What’s it: A business failure is when a business cannot operate profitably, leading to default, bankruptcy, or business closure. Businesses cannot make money because the income cannot cover the costs. It could be due to poor operating management, insufficient capital, a poor unique selling proposition, and weak competitiveness.
Small business failure rate
Small business failure rates vary between countries. It can also vary over time as the growing environment changes, such as concerning the economic or political environment.
For example, in the United States, about 75%-80% of new businesses survive the first year of opening. Or in other words, about 20%-25% of new businesses fail during their first two years of opening. The business failure rate increased for the following years and ranged from 45% during the first five years and 65% during the first 10 years.
The industry in which the business operates is also an important factor in explaining the business failure rate. It affects aspects such as the competition intensity, business model, and inherent risks. As a result, business failure rates vary across industries. For example, businesses in the information industry have the highest failure rates, and only about 37% are still operating after four years.
Why do small businesses fail
A business fails because it cannot generate sufficient income to cover its expenses. It can also occur due to external factors such as recession, high taxes, high-interest rates, excessive regulation, and competition. Other reasons include:
- Poor management experience and skills.
- Poor location.
- Poor inventory management.
- Insufficient capital.
- Overinvestment in fixed assets.
- Poor credit policies.
Intense competition. Small businesses have more limited resources and market knowledge than more established companies. As a result, their competitiveness is low, and it is difficult to survive in the market when established companies run aggressive competitive strategies.
Poor operation management. For example, your business may find it difficult to accurately estimate demand levels. It was probably due to a lack of experience and skills. As a result, your business may experience overproduction or underproduction, leading to increased costs or suboptimal sales.
Limited access to funding. Your new business may struggle to raise sufficient funds due to a poor track record. Your new business is also seen as having a high failure rate, making financiers such as banks or other investors reluctant to take more risks to lend money. As a result, your business is difficult to grow and build better competitiveness.
Less strategic location. It affects aspects such as costs, access to markets, and access to resources. For example, choosing a location in the city center puts your business at a high rent, requiring your business to generate high revenue to cover it.
Cash flow problems. Small businesses often have problems with working capital. They cannot pay suppliers or short-term loans on time. They also face difficulties in managing cash in and cash out in the short term, leading to business failure. Management quality, credit policy, negotiation skills, and financial skills are influencing factors.
Low market and marketing knowledge. For example, your business targets a mature market. Therefore, it makes your chances of increasing business size low due to low market growth. Or, you may not understand the needs and wants of consumers. As a result, your unique selling proposition does not sell well in the market.
Failed to build a customer base. Your new business must increase its customer base to sell more goods and improve profits through, for example, economies of scale. Failure to do so prevents your business from achieving higher revenues and lower costs.
Poor human resources. Poor management skills lead to poor operations management. For example, new businesses struggle to recruit talent with the right skills, leading to low innovation, inefficient operations, and poor customer service. On the other hand, people prefer to work in an established business over a new business.
Legality issues. Non-compliance with regulations and laws can lead to prosecution and revocation of business licenses.
Changes in the business environment. Various external factors influence the success of a new business. It may be related to competitive, economic, or political factors. For example, when a recession hits, new businesses struggle to sell products because household demand falls.