Why Do Many Start-Up Businesses Die So Quickly?

New businesses have always been at an economic and business disadvantage compared to more established companies as a result of lower productivity, a lack of experience and insufficient contacts. More recently there have been significant shifts in the business climate as a result of globalisation, which increases competition as larger companies attempt to establish international branding and standards globally. To counteract this smaller companies are forced to focus on their strengths and cooperate more where they are less competent. This evolving framework is creating a new balance where both large and smaller companies. For start-up companies this will require a more considered but also more agile and collaborative philosophy, as there is less room for failure in today’s global economy. However, despite this there is significant scope for new start-ups to fill niches too small or ignored by larger companies.

Overcoming the First Business Hurdles
Aidis and Mickiewicz felt that younger business leaders were at a disadvantage compared to more experienced businessmen, as “experience accumulated in the current business is another important factor that makes the owners of businesses more confident in choosing a risky strategy for business expansion.”[1] However, Honjo considers that younger business leaders find it easier to deal with changeable environments.[2] Overall, academics opinion appears to confirm that younger entrepreneurs are less successful than more experienced businessmen.

Given the difficulties of entering a marketplace it is imperative for a high level of business understanding, both in terms of life experience and research. Peel considers that on average high planners are significantly more profitable and successful than low planners. He also concludes that strategic planning intensity is positively associated with the use of formal investment appraisal techniques and that SMEs “engaging in detailed strategic planning also employed the more sophisticated net present value capital budgeting technique to a significantly greater extent than their counterparts who worked out their strategic plans in less detail.”[3]

For SMEs it is important to get sound advice on raising finance, government assistance and training in the use of marketing techniques. Storey felt that “whilst there is a wide range of policy initiatives to assist small firms, governments throughout Europe have yet to formulate a coherent policy towards the sector,…public policies have been developed, jettisoned and often reintroduced on a piecemeal basis.”[4] Chen and Williams noted that “development assistance programmes tend to improve small business success rates for high-technology industries while they are ineffective for the low-technology industries.”[5] They also felt that bank loans “generally play a leading role in explaining business failure rates for high technology industries.”[6]

SMEs tend to have weak finances, with small cash flows making it difficult to invest significantly in projects. Foreman-Peck et al highlight that modern business relies on four main practices: ICT use, innovation, skills development and networking. Individual SMEs and their management may be “distinguished by their strategies and their emphasis on the policy instruments available to them.”[7] As start-up companies are limited by their smaller budget it is only feasible to explore a small handful of competences, otherwise the cashflow may be affected and the company is more difficult to coordinate due to its limited number of employees. For example, SMEs usually have to buy in services and/or undertake tasks with less specialized staff. An example of these handicaps is VAT compliance costs, which are extremely regressive: 7.8% of revenue for the lowest turnover range of firm in 1986–87 compared with 3.69% for the average.[8] Similarly, greater regulatory costs disproportionately force smaller firms out of business.[9]

Many companies look towards the Internet to improve their revenues. However, in a survey Webb and Sayer found that only 50% of respondents could identify tangible benefits as a result of their Web presence. Of these, only 69% felt most benefits were in the area of advertising and public relations, 15% in marketing and sales, 7% in customer feedback, 7% in globalisation; 15% felt it was too soon to tell.[10] They do not consider web sites critical enough unless they support existing business operations or create new opportunities for doing business. This is backed up by Schlenker and Crocker, who highlight how the optimism of the New Economy decreased, citing Amazon.com’s rapid recognition of the need to manage regional distribution outlets in order to maintain a rapid supply chain.[11] Consequentially, it is important for new start-ups to fully understand what the Internet and having a Web presence means to the company in allocating resources.

SMEs in the Context of Globalisation

Increased cooperation between governments over trade, including lower import tariffs and uniform trading standards combined with the development of faster and cheaper logistics and access to information via the Internet has helped to usher in a new age of global trade. The high levels of trade have put pressure on both large and small companies in different ways. Tambunan suggests that “great demands are made on the ability of SMEs to improve their efficiency and productivity and to adapt to and be flexible as regards market, product, technology, management, and organization.”[12] He goes on to suggest that further globalisation will generate larger market opportunities, with individual SMEs “often unable to capture these opportunities that require products with better quality and prices and good services after sale, larger production quantities, products homogeneous standards and regular supply.”[13]

For Web and Sayer the shift from concentrating on products to focusing on the services accompany the products “distinguishes the new economy from the old,”[14] with the evolution having several consequences for “firms that design, manufacture and distribute their products and services. If competitive advantage no longer comes from the physical characteristics but from the services and information integrated in the product offer, the market will favour firms that are capable of producing services and information to the detriment of purely manufacturing concerns.”[15]

