Some common reasons why small businesses fail

Posted in Business and entrepreneurship.

According to a report compiled in 2020, about 20% of small businesses fail within the first year, while almost half don’t make it through the first five years. Becoming an entrepreneur has always come with risks, but don’t these statistics sound worrying?

What’s the cause of this high failure rate? When we look at those businesses that have survived and compare them to those that haven’t, we can find some common reasons why some did not manage to make it past the five year mark.

1. Not being able to tap into the market effectively

In order for a business to be successful, it needs to be able to tap into the market it is aimed at. The biggest reason businesses are unable to tap into that market is because there is little to no market need for their product or service in the first place. Unless businesses are solving a specific market problem, they are unlikely to last very long.

Secondly, market timing is important. Demand fluctuates over time, and the necessary technology and techniques that would make a product or service viable may not be available at the time. Sometimes companies launch a product too soon. A commonly cited example of this is LaserDisc technology from the 70s and 80s that was superior to VHS and Betamax but did not manage to replace them.

Thirdly, it is important for small businesses to effectively sell the idea of their product or service to their market in an accessible manner. Even if a product or service has a market need, the amount of people that can access their product or service is important as well. When there is a disparity between the amount of people with a need versus the amount who would be willing to pay for the product or service a business is likely to fail.

Lastly, competition can hinder the ability to tap into the market. If other businesses’ timings are better – establishing themselves earlier or entering the market with a smaller lag phase – they can cement their place in the market. If their product can do more or cost less, more people are going to be drawn to it.

An inability to tap into the market is often associated with a lack of research to begin with…

2. Lack of initial research

Small businesses that don’t put any effort into researching the market that they want to enter are bound to come across problems. Many aspiring entrepreneurs are excited to execute their plans. They are inspired by their business idea and want to make it a reality as quickly as possible. However, it is probably a good idea to take a step back and think through things. A product or service might solve an interesting problem, but does it solve a problem people are willing to pay to have solved?

Furthermore, entrepreneurs may have an entire product or service thought out and a well-thought-out business model to go along with it only to find out after the fact that there is a more established competitor doing the exact same thing that they are. The idea doesn’t have much value, it is all about the execution.

Another research aspect to consider is the design of the product or service. Consumer-facing companies need to take into account the end-user experience. A product or service may not be as intuitive to customers unfamiliar with it as it is to the creators. Having outsiders test and review a product or service may be important before releasing it into the market.

Taking a step back to do the initial research helps to create a solid business model…

3. Unfeasible business models

A well-designed product or service aimed at the right market at the right time may lead to short-term success, but without a feasible long-term business model, a business is unlikely to succeed in the long run.

Entrepreneurs tend to be very optimistic and overestimate the number of customers that their product or service will attract. It is better to be prudent and use conservative estimates in the business plan. Another problem is targeting high growth and then doing unreasonable things to achieve that growth. For example, spending huge amounts of money on advertising or giving large discounts. This may work out in the short-term, but eventually the cost of acquiring customers starts to outweigh the lifetime value of those customers. For instance, a strong initial marketing campaign may lead to a strong influx of customers, but then all those customers leave before you can recoup the marketing investment made.

Generally, a good business model includes ways to monetise customers above the costs to acquire them. If all your sales and marketing processes (salaries, campaigns, product or service costs, etc.) sum up to $1,000 in a year, then the revenues from the product or service needs to exceed that in a year (or whatever your payback horizon) in order to make any of that money back. One good way to ensure this is to try to create recurring purchases from your buyers.

Furthermore, business models that aren’t scalable are unfeasible in the long-term. Small businesses that don’t have the ability to scale up or down are unable to adapt to changes in the market and are therefore vulnerable.

Oftentimes, small businesses are a lot more personal and the planning behind the business is not the only cause of failure…

4. Dysfunctional teams

A common problem in failed small businesses is a weak management team. A poor management team might not make the necessary effort to do research and might rely on strategies that may not specifically work for their business. The people calling the shots need to be competent in order for the business to function well. Also, their incompetence might trickle down into the other teams.

In a small business, there are fewer people to work on things. Thus, task management is important. However, with not enough dedicated people for each task, someone is bound to be tasked with something that they are not adept at. Small businesses started by a small group of people with a limited range of skills are less equipped to deal with a wider range of problems, often needing to outsource work.

Another way in which the core team may fail a business is through disharmony. A team that cannot work well together is likely to do worse than if everyone did things individually. Competing ideas may lead the business in all sorts of directions without a clear plan. Businesses started by a group of individuals often rely on each individual doing their part. If one person decides to leave due to disharmony in the core team, business processes may halt while a replacement is found, or all momentum may be lost, and the business may fail.

While small businesses may fail due to the interactions between people, motivation is what started the business and the lack thereof may end it…

5. Burnout

When a small business is starting out, it lives and dies by the efforts of its founders. A business requires a lot of hands-on work at the beginning (and sometimes throughout its lifetime). This energy comes from the motivation of the core team. If a lot of effort is put into setting up and maintaining a business without much reward, then burnout can set in – things start to feel hopeless and work only happens, because it feels necessary.

Burnout generally sets in when entrepreneurial ideals are replaced by a mundane grind. The business founders start to lose track of why they started the business and what gave them the motivation to begin with in the first place. “Is it all worth it?” they ask. Eventually the founders cut their losses and the business fails.