Reasons For The Fall Of Small Businesses And Methods To Avoid It - Research Paper Example

Reasons For The Fall Of Small Businesses And Methods To Avoid It In recent times every other day one can hear of another store or business shutting doors and invariably the reasons associated with such failures are economic meltdown, recession, or no liquidity in the market. However, researchers find different reasons why stores shut down or businesses fail and economic recession is not always the cause and not the only cause. Watson and Everett (1995) found through a study over a period of 30 years that the rate of failure of small businesses decreases as the business enters the 6th year of its existence. This implies that strategy-ups in the first five years have a high chance of failure. Large businesses tend to have rates of failure than small businesses when bankruptcy is the definition for failures. The rate of failures in small businesses is high when there is discontinuance of management (definition of failure in case of small businesses). Sometimes stores shut down to prevent further losses or there is discontinuation of ownership and all fall under the category of failures. Any business failure is associated with lack of vision and direction from the top management, poor business forecasting and the inability to take strong decisions. Pricing decisions and lack of proper understanding of customer demands are other reasons where marketing efforts fail. Lack of working capital, excessive debt, eroding profit margins, excessive overheads and generating inaccurate financial performance data add to the problems of inefficiency thereby leading to closing of business units. Longenecker Simonetti and Skarkey (1999) conducted a study of 25 organizations to study the causes of failure and their study revealed the following: Source: Longenecker Simonetti and Skarkey (1999) The study revealed that small, simple things when ignored can lead to problems. Managers have to be effective, leaders have to lead and the management fundamentals have to be strong. Several studies have been conducted why businesses fail and there is no consensus on the arsons. Some do hold the economic recession as partly responsible for the failures. A study of 100 entrepreneurs by Lussier (1996) revealed the following reasons of failure: Source: Lussier (1996) Dun & Bradstreet recorded business failures per 10,000 firms as per the table below: Source: Altman, 1983 This table demonstrates that failure rates increase during the recessionary period. Credit market availability, capital market activity and price changes affect businesses. Conditions leading to change in business profits are logically related to failures since even a slight drop in profits, especially when the firm is working on marginal profits, can be critical to its existence (Altman, 1983). Credit conditions depend on the supply and demand for funds. Hence businesses can fail to the cumulative effects of reduced real economic growth, reduced stock market performance, reduced money supply growth and increased business formation. Reasons for failures led Magretta (2002) to believe that businesses do not start with a definite or an appropriate business model. Most often businesses do not differentiate between business model and business strategy. For instance, during the internet boom everyone started the web-based business model. Everyone started an online business without any special competence in the hope of receiving wild-profits in some distant, ill-defined future. While the web-based business model may have been right but there was distortion and misuse as in the case of Webvan. When online stores started several entrepreneurs entered the market without any concrete plans in place. Everyone wanted to become big fast during the dotcom boom. Webvan the online retailers, started with enormous infrastructure and established itself in multiple geographical areas too quickly, which became the prime reason for its failure (Farmer & Sandoval, 2001). It faced a number of challenges including sluggish consumer spending, investor indifference and a sharp economic downturn. Webvan’s closure does not indicate that online grocery business was going down; the business model would have to change. When they changed their delivery fees, they experienced reduce in orders. During the same time, they received adverse publicity when the CEO stepped down. In its initial years, Webvan had attracted more funding that any other e-tailing company except for Amazon.com. It had raised $375 million in its initial public offering and has high-profile backers like Benchmark Capital, Softbank, and Sequoia Capital. They were once worth $1.2 billion and covered 26 cities. It had also acquired HomeGrocer, one of its leading rivals. However, over-ambitious