Reasons for Business Failure

Reasons for Business Failure

Learning Objectives

  • Understand the reasons for business failure.
  • Identify cash flow problems.
  • Recognize the impact of a lack of finance.
  • Understand the importance of competitiveness.
  • Appreciate the need for adapting to market changes.

PepperTap Case Study

  • Background: Navneet Singh established PepperTap in India in 2013, a mobile app-based food delivery service connecting customers to local shops.
  • Initial Success: By 2015, PepperTap was thriving, operating in 17 cities with 20,000 daily orders and ranked among the top three food delivery services in India.
  • Failure in 2016: Despite initial success, PepperTap closed down in 2016 due to three key reasons:
    • Inaccurate Stock Information: Local shops struggled to provide accurate stock information to the app, leading to missing essential items.
    • Smaller stores had difficulty adopting electronic inventory management and billing systems.
    • Larger stores were easier to integrate with due to existing electronic systems.
    • Expensive Discounts: PepperTap used generous discounts (around 20%) to attract and retain customers, which proved to be unsustainable.
    • The strategy was to invest heavily in discounts initially and recover costs later with a loyal customer base.
    • High Staffing Costs: Maintaining high staffing levels to ensure deliveries within two hours was expensive.
    • PepperTap aimed for efficient delivery operations based on prior experience in the team, with the expectation that costs would eventually decrease.
  • Attempted Solutions: PepperTap tried to address these issues by closing operations in smaller cities.
  • Outcome: Despite orders rising to around 30,000 a day, the company faced losses on most deliveries, leading to rapid cash depletion and forced closure due to a lack of competitiveness.

Business Failure Statistics

  • Difficult to obtain precise figures, but the failure rate is high.
  • Approximately 58% of new businesses in the UK fail within 4 years.
  • A common cause of business failure is money-related issues.
  • Businesses often run out of cash due to insufficient initial funding or the inability to attract further funding.
  • Effective financial planning is crucial for business survival.

Cash Flow Problems

  • Businesses run out of cash, focusing more on profit than cash flow.
  • Causes of cash shortages:
    • Overtrading: Expanding too quickly without sufficient resources.
    • Excessive Stock Purchases: Buying large amounts of products with insufficient cash reserves.
    • Over-investment in Fixed Assets: Tying up too much capital in long-term assets.
    • Excessive Credit: Allowing customers too much time to pay.
    • Over-borrowing: Taking on too much debt.
    • Seasonal Factors: Fluctuations in demand due to seasonal changes.
    • Unexpected Expenditure: Unforeseen expenses.
    • External Factors: Economic downturns or other external events.
    • Poor Financial Management: Ineffective handling of finances.

Valtrex Construction Case Study

  • Background: In 2016, Valtrex Construction, specializing in wooden homes, collapsed with debts to over 300 suppliers.
  • Growth and Strain: The business grew to US$30US\$30 million in sales by 2014 and recorded US$45US\$45 million in sales in 2014, but rapid growth strained resources.
  • Cash Flow Crisis: Valtrex could not raise funds for new business, and banks refused to extend overdraft lending, leading to serious cash flow problems.
  • Consequences: The business failure resulted in 85 staff redundancies and approximately US$12US\$12 million in debts.
  • Overtrading Defined: Overtrading refers to expanding a business too quickly without adequate financial resources.
  • Profitability vs. Failure: A profitable business can fail if it lacks sufficient cash flow to meet its obligations.

Lack of Finance

  • Insufficient funds to operate the business effectively.
  • Difficulty in obtaining funding due to perceived risk.
  • New businesses struggle to secure funding due to a lack of trade history.
  • Undercapitalization: Starting a business with insufficient funds.
  • Entrepreneurs often start businesses without enough capital, which can lead to failure.

