Small Business Failure Rates and Causes
The Wall Street Journal reported in September 2013 that 56% of Americans thought that they were capable of launching their own company while 9% actually took the plunge and took steps to start a business. Against this backdrop of optimism and confidence stands another set of sobering statistics that outline the causes of small business mortality. Though much anecdotal evidence abounds to explain the demise of small businesses this paper will attempt to present findings from the few studies that employed statistical analysis to describe where and how firms fade to the dustbin of history.
Choice of industry matters—a lot
Using the U.S. Census Bureau’s Business Dynamics Statistics database, researcher Scott Shane plotted five-year survival rates by industry for firms founded in 2005. His analysis revealed that mortality rates vary considerably by industry and are reported as follows:
|Industry||5-Year Survival Rate (%)|
It should be noted that Shane’s observation period commenced during a time of general economic prosperity in the United States and concluded during the worst economic downturn since the Great Depression. This fact may skew mortality rates for all industries to the high side and may also have produced uneven impacts on industries, particularly construction where a residential housing construction boom in 2005 turned to a near total collapse by 2010. It is quite possible that a study that begins in, say, 2010 might produce different overall mortality rates and some re-ordering of the casualty list.
The moral of the story is that it is worth trying to understand larger economic, demographic and social forces that drive business prospects before investing your hard-earned money in a new venture. For those aspiring entrepreneurs who have little time or inclination to stay tuned to cable business news shows all day or to get to work on their M.B.A. degree there is another path. The ISBDC offers clients—at no charge—access to industry analyses. Covering hundreds of industries, these reports provide insight to the impact that “macro” developments and trends hold for each. Additionally, these reports offer assessments of each industry’s structure and how these macro changes may influence the numbers of industry participants, their pricing power and their profit margins.
Causes of business failure
Selecting a vibrant industry is a start, but only a start, to improving the probability of leading a business with staying power. Note that even the industry with the highest predicted life span of five years barely cleared the 50% threshold. Thousands of businesses fail even during the best of economic times and in industries that ride high during those periods.
To gain insight to the contributing factors to business mortality, researchers at the University of Tennessee studied failures of thousands of small businesses and attempted to identify the primary culprit leading to demise. They grouped their findings into broad categories but “drilled down” within each to identify root causes of failure.
The leading cause of business failure was determined to be “Incompetence”. Fully 46% of failures could be explained by this broad-brush term. The specific behaviors that underlie this headline, however, are fairly specific and revealing. These include:
- Taking an emotional approach to pricing
- Non-payment of taxes
- No knowledge of industry pricing conventions
- No knowledge of financing requirements and conventions
- No experience in record-keeping
- Living beyond the means of the business
- Lack of planning
Next in line as a primary contributor to business failure was “Unbalanced experience or lack of managerial experience”. This condition explained 30% of small business failures and was manifested primarily by poor credit-granting decisions.
Eleven percent of failures were attributed to “Lack of experience”. Specific shortcomings that proved lethal included the failure to maintain adequate inventory, no knowledge of suppliers and wasted advertising budgets.
The remainder of failures was chalked up to fraud, natural disasters and neglect.
Clearly, there is a lot that can go wrong when running a business. If there is one recurring theme to the work of the Tennessee researchers it is that sustainable businesses just cannot be run “by the seat of the pants”. Rather, some element of planning and structure must pervade every aspect of the business. Sadly, all too many small business owners are unaware of the various bases to be covered, let alone possess the tools or expertise to measure performance for each.
Again, the ISBDC can provide assistance to the small business owner on a number of fronts. Business Advisors can coach owners or aspiring entrepreneurs through the development of a comprehensive business plan. This process enables the business owner to systematically consider and evaluate key success factors ranging from financial capacity to business strategy to risk management, among others. Additionally, the ISBDC can work with the small business owner on focused market research, financial forecasting and strategic planning projects to greatly improve the odds that the business will avoid the fate of the unprepared, the unstructured and the undisciplined.