Webb and Sayer also feel that the emergence of standards of quality will make it difficult for many companies to succeed, especially as companies have unprecedented access to corporate and consumer information. Their solution lies in SMEs benchmarking, as new or small companies are in most cases unlikely to be influential enough to go against the standard set by larger companies. Webb and Sayer consider benchmarking to be “the need to learn the business lessons of the early (or earlier) adopters.”[16] In terms of Internet start-ups they consider that the “pattern of Internet penetration and maturity is well established, having been repeated many times in many countries around the globe. It is not very difficult and does not take very long to establish your own level in this pattern.”[17] It is important to bear in mind that having a better standard means very little if everybody is using a more established platform

Balancing Self Sufficiency With Interdependency

Hughes asserted that the SMEs that succeeded in growing were more likely to have introduced product or process innovation. They were also more likely to have developed networks of collaborative partnerships and faced up to management development and reorganization needs as growth proceeded.[18] This is backed up by Kay who suggests that “firms survive and grow in a competitive environment if they are good at providing something the market wants. ‘Competencies’ of firms may thus be the key to growth.”[19] For start-ups the competency approach suggests that nurturing firm-specific knowledge and skills and investing in training of the appropriate type will be conducive to growth.

The Asian Development Bank considered that many enterprises “experience difficulties achieving economies of scale, and they also constitute a significant obstacle to internalizing functions such as training, market intelligence, logistics, and technology innovation and can also prevent the achievement of a specialized and effective inter firm division of labour, all of which are at the very core of firm dynamism.[20]

One method to combat this is to create trade clusters, which Tambunan considers to be effective both in Indoensia and Europe, with experiences in many European countries showing that “clusters can be a powerful means for overcoming…constraints and succeeding in an ever more competitive market environment. Through clustering individuals can address their current problems related to their size, production process, marketing, procurement of inputs, risks associated with demand fluctuations, and market information and can improve their competitive position. Through a cooperation of enterprises in a cluster, they may take advantage of external economies: presence of suppliers of raw materials, components, machinery and parts; presence of workers with sector specific skills; and presence of workshops that make or service the machinery and production tools. A cluster will also attract many traders to buy the products and sell them to distant markets.”[21]

Despite the perceived benefits of joining trade associations as a result of improved contacts and prestige there are a number of critics, as membership “significantly reduces the chance that an SME is in the ‘high growth’ category, which is consistent with the cartel hypothesis.”[22] In comparison to the profitability result, the impact of trade association membership on growth category remains negative and significant at the 5% level for manufacturing, the professions and finance interacting.[23] Nijkamp felt that the benefits of the Rotary Club can be distracting, as the time lost from business may be unproductive and that the uniform networking style is perhaps contrary to the entrepreneurial spirit.[24] However, this criticism is mainly in regards to high growth companies, with trade associations likely to be beneficial to new SMEs.

Unfortunately, there are intrinsic difficulties in forming such networks through purely market relations. These depend upon the ability to evaluate what is to be exchanged in advance. But in the case of information, the evaluation cannot be made independently of the exchange: once a potential buyer knows how much a seller’s information is worth, they also know what the information is, and so need give up nothing in exchange. Because of this difficulty of creating the property rights in information and knowledge, there may be a ‘market failure’, a suboptimal rate of innovation and therefore of cost reduction and/or product development for start-up companies.

This situation is also exacerbated in the case for R & D, as all firms are “forced to maintain an equivalent breadth of R& D competences as other firms in the same industry, and at the same time maintain their innovative activities at the industry rate of evolution.”[25] Narula also felt that SMEs greater flexibility and rapid response compensate for some of the disadvantages of size, and may allow SMEs to maintain the rate of technological change. However, they do not “necessarily help SMEs when it comes to the absolute limit on its resources.”[26]

All SMEs should be cautious when assessing whether to use internal or external R & D. Although recognising overlap, Narula considers that “niche and marginal competences are strategically less significant and can be taken through alliances. However, “the strategic importance of these technologies determines to what extent their development can be externalised.”[27] This in turn is determined “by the extent to which the technology is tacit, the extent to which collaboration is required to utilise it, and to what extent the partners’ activities need to be monitored.” One method of overcoming such problems is to make sure that none of the SMEs partners has enough of the technology to be a competitor and try and work with smaller companies so the chance of abuse is minimised. Narula’s anecdotal evidence suggests that this is important enough to the point of rejecting cheaper contracts in return for greater access to the complete product in case the partner becomes a competitor. For Narula, “the more successful SMEs have been able to maintain their competitive position through a more astute use of non internal R & D, with less in-house R & D than larger firms. In the case of start-ups this is more critical as they have limited opportunities to fail with bad business partners.

