Running a business is very risky. In fact, an estimated 49% of businesses fail within their first five years and approximately 30% of businesses don’t even make it through the first two years. Some industries are particularly risky and have even higher failure rates. For example, about 61% of independent restaurants don’t make it through their first three years, and the failure rate for technology startups is about three times higher than that of all other businesses.
These statistics may not be very encouraging to new entrepreneurs. But chance only plays a small role in a business’s fate. Most fail due to lack of direction, poor planning, or poor leadership, even if the idea, product, or service is a winner.
So how can your business avoid failure? We’ll take a look at common problems and real-life examples of business failures to find out.
Importance of a Good Business Model
A business model is the method by which a company develops and creates value for its customers. It is an essential element of the company’s core strategy. However, if the business model isn’t solid or is fraught with problems, the business is inherently at risk.
Some problems in a company’s business model may include:
- Saturated Market. Sometimes a company may try to reach customers who don’t need more of a certain product. When customers are satisfied with what they have, they have no incentive to purchase more, and the market is thus considered saturated. In this case, the company will struggle to find a customer base.
- Too Much Competition. The more competitive a market, the harder each company must work to gain market share. In fact, established competitors are likely to be very powerful and resourceful and can easily drive new companies out of business. For example, major retailers like Walmart have been blamed for the failure of many smaller businesses that simply could not compete.
- Barriers to Entry. Some industries are difficult to get into. This could be because legal requirements are prohibitive or because start-up costs are high. This can make the process of entry too cumbersome for many companies such that they fail even before they get off the ground. In fact, barriers to entry may not be immediately evident in the beginning, especially if the product or service is new or has not been sufficiently researched.
- Bad Idea. Many entrepreneurs think they have the next big idea. They believe their product will be a rip-roaring success right after they implement it. Because of their conviction, they don’t take the time to understand the target market or to market test their product effectively.
- Difficult to Implement. Some businesses can be too optimistic about what it takes to manifest their plans. They may not realize how complex their product is or how difficult it will be to design or assemble. For example, a company may get the ball rolling only to discover that they have neither the resources nor the talent necessary to keep it going.
- Outdated Technology. Businesses must also understand the importance of technology to their business. State-of-the-art computer or manufacturing systems may streamline a competitor’s business and save them millions of dollars. But a business that tries to compete with outdated technology is unlikely to hold a competitive advantage, or they’re unlikely to hold one for long.
A bad business model can ruin a good company. Businesses need to thoroughly understand what their customers want, and how to efficiently produce and deliver their products or services. The key to avoiding a bad business model is to invest the time and money in solid research and planning.
Management and Attitude
You’ve heard that attitude is everything. Well, it may not be everything when you go into business, but the wrong attitude can certainly ruin everything in spite of the best laid-out plans.
Some entrepreneurs go into business because they are passionate about the product or service they want to offer. While having a passion is extremely important to making a business successful, unfortunately, passion alone isn’t enough.
A mentor once shared a story with me about his brother who had a passion for parrots. He thought the rest of the world must also love parrots, so he decided to start a business that specialized in selling parrots. He was disappointed, however, when it didn’t turn out to be as successful as he had hoped.
His mistake was in identifying his target market. Or rather, in misidentifying it. He didn’t realize he’d have to take extra steps to reach other parrot lovers since he assumed that everyone felt the same way he did. Fortunately, he changed his mind about selling parrots and started a dog-washing business instead. Since this was a service that appealed to more of his target market, he ended up making more money.
Doing what you love is important, but it cannot be your only consideration for starting a business. Profits need to be a primary objective in order for any business to survive. If passion gets in the way of a proper business model or planning, it can be downright destructive.
That said, the right attitude is an unbiased one. If you can objectively examine what is likely to work and not to work according to your research and not your emotions, your chances for success are that much higher.
Poor Research and Planning
Successful companies make sure they have all their ducks in a row before they ever open shop, which means the research and planning process often takes months. Here are some questions to be answered before a business is launched:
- Who Are the Customers? A business needs to identify all potential buyers for a product or service. They should further break customers down into demographics and identify how large the market is for each group.
- How Does Competition Work in the Industry? Understanding how the other players compete is key. Sometimes it’s a good idea to go against the status quo, whereas in other instances it’s best not to reinvent the wheel. Either way, entrepreneurs need to identify these processes ahead of time and establish their own strategy.
- Which Group Should They Target? A business should select a market that is substantial, but not overly targeted by competitors. Moreover, it’s best to target a market that is understood, perhaps a market that the business owners themselves are members of. Competition within that market should also be analyzed to ensure the niche will be profitable.
- What Laws and Regulations Need to Be Followed? Businesses are subject to state and city laws, as well as regulations set by and for their respective industries. Failure to follow the regulations of city, state, or federal government agencies can lead to lawsuits, fines, forced closures, and even imprisonment. Businesses that fail to take these factors into consideration place themselves in serious jeopardy.
Some businesses are run by individuals who have a great concept, but lack leadership skills. The following traits are often necessary to lead a company to success:
- Experience and Understanding of the Business. A good leader will have been around the block enough times to know what works and what doesn’t. They know what customers are looking for, how to negotiate deals, and how to resolve conflicts.
- Ability to Think Under Pressure. Running a business can be very stressful. A good leader will know how to deal with it.
- Ability to Prioritize. Running a business is all about multi-tasking, which means deciding where, when, and how to exert resources in multiple directions. If the most important tasks aren’t attended to, the business is much more likely to fail.
