it - half the population have an IQ of less than 100 and some of those people start businesses. Is it any wonder many of them will fail?

Commenter

dgusten

Location

Melbourne

Date and time

August 17, 2011, 11:07AM
Ah ASIC - $219 for 1 piece of paper every year and it's not even gold plated.
In the panel industry part of the problem is that you all want your car turned from a sows ear to a silk purse for $200. You take it in for 1 dent and expect the whole car repaired for free. Notably the rich are the worst offenders - plenty of money to go on holidays, plenty of money to go out with friends but sadly none or let's say "no intention" of coughing up for someone who has just spent the last 3 weeks of their life working on your pile of junk.
NRMA/AAMI cut quotes down below the bare bones and unreasonable timeframes to get the work done - mind you don't tell the customer they did that, it's supposedly all the panel shops fault!
People seem to think a panel shop will fix their car, change your light globes, mechanically repair things and all for the huge sum of ZERO.
Most of you have probably been watching "Fifth Gear" on the weekend where they fix a car in a week. What that program doesn't tell you is how much the job was worth and considering there is normally 15 people working on that car for a week I can tell you it's probably up around $45,000 if not more but in Australia you all think they should work for $2.50 an hour.
It's the old saying "what you do is worth it's weight in gold but you want to pay peanuts for anyone else's work". Maybe some of you should try fixing your own car and see just how much you think it's worth by the time you finish.

Commenter

Megan

Location

sydney

Date and time

August 17, 2011, 12:57PM