Internal and External causes of business failure 2.3.3

High failure rate of new business

The highest rate of business failure is amongst new businesses (start-ups). It should be pretty obvious why this is the case:

• Difficult to test a business model without trading 
• Easy to be over-optimistic in the business plan
• Competitor response is often aggressive
• Management may lack experience

Among the most common reasons why new businesses fail so frequently are:

1. No demand for the business idea

• Poor market research and unrealistic plan
• Competitor response
• Just a bad idea - was doomed to fail

2. Good idea, but poorly executed

• Wrong people; poor management
• Growth is too quick (over trading) or too slow
• Failure to manage cash flow
• A competitor grabs the good idea and does it better

3. External shocks

• Economic change e.g. sudden decline in market decline due to recession
• Legal and social change e.g. change in legislation impacting demand or increasing costs

Why do Established Businesses fail?

Internal reasons for business failure
Financial reasons	Non-financial reasons
Liquidity – poor financial management, and lack of forward planning, may lead to cash flow problems and bad debts occur	Management error – in a fast moving market, clear and skilled leadership is crucial – poor management can be fatal
Poor accounting – poor procedures can mean money/cash flow is not being closely monitored or used wisely leading to inadequate resources. Additionally, failure to plan for significant capital and/or exceptional expenditure.	Wrong strategy – the business loses touch with the market and its customers, ignoring the need for innovations, market orientation and market research. Could lead to targeting the wrong segment and underestimating the degree of competition
	Communication – lack of it means the business cannot co-ordinate production or forward planning
	Failed expansion – many businesses expand and fail because they do not anticipate all the problems and end up over trading and not being able to handle the additional contracts
	Poor quality – in the digital economy poor quality or service can be quickly exposed
	Lack of investment – too much short-term profit taking and not enough investment for the future
	Poor marketing – getting all aspects of the marketing mix right is crucial; incorrect pricing, advertising or poor distribution are just some of the causes

External reasons for business failure
Financial reasons	Non-financial reasons
Exchange rate – a floating exchange rate means the value of the currency changes constantly and can have an impact on those businesses that export or import	Structural change – over a longer time period the demand for some products and services decreases; those that cannot adapt or find new markets where sales are rising, will fail
Interest rates – although relatively stable and low they can change and increase borrowing costs, as well as affecting customers’ spending	Competition – businesses that do not adapt when customer preferences change, or when competitors develop new or better value products, will face falling demand
Lack of finance – finance can be hard to obtain from many financial institutions, without it many otherwise healthy businesses/start-ups may fail	Natural phenomena – events beyond control such as bad harvests, weather and civil unrest
Recession – Some businesses are prone to recessionary impact, especially those that face income elastic demand for their products	Government regulations – regulations and legislation that place a restraint on business activity
Financial crisis – of 2008-9 was certainly the biggest shock to hit the business world in the last 50 years. For a while, bank loans were very hard to obtain	Supplier problems – if the supplier has to close down, the receiving business may encounter problems, particularly if it operates JIT system