Why Small Businesses Fail

Small businesses have forever been the heart of the American economy. Why is it then that so many of them fail when they are so vital? From the invention of new products, to the creation of jobs and higher personal income, small business is responsible for many positive aspects of our economy. They contribute to a positive national growth even though roughly 30% of new companies fail in three years and 50% in five. Research shows that there are ten common aspects that play a role in the demise of small business:

  • Started for the wrong reasons
  • Poor Management
  • Insufficient Capital
  • Location
  • Lack of Planning
  • Overexpansion
  • Theft
  • Recession.
  • Competition
  • Lack of Market Segmentation

Knowing these factors can lead not only to keeping your business viable but can contribute to its success.

Starting for the Wrong Reasons

Many people who start a business get into it for the wrong reasons. For instance, some people might begin a new business venture to avoid having a boss; this may be true, but only in a limited capacity. The demands of customers, business partners, and the regulative bodies surrounding their business may be the equivalent, or possibly worse, than a heavy-handed boss. Other entrepreneurs believe that by starting their own business they can get rich quick, and live the easy life—this is hardly ever the case. Most businesses require an abundance of time and attention to run the day to day operations, and because associated costs are so high, it is important to not make an impulsive decision: it is essential that the potential owner properly evaluate their options and the resources involved in setting up a business.

One of the most important things when making a life altering decision such as starting a new business is being passionate about what you are doing. Being passionate about the business, and the industry it is apart of, will reflect in the amount of effort and preparation made. New owner’s will place more emphasis on researching competitors and different suppliers, and will have a greater level of commitment to weather the ups and downs of business life. When most small business owners throw in the towel, a person who is passionate about their business will exhibit drive, determination, patience, and maintain a positive attitude while preparing for the long haul.

Secondly, most individual business owners thrive on independence; however, knowing that they are in control of their own destiny is not for the faint of heart. Starting for the wrong reasons is a common mistake, but it can be easily avoided by knowing what and why you are getting into the business of doing business.

Poor Management

When running one’s own business and things are not going well, the first place to look is at the owner for only 18.2% of a business is outside their control. Some entrepreneurs start their own business without fully evaluating themselves and their managing ability. While they might have all the business intelligence needed they might not have an adequate managing style. A person, who has people skills and easily gains the respect of their workers, can lead a group of people to success; however, that same person, without a business instinct, would not survive two weeks as a business owner. Conversely, an entrepreneur who has a fantastic idea and business plan could be a horrible manager of people. As a result of this, the entrepreneur could experience a high turnover rate, unhappy employees, and thus unhappy customers.

As a business owner you must surround yourself with people of expertise in areas such as finance, management, purchasing, sales, production, and human resources if your skill set does not match those key areas of day-to-day business. It is very rare that one person can become an expert in all of those areas without sacrificing quality in certain areas of the business. Surrounding yourself with knowledgeable people can fill the voids that as an owner one might lack. Knowledge is power; with power comes success; and with success comes greater knowledge. Expertise might very well be the saving grace of your particular company, and trying to do everything on your own could be its downfall.

Insufficient Funds

One reason some small businesses fail, although probably the most obvious, is insufficient funds. Some small business owners underestimate the complex and extensive costs of running a business. Significant time and effort must be put into planning and predicting the day-to-day costs of running a business. Everything from electricity, to break-room amenities, must be accurately assessed, because miscalculations in these costs can greatly reduce profit margin and the overall viability of the business. Planning is also crucial if a loan is needed to get a small business off of the ground. Going to a bank with an incomplete or inaccurate analysis could cause the bank to reject your loan request and stall the owner’s progress on getting started.

Secondly, if the owner is not the type of person who is frugal, and can not easily manage money, then starting a business could be very difficult. Being able to manage the books, and keeping the company in the black is no small task. Making sure your bills are paid on time, keeping your store or business stocked with inventory, and keeping up with employee expenses could be a menacing task in itself. It is important to properly budget for all costs, including, among others, inventories, advertising and taxes. Insufficient funds should be the last thing that keeps a business from being successful, but unfortunately it is one of the most common pitfalls. Always keep good records, and if this is not an area of expertise, employ an accountant.

Finally, the most important thing for all businesses is cash flow.  All businesses need to have a secure cash flow to ensure that payments go out on time and so the owner can reinvest in the company to continue to make it flourish.

