13 Reasons Why New Businesses Fail

These views are of Jonathan T. Scott, Sustainable Business Champion, he expressed in a report The Entrepreneur’s Guide to Building a Successful Business.

The Thirteen Main Reasons Why New Businesses Fail (and How to Prevent Them)

  1. Inadequate Planning
  2. Underestimating the Commitment it Takes to Succeed
  3. Cash Flow Problems
  4. Poor Management
  5. Not Understanding the Importance of Customers
  6. Staffing Problems
  7. Inflexibility
  8. Poor Marketing and/or an Inability to Sell
  9. Not Enough Capital
  10. Pricing Problems
  11. Lack of a Competitive Edge
  12. Going It Alone
  13. Growing too Fast  

Entrepreneurship statistics often vary. Some estimates claim that up to 95% of new businesses fail within five years. Others say the number is around 65%. Either way, these are staggering figures when one takes into account that most new businesses fail for more or less the same reasons. Most of these reasons are presented below ranked in the order of the threat they pose according to the entrepreneurs surveyed for this book. Note, however, that those placed at the end of the list are not the least dangerous. ‘Any one of them, combined with another or on its own, carries enough firepower to bring down a business,’ says the owner and operator of ASAP UK Ltd. (a sign making and print shop in Southampton, England). It therefore makes sense to do as much as possible to avoid all of them.

Reason 1: Inadequate Planning

As simple as it sounds, lack of forethought and planning is the main culprit behind virtually every business failure. Thankfully, 75% of most business ideas fail on paper (i.e.: the planning stage), which is exactly where a business idea should fail. The only other option is to collapse on the street, perhaps under a pile of debt. Inadequate planning includes (but is not limited to), not fully understanding a product or service before selling it, not conducting detailed market or labor research, not compiling a realistic customer profile, not researching the competition, not selecting a proper business model, not determining all costs beforehand, or, in general, not doing enough preliminary work to determine if all the numbers add up. In short, running a business without a well-researched plan is like hacking through a jungle without a map. Put another way, if you don’t have the time or inclination to plan, write down, investigate, and analyze what it is you want to do in regards to starting a business, then you probably don’t have what it takes to succeed. Period. For further information on this critical subject.

Reason 2: Underestimating the Commitment it Takes to Succeed

In a world where almost everything is wanted on a silver platter the moment it’s demanded, it’s easy to forget that quality and strength take time to acquire. For example, it can take up to six months or longer to put together a business plan and as much as five to seven years (or longer) to establish a solid customer base. I’ll use the story of the photocopier to illustrate this point. The idea of photocopying text instead of making copies by hand was the brainchild of Chester Carlson, a visionary who developed his first successful machine-made ‘dry writing’ image in 1939. Over the years Carlson offered his idea to over 20 companies including GE, IBM, and Kodak, yet each turned the invention down by explaining that photocopiers weren’t needed because carbon paper was good enough. Much to his credit, Carlson persisted – eventually winning over the president of a small photographic paper company (Joe Wilson) who agreed to fund the development of what he saw as a promising new idea. Through thick and thin Mr. Wilson kept his word, faithfully supporting Carlson even when he could not afford to do so. At one point, during the winter of 1959-1960, a team of engineers worked 24 hours a day, seven days a week to meet a deadline. With Wilson and Carlson unable to pay the heating bills, the men huddled around the prototype as they worked, wearing coats and boots (and with a blanket draped over themselves and the machine) in order to keep warm. The result was the launch of Xerox, a company that reached $1-billion in sales faster than any other business in history up to then. It took over 20 years and brought several people to the brink of financial ruin, but persistence, dedication – and a good idea – paid off.

