Why entrepreneurs fail to grow their businesses

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In the western world small firms represent about 99 percent of employers, employ about half of the private sector workforce and are responsible for about two-thirds to three-quarters of the net new jobs (Office of Small Business Advocacy, 2003). According to Asia-Pacific Economic Cooperation, small and medium-sized businesses employ as much as 80 percent of the workforce, contribute up to 60 percent of GNP, and account for around 35 percent of total exports in the region (APEC, 1998). Thus the economic development of a country is closely related to the health and progress of its small and medium-sized enterprises (SME) sector because this is a crucial source of new job opportunities, improvements of living standards, innovations and leads to economic growth. Small businesses are commonly defined as privately owned and operated firms, usually partnership or sole proprietorships, with low volumes of sales and limited number of employees; fewer then 50 in the European Union, 100 in China and 500 in the USA. Despite there is no doubt about the prevalence of SMEs in the world's economies and their importance for a dynamic development, unfortunately, according to the U.S. Small Business Administration (2003), over 50% of small businesses fail in the first year and 95% fail within the first five years. "Businesses with fewer than 20 employees have only a 37% chance of surviving four years (of business) and only a 9% chance of surviving 10 years", reports Dun & Bradstreet (1996). Hence what are the causes of such high failure rates of small businesses and what do successful SMEs do in order to survive and grow? These are the questions to be addressed in this essay in order to better understand why small businesses fail to grow and how those causes can be avoided, illustrated on examples of tactics employed by successful entrepreneurs.

Why do such a large proportion of founding entrepreneurs fail to grow their businesses and consequently fail to survive?

Before the analysis of causes preventing the growth of small businesses is undertaken let us clarify what is meant by growth. For the purpose of this essay, a growing business is any firm whose business generates significant positive cash flows and earnings enabling to increase the number of its employees and profitable reinvestment opportunities from its own retained earnings (Phillips & Kirchhoff, 1989). The growth of the business can be measured by the extent of growth in "net" increase in employees, i.e. the net of total employment in the last year minus total employment in the birth year. This employment measure has the advantage of being unaffected by inflation and therefore is more reliable over time than growth measures expressed in dollars (Phillips & Kirchhoff, 1989). Now in order to examine various factors stopping entrepreneurs from positive business expansion these can be divided into three main categories; exogenous factors, economic factors and management factors.

To begin with, exogenous factors that hinder growth and in many cases the alone survival of the business are classified as those, whose occurrence cannot be (or to a very limited extent) influenced by the entrepreneurs. Natural disasters, thefts, fire damaging the physical assets of business or an illness or sudden death of the entrepreneur fall under this category. According to Gaskill's study (1993) the above mentioned accounted for 30 percent of discontinuance of businesses. Even though exogenous factors are often causes of business' failure to grow or even survive, it is economic and management aspects that we want to focus our attention to in this essay, since they can explain common mistakes made by entrepreneurs and help to draw implications on how to avoid them.

Economic factors affecting growth opportunities of small businesses can be of an external and internal character. "Know your enemy, know yourself, and your victory will not be threatened. Know the weather, know the terrain, and your victory will be complete" (Sun Tzu cited in Giles, 1910). Thus before entrepreneurs make a decision to start a business they need to examine the external environment. The evaluation of the economic situation in the economy and within the industry will play an important role in timing of the entry. The wrong timing in periods of negative economic growth and expensive credit can cause poor customer consumption propensity and high costs of borrowing of capital necessary for funding profitable investments. Furthermore, the failure to evaluate potential competitors, their product and service offerings and competitive strategies can limit entrepreneurs' ability to differentiate themselves in quality or price and thereby succeed in growing their business.

With regards to internal economic factors affecting small business development, about two-thirds of those businesses that cite economic factors as a reason for failure, indicate that a lack of profits is the primary reason (Watson, 1996). There is, however, a complex link between profits and cash-flows. The lack of profits is often a misclassified imbalance of cash-flows within the business. Insufficient budgeting can lead to disparity between incoming money from customers and outflows to suppliers, overheads and salaries. Such failure of matching revenues with expenses usually arises from allowing excessive credit to customers, building up stocks to unnecessary levels, taking excessive credit from suppliers, investing heavily in fixed assets or under-estimating the effects of inflation (Wood, 1982). Moreover, undercapitalisation of small businesses can lead to the inefficiencies in the production process due to the use of obsolete machinery and a lack of innovation and thus make firm's products or services unattractive on the market, limiting sales and profits and thereby potential growth. According to the survey of 100 failed businesses by Lussier (1995), 32 percent identified undercapitalisation as a primary source of their failure to grow their business.