Not Competitive

  • Inability to compete with rivals.
  • New Entrants: Smaller businesses may suffer due to market domination by larger businesses with superior products.
  • Ineffective Cost Control: Inability to keep costs down, leading to higher prices and failure to exploit economies of scale.
    • Wasteful budgeting systems and poor cost management.
  • Ineffective Marketing: Weak marketing efforts that fail to make an impact.
    • Inability to launch products effectively, inappropriate pricing strategies, and overpriced or inappropriate marketing campaigns.
  • Lack of Business Skills: Insufficient skills to run a business or knowledge of the market.
  • Poor Leadership: Mistakes by leaders and poor decision-making skills leading to business failure.

Kingfisher Airlines Case Study

  • Background: In 2012, Kingfisher Airlines, an Indian airline, ceased trading with debts of around 7000 crore (1 crore = Rs 10 million).
  • Early Success: Started flights in 2005 and became the market leader in 2009.
  • Acquisition: Acquired Air Deccan to boost market share.
  • Factors Contributing to Failure:
    • Poor Management: Lack of a strong leader and frequent changes in personnel at the top created instability.
    • The owner, Vijay Mallya, did not actively run the business, and it was given to his son, Siddharth Mallya, who lacked the necessary experience.
    • High Operating Costs:
      • Kingfisher offered high-quality inflight entertainment (e.g., DishTV) and free headphones, which were unusual for domestic flights.
      • Expensive advertising campaigns featuring well-known actors.
      • Exclusive lounges and luxury meals for passengers.
    • External Factors: Poor economic conditions after 2008, high fuel prices, and discretionary taxes.
  • Value of Kingfisher's Debt: The value of Kingfisher's debt in US dollars when it collapsed in 2012 (assuming US$1=Rs66US\$1 = Rs 66) was approximately US$1,060,606,060.61US\$1,060,606,060.61 (calculated as 7000 crore × 10,000,000 / 667000 \, \text{crore} \, \times \, 10,000,000 \, / \, 66).
  • Impact of Poor Management and High Costs:
    • Poor management led to instability and a lack of expertise in running the airline.
    • High costs made it difficult for Kingfisher to make a profit.

Failure to Innovate

  • Failure to Adapt: Businesses fail to change with the times and adapt to new technology.
  • Risk Aversion: Lack of willingness to take risks and invest money.
  • Loss of Competitive Edge: Rivals take the lead due to innovation.

Plenary Questions

  • Question 1: Which of the following is a possible cause of business failure owing to ineffective marketing?
    • Answer: A. Charging a price that is too high
  • Question 2: What term describes a business that begins trading with insufficient capital?
    • Answer: B. Undercapitalised
  • Question 3: Which of the following is most likely to cause a cash flow problem?
    • Answer: C. Spending too much on expensive fixed assets
  • Question 4: Overtrading might occur if a business tries to do which of the following?
    • Answer: A. Expand too quickly

Dandenong Soft Furnishings Case Study

  • Background: Dandenong Soft Furnishings began in 1965 and expanded to 87 stores by 1998.
  • Profit Decline: In 2001, the business made a profit of A3.3 million, but things started to decline from that year on.
  • Leadership Change: Charlie Dandenong retired and appointed his daughter, Agnes, as CEO.
  • Agnes's Mistakes:
    • Lacked strong leadership skills despite a degree in business management.
    • Bought rival chain, Marigold Furnishings, for A6.3 million, an excessive price.
    • Invested heavily in a national television advertising campaign, stretching the company financially and forcing them to borrow A10 million.
  • Stagnation: Between 2002 and 2008, the company barely broke even, with interest payments eating into profits, and sales declining.
  • Missed Opportunity: Agnes opposed setting up an online facility, despite a marketing report highlighting its importance.
  • Financial Trouble: In 2010, the company started losing money due to falling sales.
  • Failed Expansion Plan: Agnes planned to open stores in Western Australia, needing an investment of A5 million, but lenders were not interested.
  • Closure: In September 2014, Dandenong closed down owing banks A$$12.5 million.
  • Conflicting Reasons:
    • Agnes claimed the business failed due to a lack of finance.
    • The marketing manager attributed the failure to a failure to innovate.