Reason 3: Cash Flow Problems

If passion, commitment, and planning are more important than money (as stated in Chapter 1), then why do cash flow problems appear at the top of a ‘reasons why business fail’ list? Think of it this way: money isn’t needed to conceive a baby, but once a baby is born it needs to be fed – and the bigger a baby gets the more food it needs. So it is with a business. Too many entrepreneurs confuse the word cash with the word profit, thinking that they’re one and the same. ‘Profit’ is a word for accountants. ‘Cash’ is what a business feeds on in order to survive. Employees, banks, and many suppliers must be paid in cash – not profit percentages. If customers take 30 days, 60 days, 90 days, or longer to make their payments, a business could be in trouble if it needs those payments to cover expenses. One of the most difficult things to explain to wannabe entrepreneurs is that profitable businesses all too often end up going bust due to cash problems because much of the world runs on credit. Even a business with $20-million in sales can face bankruptcy if it can’t meet its payment obligations while waiting for customers to pay for what they purchased.

Suggestions for improving cash flow include:

− Don’t go on a spending spree during the first year or two of operations. No matter how successful your business appears, or how enthusiastic you are to make improvements, the first year of operations is not the best time to spend money. It’s the time for collecting money. Avoid the temptation to celebrate or spend a lot of money during the first year or two of operations.

 − Avoid bad customers. Before accepting credit from anyone, ask for and check credit references. Some banks will do this for you. Or try an internet search. In the UK, the Better Payment Practice Group (BPPG) names and shames 10,000 delinquent payment companies on its website. The worst offender on its 1999 list was WorldCom

– a company that took 256 days on average to pay its suppliers and went bankrupt three years later (Simms, 2006). In the USA, contact Dun & Bradstreet for a quote. Note: Credit-checking services are available in most countries so take advantage of them!

− Bill promptly. When possible, always ask for cash up front when selling a product or service. Otherwise, set up a regular billing system, clearly state your terms, or negotiate with customers for payment in advance.

 − Create an incentive for receiving prompt payments. Offering customers a discount of 1% or 2% if they pay within ten days often provides a big incentive for them to do so.

− Reduce inventory. Determine how much inventory your business really needs and cut back on stock. Reducing the amount of money you spend on inventory frees up capital.

 − Consolidate your loans. If you’ve borrowed money from several different sources, consider taking out one big loan that covers them all. This may involve stretching out your payments for another year or two (thereby costing more in the long run), but if you need to lower your monthly expenditures it may be a good option.

− Learn to barter. Sometimes products or services can be exchanged without money changing hands. For example, many years ago I convinced a gym owner to expand his hours of operation by bringing in students that needed to do internships. Local university rules forbid the paying of interns so any company that ‘hired’ one received free labor in return for providing the student with some work experience. Ten years later, I expanded this idea to rescue a multi-million dollar equestrian operation located in the Middle East. After advertising for, and finding, a number of volunteers who were qualified to give riding lessons I set-up a profitable program that allowed these volunteers (none of whom could afford their own horse) to ride a horse whenever they wanted in exchange for teaching my customers how to ride (this also reduced the amount of time and money that had to be spent exercising horses). As a result I never had to pay my instructors a wage, they brought in loads of new customers, and the business became profitable in six months.

Reason 4: Poor Management Entrepreneurship is the death of management.

Paradoxically, it’s also been said that management is the death of entrepreneurship. What these comments refer to is the belief that after setting up a business too many entrepreneurs stiffen into rigid managers that are guided by routines – a problem that probably arises due to the fact that most people don’t know what good management is about. In short, management is not about being a boss. Good management is about serving others: providing for others, motivating people, getting work done through others, and streamlining a business toward making a sale — and that’s just the beginning. Indeed, some practitioners believe that managers in denial of what’s going on in their business is the real number one reason why most businesses fail. Additional managerial problems include an inability to delegate, inflexibility, micro-managing the work of others, or abdicating important work responsibilities. Fortunately, it doesn’t take genius to be a good manager. For the most part, competent management involves being curious and open-minded, having a good attitude, adopting adequate organization skills, offering quality training to employees, listening to others, being flexible to new ideas (i.e.: remaining entrepreneurial), harboring a hatred of the status quo, and instilling a business with a can-do attitude that may involve breaking the rules (but not the law).