Start-up companies have to recognise the strengths and weaknesses of their company relative to other companies. The ability for consumers and companies to access goods and services cheaply across the globe has increased the spectre of companies not being able to establish themselves quickly enough. To deal with this start-ups must be prepared to fill very tight niches that other companies ignore, trade on their strengths and collaborate where they lack competences or are unable to benefit from significant scale. Ignoring these pressures and spreading too thinly investment and coordination makes SMEs less profitable and dynamic in the long run. Over time it may be possible to expand the competence of goods and services but this should normally be only after the organic growth of a company. However, significant research needs to be taken into the type of association or partnership that any company takes, as it will affect future development of any business and perhaps determine whether any start-up succeeds or fails.

Written by Jonathan McHugh
First written in May 2007

---

[1] Aidis, R and Mickiewicz, T Entrepreneurs, Expectations and Business Expansion: Lessons from Lithuania (Europe-Asia Studies, Vol 58), 2006

[2] Honjo, Y Business Failure of New Software Firms (Applied Economics Letters), 2000

[3] Peel, M and Bridge J How Planning and Capital Busgeting Improve SME Performance (Long Range Planning, Vol 31), 1998

[4] Storey, DJ Understanding the Small Business Sector (Routledge, London) 1994

[5] Chen, J and Williams, M The Determinants of Business Failures in the US Low-Technology and High Technology Industries (Applied Economics, Vol 31), 1999

[6] Chen, J and Williams, M The Determinants of Business Failures in the US Low-Technology and High Technology Industries (Applied Economics, Vol 31), 1999

[7] Foreman-Peck, J; Makepeace, G and Morgan, B Growth and Profitability of Small and Medium sized Enterprises: Some Welsh Evidence (Regional Studies, Vol 40) 2006

[8] Sandford, C; Godwin M. and Hardwick P Administrative and Compliance Costs of Taxation (Fiscal Publ., Bath) 1989

[9] Ollinger M. and Fernandez-Corrnejo J Sunk costs and regulation in the U.S. pesticide industry (International Journal), 1998

of Industrial Organization 16, 139–168.

[10] Webb, B and Sayer, R Benchmarking Small Companies on the Internet (Long Range Planning Vol 31), 1998

[11] Schlenker, L and Crocker, N Building an e-business Scenario for Small Businesses: The IBM Gateway Project (Qualitative Market Research: An International Journal), 2003

[12] Tambunan, T Promoting Small and Medium Enterprises with a Clustering Approach: A Policy Experience From Indonesia (Journal of Small Business Management), 2005

[13] Tambunan, T Promoting Small and Medium Enterprises with a Clustering Approach: A Policy Experience From Indonesia (Journal of Small Business Management), 2005

[14] Webb, B and Sayer, R Benchmarking Small Companies on the Internet (Long Range Planning Vol 31), 1998

[15] Webb, B and Sayer, R Benchmarking Small Companies on the Internet (Long Range Planning Vol 31), 1998

[16] Webb, B and Sayer, R Benchmarking Small Companies on the Internet (Long Range Planning Vol 31), 1998

[17] Webb, B and Sayer, R Benchmarking Small Companies on the Internet (Long Range Planning Vol 31), 1998

[18] Hughes Small Firms and Employment. (ESRC Centre for Business Research, University of Cambridge) 1997

[19] Foreman-Peck, J; Makepeace, G and Morgan, B Growth and Profitability of Small and Medium sized Enterprises: Some Welsh Evidence (Regional Studies, Vol 40) 2006

[20] ADB Best Practice in Developing Industry Clusters and Business Networks (Asian Development Bank), 2001

[21] Tambunan, T Promoting Small and Medium Enterprises with a Clustering Approach: A Policy Experience From Indonesia (Journal of Small Business Management), 2005

[22] Foreman-Peck, J; Makepeace, G and Morgan, B Growth and Profitability of Small and Medium sized Enterprises: Some Welsh Evidence (Regional Studies, Vol 40) 2006

[23] Foreman-Peck, J; Makepeace, G and Morgan, B Growth and Profitability of Small and Medium sized Enterprises: Some Welsh Evidence (Regional Studies, Vol 40) 2006

[24] Nijkamp P Entrepreneurship In A Modern Network Economy (Regional Studies, Vol 37), 2003

[25] Narula, R R & D Collaboration by SMEs: New Opportunities and Limitations in the Face of Globalisation (Department of International Economics and Managemnt, Copenhagen Business School), 2000

[26] Narula, R R & D Collaboration by SMEs: New Opportunities and Limitations in the Face of Globalisation (Department of International Economics and Managemnt, Copenhagen Business School), 2000

[27] Narula, R R & D Collaboration by SMEs: New Opportunities and Limitations in the Face of Globalisation (Department of International Economics and Managemnt, Copenhagen Business School), 2000