Location, Location, Location

Location is the unofficial “make or break” point of a small business. The importance of location depends on the type of business, the facilities and resources, and where your customers are. A bad location can cause the business to fail, while a good location can help give the business that extra edge it needs to be successful. If the business is in a hidden, inconvenient location, it will not matter how exceptional the product or service is because visibility will be minimal. Some factors to consider where choosing a location:

  • Where your customers are
  • Traffic, accessibility, parking and lighting
  • Location of competitors
  • Condition and safety of building
  • Local incentive programs for business start-ups in specific targeted areas
  • The history, community flavor, and receptiveness to a new business at a prospective site

If the business deals with distribution, then location is vital; however, if the business is internet based or strictly informational, then location does not play as much of a dominant role. Before looking for a location, the before mentioned factors need to be considered, thus leading to a decision of what is important to you and your business. Once the mistake is made it is very difficult if not impossible to reverse. You will also have to consider taxes, costs, security, availability, infrastructure, and personal considerations. Please see the checklist attached in the appendix.

Lack of Planning/Experience

It is very important to a small business to know what lies ahead so management can plan and execute ideas that will let the small business thrive. Many small businesses fail because of lack of planning. It is very crucial that a small business, before it gets off of the ground, develop a business plan. It does not necessarily have to be a detailed 40 page work of art, but it needs to at least be in construction because it shows that leadership has thought of all the aspects of the company, market, and competition. A carefully scripted business plan forces the company to think about the future and the challenges it will face. It also forces the company to consider financial needs, marketing and management plans, competition, and the overall blueprint for success. Lack of planning can also be that the owners are looking too much in the present and not enough in the future. With this lack of foresight comes a failure to look at the big picture.

Lacking experience is another reason why small businesses fizzle out. Even though the owner of the small business might have the passion and desire for this newly founded business, they might not have the know-how. The smartest business owners surround themselves with experts in areas of business in which they are weak. Too often, owners try to do everything themselves to save money but they pay the ultimate price.

Overexpansion

Overexpansion is another key factor in a businesses’ success. Before you even think about expanding you have to establish a strong customer base and have a good cash flow. Many business owners confuse success with ability to expand. Overexpansion causes the owner to get in over their head. The optimum growth pattern for a business is slow and steady. This will help to keep the business owner out of trouble from over expanding. Overexpansion leads to one terrifying thing—bankruptcy, but being timid towards growth is not healthy for your business either. Finding a happy medium is crucial. If looking, clues that may indicate the need for expansion such as your employees have a difficult time keeping up with production demands and satisfying the needs of customers in a timely manner should be easy to find. If you are still considering expansion after careful review, you need to brainstorm and reevaluate your customer’s needs and wants.

Theft

Theft is a big problem in any business no matter how big or small. There are many different kinds of theft; mainly internal and external. Internal theft is a big problem for small companies whether the economy is good or bad. Thirty percent of business failures result from employee losses according to the U.S. Commerce Department. They also estimate that American companies loose $20-40 billion annually from employee theft.

Smaller companies tend to be more at risk because they cannot withstand the effects of employee theft like a big corporation can. Here are some ways to try to safeguard your business from employee theft:

  • Screen job candidates thoroughly
  • Write and post an ethical conduct policy
  • Educate workers of the cost of theft to the business
  • Make it hard to steal
  • Conduct an annual independent audit of your books
  • Always require a counter-signature on company checks
  • Take time to go over accounts payable
  • Do not allow company books to leave your office

Other ways to help prevent and handle employee theft is to implement an anonymous reporting system, create a positive work environment, investigate every incident, and perform regular and irregular audits. External theft is also a thriving issue. If you take standard precautions to reduce theft, external theft should not be a big issue.

Recession

An economy in recession hurts everyone, but it especially hurts the small business owner who depends on a healthy economy—an economy that has money to spend. Usually a recession is something that a new business owner cannot predict such as a natural disaster, but it is important that if offering an economically sensitive product the owner try to wait.  Although generally unpredictable, it is important that a business retain some earnings if possible to ensure that recessions do not hit the business owner’s pocket too hard.

Competition

One of the major contributors to why small businesses fail is the increased competition that they face upon setting up. Small businesses can also underestimate customer loyalty to competitors. Small businesses often overestimate demand and usually have no unique selling proposition built into their product. If you are unable to differentiate yourself in an already competitive market you are always going to be in a losing situation. When setting up a business, you need to establish how many other businesses there are that you would be directly competing with. I.e.—if opening up a new restaurant, how many others are there within a 5/10/20 mile radius? Then you need to establish who exactly is in your target market i.e.—age, class (going to be fast food or a high-end restaurant?). Using extensive market research enables you to know who exactly your competitors are, what competitors are doing correctly, what are their weaknesses, what do the general public think of their products, and where potential customers are likely to shop. Using this information allows modification of your own product: building on competitors strengths and eliminating their weaknesses to maximize sales.