Reason 5: Not Understanding the Importance of Customers

Setting up a new business involves so much work that it’s easy to forget about paying customers. Interior design, bookkeeping, product displays and other non-revenue producing activities – although important – should not be the priority of a business. Successful business operations are reliant upon receiving money from satisfied customers on a regular basis. Yet no matter how simple this concept sounds, it’s surprising how many businesses lose sight of it. For example, years ago a wealthy doctor wanted to purchase industrial-size washing machines and dryers for the hospitals he owned. He approached me for help, but I didn’t have any free time so I referred him to my father, a retired executive who is always looking for something to do. ‘Over the past month I’ve contacted every washing machine manufacturer in the country,’ he told me later, ‘but no one seems able to answer even my most basic questions, my messages aren’t being returned, and I’m tired of begging.’

Reason 6: Staffing Problems

 People problems usually begin by: (1) not fully investigating the background of job applicants, (2) failing to fully train employees, (3) hiring friends and relatives (in a long-term capacity), and (4) employing people who are clones of the entrepreneur rather than those whose skills will counterbalance the entrepreneur’s weaknesses. No matter what the business, finding honest workers who share the owner’s passion and commitment can be an arduous and time-consuming process. To be sure, almost every small business has, at one time or another, been forced to hire the first breathing job applicant that appeared in the doorway. That being said, it is possible to entice capable people into joining an organization because it, or the person behind it, impresses them. Don’t be the type of boss whose behavior resulted in a prospective employee leaving his or her last job (‘Though we are supposedly living in a democracy, most of us spend our lives working in private tyrannies,’ says business writer John Emerson). As an entrepreneur, you may not be able to pay your employees more than your competitors, but you can certainly give them more. Employees should be trained properly and be made to feel useful because people work harder and show more commitment when they feel that they belong to an organization and are being listened to. In any business, employees come and go for any number of reasons, but it only makes sense to try and keep the good ones for as long as possible; high employee turnover is expensive, time consuming, and draining. For many small businesses the process of finding good employees begins by placing a classified ad in a newspaper or magazine, by sticking a ‘help wanted’ sign in a window, or, by pinning a notice on the bulletin board of a community center, supermarket, or similar venue. This obviously doesn’t allow for any screening to take place, but it can result in a larger number of potential candidates from which to choose. Employment agencies are another option (although their services may be expensive). Colleges, universities, and high schools provide an additional hunting ground particularly when it comes to part-time help. Don’t forget to ask friends and business contacts if they know of anyone looking for work – just be firm in insisting that the people you’re seeking must be qualified. Remember to keep a file of all candidates. You may need it in the future. Before a candidate has been selected, check his or her background. Any claims made on a resume should also be investigated. This will save a lot of time, money, and hassle. Plan the interview process in advance, prepare a list of questions, and try to determine how ‘hungry’ the candidate is to work. I, and others, have found many excellent employees by focusing on their desire to work rather than their education and experience. People who are hungry for work are usually committed and want to do well. Again, the more time and effort spent on finding and screening job applicants, the less chance there will be of suffering through the nightmare of staffing problems.

Reason 7: Inflexibility

Small businesses should not act like rigid, inflexible corporations. From the business plan to the marketing campaign to the importance of finalizing a sale, if something isn’t right it should be changed quickly. Change can happen in one of two ways: it can either be done by you or it can be used to run over you. Keep in mind the definition of insanity (the constant repetition of a behavior with the expectation of a different result) and the perils of inflexibility become more obvious. Persistence is an admirable trait, but when it turns into stubbornness it can lead to trouble. Examples of inflexibility in a business include not deferring to customer demands, feeling invincible against competitors, and refusing to acknowledge changes in technology, markets, or work practices. Simply put, the role of a business is to sell what customers want to buy, not what the business wants to sell (and selling what customers want includes how, when, and where the customer wants the product sold). For example, many years ago I worked for a fitness club that decided to adopt a direct debit billing format. At the time direct debit was a new concept and many customers were reluctant to authorize an automatic monthly deduction of fees from their bank accounts. One day a man came in to buy a year’s membership for his son. As I began to explain our direct debit policy, he pulled out a wad of cash. ‘I’d like to pay with this if you don’t mind,’ he said. At that moment the club’s manager walked by. ‘What are you doing?’ he bellowed, ‘I’ve said 100 times that customer payments can only be made by direct debit!’ Of course the customer left. Needless to say, the business collapsed soon afterwards. Years later I found myself in England joining a local gym. ‘Would you like me to pay by cash, cheque, or credit card?’ I asked. ‘Yes, yes, or yes,’ the owner cheerfully replied, ‘whatever’s convenient for you.’ Now that’s good business!

