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Diversions: I see nothing, I know nothing!! The internal causes of business failure

The causes of failure in an organisation are complex, typically broken into internal and external factors. Today, we look at the internal factors that (although complex in practice) are relatively simple to identify and rationalise. Management cannot be in denial about the true causes of failure... 

 

 

What are the reasons attributed to business failure? Many are external to the businesses in question. At the moment, there is a lot of emphasis on the cost of living, the impact of government fiscal policy on demand, government and regulatory change, tariffs, the causes of inflation (military action in Europe??), the cost of energy, and redundant technology. Many of these forces are global and largely uncontrollable.

Of course, business should look inward as well. In a sister article Diversions: He's just a dreadful goalhanger! Understanding the causes of business failure, we focussed on management, as a key cause of failure. However, it's not as simple as bad decisions, we should assess the underlying internal causes of decline.   

Internal Casual Factors 

Some of the common business- specific casual factors for failure, are briefly set out below:  

 

FactorComments
Financial Control is Lacking  
  • Absence of cashflow forecasts and budgetary control, Inadequate costing systems, Poor monitoring of Key Performance Indicators
  • Management reporting information overly complex, involving volumes of data but no information, taking hours to produce but basically useless 
  • Financial control placed too high in an organisational hierarchy, whereas budgetary responsibility should be at lower levels
Working Capital Management is off the Mark 
  • Generation of sustainable cashflow is key - increasing stock and debtors and decreasing creditors consumes cash 
  • For businesses on large milestone payments, managing WIP, debtors, wages and materials is key
  • Businesses in seasonal sectors need to ensure finance facilities are available to purchase required stock levels
Costs are not Controlled and Monitored
  • Relative cost disadvantages: inability to take advantage of economy of scale 
  • Absolute cost disadvantages: competitors control the means of production, cheaper labour or raw materials
  • Management style disadvantages: leaders who rely on more personnel will incur more overhead, as opposed to those who devolve responsibility
  • Operating ineffectiveness: poor labour and production planning, lack of maintenance and plant layout 
  • Government policy: relative to interstate or overseas competitors – lack of a ‘level playing field’ 
Marketing Effort is Lacking
  • Lack of customer responsiveness, after sales service, wasted advertising, poor targeting, outdated material and product development
Focus is on Sales rather than Profit 
  • Overtrading: the process by which sales grow at a faster rate than can be sustained from cash and borrowings
  • Chasing unprofitable sales growth, without understanding margin and profitability, in the hope that customer loyalty and profit will follow
The Big Project will Save The Day 
  • Often failing businesses place reliance on a ‘big project’ or a ‘new customer’ that will save the day and be the panacea to a range of problems
  • Big projects can suffer from poor cost estimates, poor project control, start-up problems, and unexpected market entry costs
  • Rule of thumb : do not enter into a contract which, of itself, could cause failure/ insolvency
Acquisitions are Poorly Integrated
  • Failure is often synonymous with a failed acquisition strategy
  • Businesses facing decline can quite often acquire businesses with no real competitive advantage, on optimistic multiples, and where post-acquisition integration and management is underestimated
Financial Policy is too Conservative
  • High gearing: over-use of debt financing, particularly in start-up businesses where business operations have not settled into a pattern
  • Conservative financial policy: lack of re-investment into the business, high dividend payout ratio that undervalues long term investment in business operations
  • Inappropriate sources of finance: short term money financing long term investments 
Organisational Inertia and Confusion is Rife
  • Inability to make and implement decisions, as a result of poorly motivated staff, lack of clear and defined accountability, organisational confusion
  • Often in failing businesses, decisions are not made because ‘the organisation won’t let me do it’
 

Head in the sand?

As we have said in our last article, it is easy to blame management, their focus on analytics, and their personalities. But its more complex than that. It is the people inside the organisation that view the symptoms of decline, and the reactions management have.

But - an early diagnosis of the causes of decline will result in the best chance of turnaround.

Head in the sand

 

In developing this article, the authors acknowledge the work of Stuart Slatter and David Lovett In ‘Corporate Turnaround – Managing Companies in Distress’ published by Penguin Business.

Published 23rd February 2025

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By Joseph Hayes

Partner

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