Lack of Market Segmentation

Lack of market segmentation can lead to very severe problems for businesses. Without an established target market, no business can expect to succeed as resources can be very easily wasted. Costs such as advertising and extra inventory can prove to be unnecessary if they are being targeted towards the wrong people, indicating the importance of clear segmentation. When setting up, the first step is to establish the scope of your market: is your market going to local or global? For most small businesses, the scope will be local, trying to establish a base of repeat customers. Secondly, you need to build a comprehensive profile of consumers in your target market, encompassing as much information as possible—this is where marketing research is vitally important. Reports, such as the census, can be used to verify the size of your potential market using statistics such as the age percentages, the total number of people within a 20 mile radius of your location, etc. Once the target market has been established you are able to use these statistics to build a sales forecast. A sales forecast is one of the most important pieces of information for any business and its marketing plan. A sales forecast sets the standard for expenses, profits and growth, and can be used by businesses to justify loans for which they apply. Having verified the size of your potential market (census, own research etc.), you are able to estimate what percentage you are likely to get; however, this is often where businesses can also overestimate demand for their products. The best way to do this is to conduct your own market research, through surveys/questionnaires, or observe what products your target market are buying that are similar to your own.

When it comes to the profitability of any new business, the business owner is ultimately the “secret” to its success. What sets a mediocre business from an overnight triumph is their openness to new knowledge and their willingness to learn whatever it takes to succeed. History shows that companies will continue to make these ten fundamental mistakes; however, knowing these common pitfalls before-hand can lead to a company making greater strides towards being successful.

 

Works Cited

Starting For the Wrong Reasons/Poor Management/Insufficient Funds/Competition/Lack of Market Segmentation:

Entrepreneurial Small Business, 2nd edition, by Katz and Green. Chapters 7 and 12.

http://alliedacademies.org/Publications/Journals/ee1-2.pdf#page=14

http://www.businessknowhow.com/startup/business-failure.htm

http://smallbusiness-bigresults.com/whybusinessesfail.htm

http://www.nfcpa.com/whysmallbusinessesfail/

http://www.threshold-fti.com/newhome/Graphics/icon-graph.gif

Location:

http://www.powerhomebiz.com/vol14/location.htm

http://www.entrepreneur.com/startingabusiness/startupbasics/location/article21830.html

http://smallbusiness.findlaw.com/business-forms-contracts/business-forms-contracts-a-to-z/be4_4_1.html

http://www.foxbusiness.com/story/personal-finance/on-topic/small-business-owners-location-location-location/

http://www.businessknowhow.com/startup/business-failure.htm

Theft:

http://images.google.com/imgres?imgurl=http://i79.photobucket.com/albums/j142/bluewater1818/theft_graph.jpg&imgrefurl=http://stealthsecuritysolutions.org/LossPrevention.aspx&h=325&w=306&sz=15&hl=en&start=1&usg=__whlzpj-wWEfMeQxcNLZF7lKNa9Y=&tbnid=RWysp-AOIi8q6M:&tbnh=118&tbnw=111&prev=/images%3Fq%3Dsmall%2Bbusiness%2Btheft%2Bgraph%26hl%3Den%26lr%3D%26sa%3DN

http://www.newyork.bbb.org/WWWRoot/SitePage.aspx?site=24&id=a4d6526c-481d-4c8a-8c03-97a20867460d

http://www.bankrate.com/brm/news/biz/Biz_ops/20001207a.asp

http://smallbusiness.yahoo.com/r-article-a-2000-m-4-sc-23-eight_tips_to_prevent_employee_theft_and_fraud-i

http://www.bmighty.com/blog/main/archives/2008/09/top_tips_for_pr.html

Lack of Planning/Experience:

http://www.allbusiness.com/business-planning-structures/business-plans/1440-1.html

http://www.businessknowhow.com/startup/business-failure.htm

http://www.captureplanning.com/articles/69960.cfm?

http://smallbusiness-bigresults.com/whybusinessesfail.htm

Recession:

http://www.nfcpa.com/whysmallbusinessesfail/

Overexpansion:

http://www.morebusiness.com/getting_started/primer/steps-successful-business-8.brc.brc

http://www.businessknowhow.com/startup/business-failure.htm

 


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