Reason 8: Poor Marketing and/or an Inability to Sell

Contrary to popular belief, if you build a better mousetrap the world will not beat a path to your door. Equally as true is that good products and services do not sell themselves. Simply put, the success of every enterprise hinges on its ability to sell – and an ability to sell begins by understanding the basics of marketing, promotion, and human psychology. Additional problems associated with poor marketing and selling include relying too much on one particular customer, not focusing on a particular market segment, not undergoing sales training, and ignoring the competition (every business is always competing against something – even if it’s just a customer’s time). To remain solvent, a business must be able to successfully: − announce to potential customers what is being sold, − generate continuous interest and excitement in what is being sold, and, − finalize a sale before a competitor takes it away. Don’t sell yourself short.

Reason 9: Not Enough Capital

Too many new business owners underestimate how much money they need. Not to get their business off the ground, but to keep it running through the first year or so of operations when money is tight. That’s not to say that buckets of money are needed to succeed as an entrepreneur. For example, one entrepreneur in the USA made a tidy profit writing and selling a small booklet the contained recipes for 100 different meals made with ground beef. Another American entrepreneur sold fishing lures by doing little more than advertising in a sports journal. For one dollar and the cost of postage, readers were asked to send in an unlucky lure for which they would receive a different lure in reply. The scheme was nothing more than a used product swap yet no one complained and it produced a small profit (Halloran, 1992). Unfortunately, most businesses need more than a few recipes or a fishing lure to get started. You may recall that the first chapter of this book claims that passion and commitment are more important than money when it comes to starting a business. According to many practitioners this is true, however, it’s also true that most businesses don’t make any money during their first year or two of operations. Funding is therefore needed to cover taxes, wages, raw materials and other costs, as well as the personal requirements of the owner (e.g.: food, medical insurance, a mortgage (or rent), car expenses, and so on). With this in mind, many successful entrepreneurs suggest pursuing several sources of finance rather than just one (which could dry up). If possible, they also suggest trying to collect an additional three to six months worth of extra working capital to put aside for emergencies. ‘If your business idea needs a lot of money to get started then you’re probably thinking too big,’ says one millionaire, ‘consider starting out smaller.’

Reason 10: Pricing Problems

The price of a product is usually the most significant factor affecting a customer’s decision as to whether or not the product will be bought. Equally as true is that a price contains the profit a business hopes to make. Entrepreneurs want to make as much money as they can while customers want to save as much money as possible. Unfortunately, it’s the entrepreneur that usually loses this struggle. In a bid to attract customers, the most common pricing mistake made by new businesses (especially service providers) is to undercharge or give away labor or materials to attract customers. Yet once a product has been dispensed for free the business no longer has any leverage to collect payment. Another factor that must be considered when establishing a good price is the amount of time, work, and effort invested in the product or service. Setting a price involves much more than covering expenses or charging what everyone else is charging.

Reason 11: Lack of a Competitive Edge

Many small businesses starts out as a cutout copy of another business, thereby providing no incentive for customers to choose it over the available competition. Every enterprise should therefore have at least one aspect that distinguishes it from its competitors. Domino’s Pizza, for example, made its name by focusing on fast deliveries – something few other pizza parlors provided at the time. Dell Computer stays at, or near, the top of its market by manufacturing a personalized product faster than any other computer company in the market. How do businesses like these become unique – and how can yours? The ‘Marketing Mix’ elements discussed in Chapter 24 provide a good starting point. Garvin’s ‘Eight Quality Dimensions’ in Chapter 26, combined with a thorough understanding of the wants and needs of customers, can also be of help. For more information on how to obtain a competitive edge, re-examine Chapters 3, 23, 25, 27, and 31.

