The Reality of Why Small Businesses Fail

Why do only 5% of successful businesses break one million in sales? This article discusses the repeating challenge small business owners and management teams must overcome to break multi-million dollar barriers.

If you ask this question to the average investment banker, management consultants, business journalists or college professors with a PHD in business management this is probably what they will say. 

“The reason most businesses fail is because of poor management
and/or lack of funds.”

I have a problem with this answer and believe the logic is flawed. The implication is that to guarantee business success, it must be well managed and well-funded. Therefore if the business fails, it must have been poorly managed and/or poorly funded.

Don't we see exceptions to this rule throughout the business world? How many times have we heard the story of a Fortune 500 company started by a group of poor students starting out in a garage or a college dorm room? Does this sound like a story about a well-managed and well-funded business? Yet many companies, on today’s Fortune 500 list, started just this way?

At the same time, how often have we seen well-funded and well managed companies fail? Everyday profitable conglomerates run by the managers, lauded by business journals and magazines, are run into the ground. If it’s possible for well managed companies to fail and underfunded companies to become Fortune 500 companies it seems that there should be a better answer or answers to explain why one business is successful and another is not.

So what is the answer? What makes a business successful and why do some successful businesses grow so quickly? Then in the same economic environment some businesses grow slowly? Still others businesses seem to stay in the same place year after year?

In one word, the answer is - "Change".


A business's ability to change determines the speed it grows.

Just the idea that a business grows implies change. Yet we see examples of businesses that assume unlimited growth and unlimited resources.

We live in interesting times and see examples of change as dramatic as the invention of the automobile and the assembly line. To see examples we can look at industries like newspaper publishing, book publishing, as well as the music and other entertainment industries. Before the Internet these were well run, well-funded and well respected businesses. Today publishing companies that have been around for over 100 years are failing. Not because the information they distribute isn’t important. We can easily see that information these industries distribute is in far higher demand than ever before.

A product or service that is in high demand seems like the place to be. Yet newspapers publishers and many other information industries are finding it more and more difficult to be successful. The reason is that something changed and even though the industries are doing everything right, they have failed to respond to the need to change.

It’s not just industry changes that cause businesses to fail. A startup a business owner with a $40,000 investment must double that investment five times to break $1 million. Business growth is the very definition of change. When a new startup doubles their customer base from 1 to 2 customers means a major change. It may not be obvious because the business owner can track two business customers in his/her head. The problem comes when doubling again. First doubling to four customers and then doubling again to eight.

A business is actually seven or more business systems running together. Those systems include: Legal, Accounting, Marketing, Sales, Operations (production of product or servicing customers), Human Resources and business management. With one customer all the systems run pretty much in parallel with each other. As the number of customer increase, the complexity increases because each business systems requires more and more time.

If it takes 20 hours of sales and marketing to find one new customer, the finding 10 customers will require 200 hours. At the same time if each customer requires 2 hours of service each week, then it follows that 10 customers will require 20 hours per week. As the customer list increases the other business systems like accounting also require more time. As the business grows, new business owners run smack into the first of three business constraints.

Time, resources and scope are the three constraints every business owner juggles.

Because time is the limited and predictable, it naturally becomes the primary constraint for most startups. Resources are the second constraint. To make time more efficient resources can pay for additional workers and better tools that can be used to organize a work force to accomplish more in less time. Scope is the last restraint and determines when a task is complete. Often small businesses do just a little extra that the larger competitors can’t afford to do. That little bit extra is extra scope. When scope is decreased the business risks reduced quality. Reduce time and resources must increase or scope suffers. Reduce resources and it will take longer to do the same amount.

Many new business owners get lost trying to cheat the three constraints.

The result is a cycle most small business owners understand well. Often referred this is referred to as the feast or famine cycle. In this cycle the famine cycle is a marketing cycle where the owner is looking for work. The feast is when sales roll in and in order to take care of clients, time for marketing the company is sacrificed in order to perform the work that makes money for the company. When the customers are all taken care of, the owner finds him/herself back in the famine side of the cycle. Once again looking for work, but starting the sales process all over again because all the previous leads have gone cold.

This feast or famine cycle is a sign that the business has grown past its maximum capacity. The business owner needs to understand that pitfalls like the feast or famine cycle are positive signs of business growth. At the same time realize that staying stuck in a business pitfall makes it impossible for the business to grow. The business will stay in the feast or famine cycle until the business processes are changed to increase the capacity of the business.

The reason why successful businesses don’t break through the million and multi-million dollar mark is because those businesses are not able to change.

Change is essential for business growth. The smaller the business, the more change the business will need to go through to be a large business. Over the last 18 years I’ve worked with 100’s of businesses from startup and small to fortune 500. All business and organization want to grow. Those that planned for that growth and expect change are the ones that break million dollar barriers. Those that didn’t plan for change spent their time recovering from unexpected failures due to business growth.

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