Why firms fail

And how to learn from them.

External Causes of Bankruptcy

Many firms in Canada go bankrupt because of events that are partially beyond their control. These include such events as economic downturn in the market facing the firm, increases in competition, loss of a major customer as the result of relocation or market change, government regulation, echnological change, employee fraud, or labour legislation. The survey results show that for the population as a whole these external events are important. Some 68% have been affected by an economic downturn in their market. In addition, increases in competition and customer difficulties (such as the loss of key customers or volatile demand) are also significant factors.

It is noteworthy that when failure is attributed to economic downturn, increases in competition and customer difficulties are also seen to be a problem. Almost two-thirds of firms that failed due to economic downturn in their particular market also had problems due to increased competition and over half due to loss of key customers. Thus, "economic events"(economic downturn in a particular market, increases in competition, and customer difficulties) are related to one another. On the other hand, there is a very limited relationship between these economic events and all other external causes of failure.

Internal Causes of Bankruptcy

While factors beyond a firm's control certainly play a major role in failure, many businesses that go bankrupt also suffer from internal deficiencies. This study finds that while many internal deficiencies are important to some degree, firm failure that occurs as a result of internal problems is primarily rooted in the deficiencies of firm management. Internal causes of bankruptcy include problems associated with general management skills, firm strategies, expansions and buyouts, financial planning, financial management and record keeping, human resources, marketing, and production and operations. Deficiencies in general and financial management ranked highest: in almost 71% of firms, bankruptcy was attributed to problems in these areas. Managers of bankrupt firms simply lack the necessary knowledge and experience to make their businesses run. In addition, almost half (47%) of firms fail because of poor marketing capabilities.

Weaknesses in human resources, innovation strategy, and production and operations rank well behind problems with management, financial management, and marketing as causes of failure. Firms generally do not fail because they have not developed human resources programs such as training and development; nor do they generally fail because they cannot innovate or because they have inefficient production and operations systems.

Focus on the Basics
In Canada, firms fail because they simply do not have the basic management skills and characteristics necessary for success. Firms that survive the first years of life successfully develop core competencies—management and financial expertise—as well as marketspecific capabilities regarding what to produce, how it is to be produced, and how it will be marketed (Successful Entrants). Bankrupt firms, on the other hand, simply do not develop their core capabilities. Managers of these firms lack knowledge and experience and do not know how to financially manage a business. With regard to product-related capabilities, the study finds that bankrupt firms do not establish a market niche, nor do they pay enough heed to location. As a result, they do not develop a customer base to whom they can sell their products. Bankrupt firms simply fail at the basics.

The Importance of Management
Strong management skills are found in firms that manage to survive infancy and emerge into their early teen years (Successful Entrants). They are also recognized by older small- and medium-sized enterprises as the dominant factor behind their growth (Strategies for Success). This study confirms the importance of strong management to young firms by showing the extent to which deficiencies in management lead to business failure. Businesses overwhelmingly fail because of deficiencies in management skills: in 71% of firms, deficiencies in both general and financial management are described as the major causes of failure.

General Management Skills
Managerial inexperience and inefficiency are consistent themes in the literature explaining business failure. The significance that is placed on management deficiencies as a cause of failure warrants a closer look at the specific areas where these deficiencies are greatest. Management deficiencies that are seen to contribute to bankruptcy are many: in the area of knowledge, they involve the lack of breadth and depth of knowledge, and technical know-how; in the area of abilities, they involve deficiencies in communication, initiative, and control; in terms of attitudes, management is seen to pay insufficient attention to quality, to lack vision, and to be unwilling to delegate responsibilities; with regard to actions, management is seen to fail when it comes to staff supervision or the use of outside advisors.

Knowledge skills (breadth, depth of knowledge, and technical know-how)
Canadian firms go bankrupt primarily because their management lacks both breadth and depth of knowledge: over 56% of bankrupt firms failed largely as a result of these deficiencies. Management of these firms did not have sufficient general knowledge to coordinate activities involving financing, marketing, and operations, nor did it have sufficient specific knowledge within these areas. On average, lack of technical knowledge is not a major failing of the management of bankrupts.

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