plane without proper funding brought down the company to such a state that they had to file for bankruptcy. A business has to start on a scientific basis with a hypothesis which has to be tested in action. A good business model would begin with an insight into human motivations and end in a rich stream of profits (Magretta, 2002). Businesses may have sound model on which they are built but they do not have the right strategy. They usually do not factor in the competitors and every business, sooner or later has to face competition. The strategy has to focus on how the store or the business can be different from others. Thus, when stores of the same kind open all over or say when everyone enters the apparel market some have to close down. While it may benefit the customers as the prices go down due to competition but in the long run, the prices are driven down to such an extent that it no more profitable for the business. This has been termed as destructive competition by Michael Porter when too many companies rush to the market with identical business models with no definite strategy concerning the customers or the product offerings in place. A business strategy should be difficult to replicate. This concept of a new and innovative business model brought hot new outdoor-apparel brand Nau crashing down in 15 months (Salkever, 2008). They had started on a model that they want to serve the society and offer eco-friendly products as they felt customers would not object to paying a premium price for such products. They had decided to keep away 5 percent of their sales for charity and wanted to have a socially and environmentally responsible business. They had not done any market research prior to their venture and just followed on the success of others. All of their five stores had to be sold off to someone who immediately realized the problems in the business model. Trying to break too many conventions at the same time is not the right business strategy. They had decided on a social commitment and they found it difficult to go back on their own commitment. Their plans were too ambitious and the capital at hand was not sufficient to fund their ambitions. Harold’s Department Stores blame increased competition and a weak economy for going out of business (Beacon, 2008) while Circuit City, once the biggest US electronics retailer, founded in 1949, lost market share to Wal-Mart, Best Buy and online retailers (Church & Clothier, 2009). Shutting down of stores like these suggest that the business model has to change with times. As Magretta suggests, businesses tend to forget that they would encounter competition at some point. Thus we can see that the reasons for failures of stores and businesses cannot be attributed to one reason alone. It basically lies in the vision and direction of the top management and the ability to take firm decisions. Economic recession can only be an impetus for faster closure but cannot bring about a failure of a business unless it has been going through tough times from before. People enter the foray without any strategic planning, market research, market segmentation and without a proper capital base. References Altman, EI 1983, 'Why Businesses Fail', retrieved online 30th March 2009, from http://www.emeraldinsight.com/Insight/viewPDF.jsp?contentType=Article&Filename=html/Output/Published/EmeraldFullTextArticle/Pdf/2880030402.pdf Beacon, T 2008, 'Harold’s Department stores go out', retrieved online 30th March 2009, from http://www.tulsabeacon.com/?p=1187 Church, S & Clothier, M 2009, 'Circuit City to Go Out of Business After 60 Years', Bloomberg, retrieved online 30th March 2009, from http://www.bloomberg.com/apps/news?pid=20601087&sid=ao7Sc7m4zbRI&refer=home Farmer, MA & Sandoval, , 2001, ' Webvan delivers its last word: Bankruptcy', retrieved online 30th March 2009, from http://news.cnet.com/2100-1017-269594.html Longenecker, CO Simonetti, JL & Skarkey, TL 1999, 'Why organizations fail: the view from the front-line', Management Decision, vol. 37, no. 6, pp. 503-513. Lussier, RN 1996, 'REASONS WHY SMALL BUSINESSES FAIL: AND HOW TO AVOID FAILURE', The Entrepreneurial Executive, vol. 1, no. 2, Fall 1996, retrieved online 30th March 2009, from http://alliedacademies.org/Publications/Journals/ee1-2.pdf#page=14 Magretta, J 2002, 'Why business models matter? Harvard Business School, retrieved online 30th March 2009, from http://teaching.ust.hk/~ismt302/busmod.pdf Watson, J & Everett, J 1995, DO SMALL BUSINESSES HAVE A HIGH FAILURE RATE? Retrieved online 30th March 2009, from http://sbaer.uca.edu/research/icsb/1995/pdf/19.pdf Salkever, A 2008, 'A hot new outdoor-apparel brand took off like a rocket, then crashed and burned. Should Nau's creators walk away or try again? Inc. 30.11 (Nov 2008): 62(4). Read More