Reason 12: Going it Alone

Along with not doing enough research and not establishing a close relationship with customers (as well as suppliers), going it alone means relying totally on your own, infallible, all-knowing and superior intellect. Put another way, so many qualified people, books, education centers, and government programs are available to help entrepreneurs that it simply doesn’t make sense to venture into the marketplace alone. If help is needed it should be asked for. The economic strength of a nation is often reflected in the ease or difficulty with which a citizen can start a business. That’s why it can take thousands of dollars, hundreds of pages of forms, and more than a year of effort to register a business in many developing countries. Developed countries, on the other hand, make the process easier. In the UK, check the phonebook or the Internet to find the location of the nearest Training and Enterprise Council or small business information center. In France, contact the Pret a la Creation d’Enterprise (PCE). In Mexico, the First Contact Entrepreneurial Advisory Centre and CONTACTO pyME are available to help entrepreneurs. Belgium has a program that actually gives money to entrepreneurs to help start their own business (contact the Foundation for Research and Education in Entrepreneurship, or FREE, for details). Likewise, Europeans can seek out nearby SOLVIT Centers, which are located across the continent. In the Netherlands, entrepreneurs can make inquiries through TAOM, a program that offers technical assistance. In the USA, the Small Business Administration (SBA) provides help to local businesses. The Service Corps of Retired Executives (SCORE), an offshoot of this program, is yet another assistance venue. Small Business Development Centers (SBDC), many on the campuses of colleges and universities, provide an additional alternative. Business schools, universities, city halls, community centers, trade associations, and books make for further sources of information – and don’t forget the local Chamber of Commerce. The seminars, guidance, training, and pamphlets these organizations offer are bound to suit the needs of almost any entrepreneur.

Reason 13: Growing Too Fast

As odd as it may sound, having too many customers can kill a business. Think of it this way: if a business is swamped with increasing customer orders it has to increase its output, which means that it has to purchase more raw materials, buy more equipment, and possibly hire more personnel. Meanwhile the business is stuck producing the same output until it has the full ability to do more. In other words, expenses soar while revenues stay the same. This lack of incoming cash and increasing debt can result in big problems – and not just financial ones. When a business can’t deliver what it promises word of mouth spreads and customers quickly go elsewhere. Research has shown that happy customers tell three to four people about their experience while unhappy customers relay their disgruntlement to as many as 20 people. It is therefore prudent for business operators to have an adequate plan that takes into account what will be done to increase output or expand operations before the business starts growing. For example, one restaurateur discovered that the only way he could placate his growing number of customers – most of whom he had to turn away – was to offer free wine and appetizers while they stood in line. His next step was to initiate a table-booking system that didn’t offend his regular customers. In the meantime, he made plans to borrow money, expand his premises, and hire and train new employees. There is simply no other way to put it: growing businesses usually have to take on some form of structured debt in order to cover their expenses. See Chapter 12 for ideas on how outside funding can be obtained.

Advice from the Pros –

The 13 Reasons Why Business Fail should be addressed in every business plan. Don’t ignore them.

 − It’s not necessary to know everything there is to know about a business before starting one, however, it is necessary to learn as much as possible. Don’t think that the law of business failure averages does not apply to you. Familiarize yourself with the basics of business, as well as the all-too-common mistakes others make, before taking the leap into a new business venture.

− In addition to the 13 Reasons Why Businesses Fail, a few other factors can just as easily wipe out an unprepared beginner (most of which fall under the category of poor management or lack of planning). Be familiar with them. They include:

  •  Procrastination with decision making and/or the initiation of changes,
  • Failing to respond to competitors,
  • Not understanding the competition and why it either succeeds or fails
  • Not adapting to a changing market
  • Failing to prepare for the inevitability of traditionally volatile costs (fuel, raw materials, insurance, labor…)
  • Poor internal business controls (i.e.: lousy customer service, poor accounting, bad record-keeping, theft, fraud, etc…)
  • Focusing too much on cost-cutting (i.e.: not controlling controllable expenses)

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