Places to start looking for early signs of business failure

It might seem a little morbid to dwell on business failure. However, there can also be some comfort in knowing that you are helping your business do all it can to avoid it, before cracking on with the exciting stuff.

From sitting in countless planning meetings and the like (even in organisations with a low appetite for risk) it still surprises me that I’ve not yet heard the question asked: “If we continued on our current trajectory, why and how is our company most likely to fail?”

Of course, the point of the question is neither academic nor defeatist. It is a question that motivates attention on foreseeing and evaluating risks ahead of them having a sizeable impact.

While larger corporations look at risks across many dimensions, smaller and medium-sized companies don’t tend to as exhaustively, despite often facing higher levels of risk (according to business liquidation rates). Moreover, as recent events have shown us, even Governments could do better at foreseeing and mitigating risk.

Just think how much exciting stuff we could all do with our time if we’d spotted and dealt with our business problems before they materialised into fires!

Studies of business risk and failure

Risks of failure have been studied widely in both the academic business literature and by consultancies, particularly the larger ones like Harvard. Amongst the most recent, Jayasekara et al (2020) reviewed 95 such studies from 1968 to 2016. A sample of articles is referenced below. (There are many more studies that have examined how and why companies perform better or worse in different markets without necessarily failing, which we'll cover separately.)

The challenge with reviewing and extracting the practical lessons from these studies comes because the reports and papers can often offer narratives that speak to either different perspectives on failure events, or talk to different depths about underlying causes. For instance, while there may be a final straw that breaks the camel’s back, like an inability to pay a debt, there is a story to tell before a business reaches that point. The risk-taking personality of the leader might have seen it make a series of unsuccessful attempts to expand or diversify as it was gradually out-competed and lost revenue in its core market. But how did it come to get out-competed in its core market? Did it then consider better options to diversify but erroneously dismiss them because of poor information? Did it never consider them at all?

Such stories can be told in terms of the decline of inter-related elements such as financial metrics, choices of investment, the lack of necessary resources and capabilities, successes or failures of execution, or in terms of the characteristics, perspectives, and biases of the decision-makers influencing all of these things.

An essential part of the story often comes from the critical context lent by market conditions, often influenced by the industry and technology lifecycles. Such factors influence the level and nature of competition, the number of customers seeking to buy, and the profitability of investments.

Further critical context comes from the business lifecycle stage. Researchers have found a U-shape curve in the relationship between the business life stage and the liability for exiting the market (e.g. Cressy, 2006). At very early times in the business lifecycle, a business has less experience across many of the areas it is working on, making it more prone to mistakes and oversights, as well as having fewer resources to overcome its unforeseen obstacles.

While the chances of failure decline as companies age, at later life stages, mature businesses have a greater risk of becoming inwardly focused and "complacent", such that their decisions become misaligned with market economics, the nature of competition, or consumer behaviour.

Peter Drucker explained the risks of failure in terms of inadequate opportunities or resources at different points they are needed, as part of his underpinning his rallying call for businesses to innovate (Drucker, 2007). As the business performance starts to show signs of cracks, then it loses credibility with financiers that it would otherwise need to rejuvenate itself, making decline even more likely.

Consolidation of some warning lights

By no means exhaustive, here are some examples of the frequently recurring ‘warning lights’ that these studies tend to show, organised by business lifecycle stage (top to bottom) and type of "signal" (left to right). For each stage, the five different types of signal point to how a "failure story" could evolve. There is not, particularly, a start or end: just a set of dynamics that start to appear in several places.

While businesses can recover from setbacks, the best antidote is to avoid or at least minimise these potential risks, by noting which are appearing and not reinforcing them.

Start with now

More generally, to mitigate risks of failure, understanding the present moment - as a position within the different aforementioned lifecycles - is as good a place as any to start focussing. Where are we now? (in industry and product lifecycles) is surprisingly often overlooked as a question given the highly-strategic implications.

Understanding the current position of a company in the industry, product, and business lifecycles can often surface some of the most common risks that are likely to emerge next.

Trends related to (e.g.) market sales, customer choices, technology performance et al provide evidence on “where we are” in such lifecycles and show if, how, and how quickly risks are emerging and where they might lead.

Understanding the industry and product-market life stage contextualises many of the stories that are concurrently seen in industry news, like company announcements of mergers, acquisitions, and partnerships. If there is a raft of players attracting venture capital in the same market as you occupy, it could offer a forewarning that differentiation, collaboration or superior performance is critical, given a possible blizzard of “look-a-likes”. It might be a forewarning to look for a different market altogether, or at least a different position or niche within it.

Understanding the business lifecycle stage allows some preparatory thinking to be done on anticipating risks that are a little time away, but may appear suddenly. For instance, a business that is in the start-up stage might be wrestling with marketing and funding at that moment. However, it might also anticipate the challenges of the upcoming growth phase, when it will need scalable and robust processes to retain its reputation, acquire resources, and deal with the counter-moves of larger competitors.

For example, it might decide to grow a little slower but lay firm foundations. For instance, it could start thinking ahead of time about where valuable technical or commercial resources are going to be found as the demand changes and grow, given the gestation time for recruitment.

Likewise, a business that is in the mature phase should have identified, or be well on the way to identifying, its next source of growth and so ensure that it understands the key trends in consumer expectations and behaviour that relate to its category.

The role of foresight and trends studies

To look beyond here and now, "foresight and trends studies" provide structured projects to think these issues through and surface opportunities, risks and options necessary to better prepare for the future.

These studies are, in essence, research and analysis studies with a somewhat different focus to the ones that are usually carried out for examining customers’ immediate or near-term wants and needs. Pulling together trends, insights, and observations of emerging technologies, commercial ideas or consumer attitudes informs a range of realistic future scenarios that a business will face.

It is not (yet) possible to predict which of a range of possible futures will emerge with any certainty, particularly when looking much more than a year in advance. The world is too complex. However, it is very often possible to prepare better.

Sources and further reading

Jayasekara, Eranga & Narada damitha, Fernando & Ranjani, Chitra. (2020). A systematic literature review on business failure of small and medium enterprises (SME). Journal of Management. 15. 2020. 10.4038/jm.v15i1.7592.

Harvard Business Review (2019), Why your start up won't last

Harvard Business Review (2021), Why do so many strategies fail?

UK Enterprise Research Centre (2021), Digital readiness, Digital adoption and Digitalisation of UK SMEAmidst the Covid-19 crisis