Corporations are complex machines that are meticulously designed to create wealth. If you were to dissect the fundamental components of a business, you would find that each element is primed to add value or operate productively for the lowest cost possible.
The objective of a company is to deliver the highest possible financial return to shareholders, and CEO pay is often closely tied to shareholder success to ensure that the bosses in charge are highly incentivised to make that happen.
Unfortunately, all of this does not guarantee financial success. Each year, scores of companies hit the wall due to a myriad of unfortunate events.
In this article, we’ll outline the top five causes of business failure (in no particular order):
Companies live or die by the popularity of their goods and services with their consumers. So long as a good or service is highly demanded by customers, a business will usually be able to generate sufficient revenue to cover its costs.
However, not all needs are permanent. Fashions change, and new tech trends emerge.
A key threat for any business is the risk that an alternative product or service renders the existing product line obsolete. Obsolescence can occur over a period of many years, or in some cases, it can occur more or less overnight (for example, through the launch of a more effective pharmaceutical drug, or a games console which is much faster than anything else out there).
Sometimes a business will begin corporate restructuring while trading appears to be healthy. This can come as a shock to staff and customers alike.
This is because even growing and prosperous businesses can run out of cash if they are managed and financed in the wrong way.
For example, some businesses may generate operating profits but could still default on high-interest debt where the interest exceeds the profits from the business.
Businesses that just manage to survive while using all profits to pay interest on the debt are known as ‘zombie’ companies. They are often supported by the debtholder who wishes to maximise the total return on their loan. However, because they provide little shareholder return and have no spare cash, they cannot afford to invest for the future in critical areas such as research & development or long term product development.
Loss of competitive advantage
While objects obey the laws of physics, companies are buffeted by the laws of economics. When economic principles begin to turn against a company, it can be difficult to survive.
In a competitive marketplace, consumers will opt for a higher-quality, lower-cost product most of the time. Therefore, the company that can find a way to produce the same product for less, or a better product for the same price will stand to gain market share.
However, the opening of international borders to free trade has pitted factories on each side of the world firmly against one another.
Companies in different locations can enjoy various cost advantages, such as access to cheaper, renewable energy, cheaper labour or advantageous trade deals that allow them to sell goods to the same consumer with fewer financial barriers.
This can place some companies, at no fault of their own, at a disadvantage when selling to the same consumers. If they cannot sell their goods at competitive prices, they will be unable to offer prices that will allow them to hold onto market share.
Many business models require a significant amount of capital expenditure. Restaurants, manufacturing plants, and theme parks are just some examples of businesses that invest heavily in their plant, equipment, and other fixed assets. This creates a high level of overhead for the business, which will not reduce in an economic downturn.
This leaves such businesses very susceptible to an economic shock such as a recession. A prolonged dip in revenue could generate financial losses and a shortage of cash. Bankruptcy can often follow if extra finance is out of reach.