- Ability to Make Hard Decisions. Sometimes leaders have to make decisions that are unpleasant for themselves or someone else in order to benefit the company. This could mean letting someone go, saying no to a client, or cutting wages. Moreover, a leader may be subject to blame, criticism, or frustration as a result of their decisions. The ability to deal effectively with this type of stress is paramount to good leadership ability.
- Ability to Inspire and Motivate. Good leaders can create passion and motivation in their employees. If they believe in their employees, their employees will likely believe in them and support the direction they’re taking the company in.
Managing cash and financing is key to keeping a business alive. If companies don’t have the finances to pay their bills, they will fail.
Many businesses don’t realize how much money they really need to keep their company going. They may be wise to try “bootstrapping” their companies on a limited budget. However, successfully bootstrapping a company requires carefully monitoring finances.
Sooner or later, bills need to be paid and companies that are unable to do so end up filing for bankruptcy. It is essential that business owners have an idea of how much they are going to spend ahead of time and prepare accordingly.
Lack of Cash Flow
Obviously, the goal of a business is to maximize sales and profits. But even then, running a profitable business does not necessarily guarantee survival. Many businesses have high sales volumes and healthy profit margins. However, problems can arise when a lot of these sales are on credit. The business must wait to get their money and some customers are likely to default on payment.
In the meantime, the business’s bills continue, most of which probably require cash. Therefore, if businesses don’t have a healthy amount of cash on hand, they can go bankrupt rather quickly. Moreover, if a business brings in many sales on credit, it may need to find a cash supplier to pay the bills while waiting for their customers to make good on their loans. Cash is king after all.
Economic factors can be some of the hardest to deal with because entrepreneurs often feel powerless to do anything about them. Though this isn’t necessarily the case, a poor economy can make survival much more difficult. Some common economic issues to contend with include:
Changes in Spending
When consumers have less money to spend, businesses suffer. This creates a domino effect that touches almost every business. Recessions come and go, but particularly bad ones will be devastating and collapse many businesses in their wake. Those that survive generally find ways to operate on a leaner budget and offer value to their clients in spite of a rough economy.
One mistake a business can make is in cutting their prices substantially during poor economic times. This can reduce profit margins such that if sales drop further, meager profits morph into devastating losses. It can be more advantageous to add greater value to products or services at the same price point instead of lowering prices.
Changes in Consumer and Industry Trends
Market trends often change and fads come and go. Some businesses fail to adapt to changing customer interests and expectations, which means at worst their entire line of products could become obsolete. In this case, a drastic change in the business structure and model may be necessary. But this is too often a change that many businesses are unwilling or unable to make.
The infrastructure of a business can change as well. For example, IBM found itself in a position where it could no longer compete in the PC industry it once dominated. Fortunately, the company was smart enough to adapt its core business strategy and find a new market. This is something that many businesses are unable to do. They end up either willingly closing shop or being driven out of business.
Legal problems can be extremely expensive and can lead to a forced business closure or even bankruptcy.
Lawsuits and Investigations
Businesses are at risk from all angles here. For example, a lawsuit that ensues from a customer slipping on a floor can cripple a company, regardless of whether the business wins or loses. Or a business may be shut down for violating government statutes, such as health code violations or SEC regulations.
In addition to court costs themselves, legal battles can have lasting repercussions. After a business has been sued or prosecuted for an injury, they may lose trust with customers, creditors, and employees, and be required to pay more in the way of operating expenses, such as insurance.
Changes in Regulations
Businesses are also vulnerable to changing government regulations. If the government decides to be stricter about certain practices, they may enact policies that will increase the costs for many businesses. These practices are not intended to drive companies out of business and most will survive just fine.
However, some businesses may be more vulnerable to such changes due to their size or the way they operate. Combined with other factors, changes in government regulations may cause or contribute to a business’s failure.
Large Companies Aren’t Immune
Although small businesses have a high failure rate, large companies can go bankrupt as well. In recent years, large company failures include:
- General Motors. In 2009, General Motors went bankrupt after operating for over a century. The company failed for a variety of reasons, perhaps the most critical being that it didn’t create vehicles that could compete in a global economy.
- Enron. The Enron scandal was one of the biggest in history. Enron committed 98 cases of fraud, including money laundering, insider trading, and creating falsified money statements. After a whistleblower lawsuit, the company went bankrupt. Enron stands as a stunning example of what happens when a company engages in unethical behavior.
- MySpace. MySpace was one of the first social networking sites. Initially, the site was a major success. In 2006, it was the most popular social networking site in the U.S. However, within two years, MySpace was toppled by its main competitor, Facebook. MySpace failed to adapt to the changing social networking environment and its service quickly lost any distinguishing characteristics.
- Napster. Napster was a peer-to-peer file sharing site. It was one of the first of its kind, but other sites such as Bearshare, Frostwire, Gnutella, Freenet, and Limewire came along and ate up much of the market demand. Moreover, Napster got in trouble over copyright infringement, ultimately forcing the company to completely rebuild its business strategy.
- Borders. Borders was once one of the largest bookstores in the United States. However, it was forced to close and liquidate in 2011 due to massive debt; Borders borrowed over $40 million at very high interest rates. Struggling to repay the debt and find a way to compete with electronic books and online retailers, Borders was forced into liquidation.
Even if a business is doing well on most levels, one major problem can lead to its decline. Or a combination of multiple minor problems can end up being too much for a business to handle. It is difficult to be one of the few that survives; it takes capable leadership, adequate financing, well-defined goals, effective business practices, and more than a little bit of luck.
An old business professor of mine once told me to think of a business like a car. If one part stops working, the whole thing can come to a halt.
What are some other reasons why businesses fail? Have you experienced any of these first hand?
(photo credit: Shutterstock)