However, the most frequently cited cause of business failure is somewhat simplistic and all-encompassing notion of 'poor management' (Allen, 1995 cited in Perry, 2001). According to statistics from Dun & Bradstreet (cited in Lewis, 2004), 88.7% of all business failures are due to management mistakes. "While everyone agrees that bad management is the prime cause of failure no one agrees what a 'bad management' means nor how it can be recognised except that after company has collapsed - then everyone agrees how badly managed it was" (Argenti, 1976). In this essay, under bad management we understand the following particular sources of underperformance across small businesses. Firstly, the lack of market research and industry experience is a beginning of an end. The internal resources of a firm must match the needs of the environment to which the firm caters. Lack of experience in the industry will lead to poor organisation of a firm and its resources (Keats, 1988). Equally, the inability to target profitable market segments and identify market opportunities will probably allow a business to survive but will restrict the pace at which it can grow. Secondly, the lack of well-educated human capital and entrepreneurial skill can create a great barrier in pursuing expansionary strategies for small businesses, which cannot offer competitive salaries for industry experts and thus rely on their own, often overly positive, 'business instinct'. Mostly during the start-up phase of a new business, lack of entrepreneurial skills in an owner can cause a business to fail. Entrepreneurs generally have a high need for achievement and social awareness, and they are high risk takers (D'Amboise, 1992). Last but not least, failing to plan means planning to fail; and thus poor planning and control techniques finalise the commonly recognised management sources of business' inability to grow. Nine out of ten business failures in the United States are caused by a lack of general business management skills and planning (Bangs, 2002). A good business plan helps identify the market opportunities, cash-flows, cost structure, available resources, and strengths and weakness of a business. Without a clear strategy and control over its implementation small firms face a very little chance of successfully growing their business.

With all the evidence of business' underperformance and failure cited above what can be said about the small firms and their owners who managed to keep their businesses running for decades or even managed to turn them into big retail chains or manufacturing industry leaders? What is it that keeps small businesses away from their demise? The answer is growth. According to the survey done by Phillips and Kirchhoff (1989) if an entry firm having one to four employees grows at all, even adds only one employee a year, its survival rate more than doubles to 65 percent; as opposed to no growth survival rate at 26 percent. And, as the extent of growth increases, the survival rate increases as well, ultimately reaching 77.5 percent for high growth firms. Thus the question remains, what is it that successful small businesses do to achieve positive growth?

What defines entrepreneurs who are able to grow quickly?

Primarily, it is avoiding the common nascent entrepreneur's roots of failure listed in the first section of this essay. In other words, before any firm can engage in any growth strategies it has to ensure it has researched its target market, identified opportunities and picked the right timing for entry in terms of the economic cycles. The evidence from survey carried out in the U.S. by Perry (2001) shows that successful entrepreneurs have always planned their cash-flows, creditors' and debtors' periods such that their cash inflows outweigh their cash outflows for at least twelve moths ahead, and consequently enjoyed a three-times higher success rate in growing their business then entrepreneurs who failed to plan for a minimum of twelve moths ahead. Moreover, Lussier (1995) suggests that successful entrepreneurs keep fixed costs low and attain adequate capital before they slowly engage in expansionary activities which can be turned into fast-moving growth. "A rule of thumb to define adequate, is to get the best estimate available of all costs, then double it" (Lussier, 1995). Once sufficient planning and budgeting is complete, winning entrepreneurs choose growth strategies which do not involve high fixed costs and capital requirements. A good example is a free-riding strategy. The free-riding is "the imitation of the early mover's strategy to benefit from the opportunities created by these early movers, without incurring the associated developmental costs" (Lee, Lim, Tan, 2002). These benefits could be related to product and service innovation, advertising and promotion or initial market penetration. In addition to free-riding, another very popular low-capital growth strategy for small businesses is a niching strategy, which is "the concentration of resources towards the fulfilment of the latent demand of some select market segments (niches) that have been ignored by existing suppliers" (Lee, Lim, Tan, 2002). Targeting such market gaps ignored by existing suppliers reduces the competitive forces of the external environment and secures sustainable demand, which in results in increased sales and profits, thus enabling fast growth. The above described strategies have proven to be efficient in achieving small-business to grow by initially slow expansion activities funded with the retained capital, seeking unmet demand to boost sales whilst minimising fixed costs and investments required for marketing or product innovation.


In order to address the issues that lead to business success or failure a firm has to be viewed in a broad perspective. Some of the causes are directly related to the entrepreneur's skills, human capital and planning and control, classified as management factors, while others are more related to the environmental variables such as economic conditions, competition, customer behaviour etc. Despite the recent statistics of nascent SMEs' failure rates reveal some dreadful figures, we have identified that firms' survival chances are greatly increased by even a minimal growth in firms' number of employees reflecting slow expansionary strategies. The evidence shows that many entrepreneurs manage to successfully grow their businesses provided they undergo sufficient pre-entry market research, evaluate the external conditions of the economic environment, undertake rigorous financial and management planning and select unhurried expansionary strategies which can be funded with the firm's retained capital, do not involve excessive sunk costs and provide sustainable demand for their products or services.