THE CAUSES OF NORMAL FAILURE

The symptoms outlined in the previous chapter are the outward signs of decline. While it is the symptoms that kill you, the real cause of death is the underlying disease.

An unpalatable truth about business failures is that the insolvency practitioners who deal with failures generally think that, if your business has survived its first three years, the most important underlying cause of failure (whatever the precipitating event) will be how you manage your business.

However, on a more positive note, if this is true, you control how you manage your business and so it is totally within your power to do what is needed to save it.

When looking at the causes of failure there are four important points to bear in mind.

1. The situation may appear highly complex

You may find the situation appears highly complex because there will often be a number of levels of causes underlying the business’s difficulties. Usually, some primary underlying cause (such as a lack of leadership and/or investment) has allowed a variety of secondary causes (such as inefficient production or a lack of new products) to grow over time until a crisis is precipitated by some specific new cause (such as a new competitor entering the market who uses new technology). This then impacts on a wide variety of areas across the business, leading to many different symptoms, all of which need to be addressed.

One of the ways an experienced outsider can often help in these situations is by providing a fresh pair of eyes to help you to cut through the apparent complexity so as to identify the real issues. In fact, the fundamental issues usually turn out to be the reasons for your inability to address the many individual apparent problems. For example, a lack of leadership might simply arise where a managing director who is shy has inherited a business he did not actually want to run.

2. Short-term requirements must be balanced against long-term requirements

One of the fundamental tricks in running a successful business is to be able continuously to balance short-term requirements with long-term requirements. The short-term requirement is that you need to be generating cash and profits. The long-term requirement is that you need continuously to be reinvesting cash and profits into the future of the business to ensure you satisfy customers (and, hence generate profits and cash) into the future.

With a turnaround, the short-term cash position is likely to be very tight, while refocusing and reviving the business will usually require a long-term reinvestment of time and money. So in a period of turnaround the apparent conflict between these two imperatives will be at its greatest.

3. The whole business needs moving forward simultaneously

As well as balancing the present needs of the business with those of the future, you need to balance the pace of development and change across the different areas of the business so that the whole business moves forward simultaneously, and across all functional areas.

Example

Company C employs 50 people and is looking to double its turnover over three years as it comes out of a turnaround. As sales expand it has to expand the fulfilment side of its business (i.e. production and delivery) and also the financing of its operations so as to avoid overtrading.

This means it must expand its back-office administration to cope with the extra paperwork involved, and its accounting systems will need upgrading to handle the increased functions. It will thus need bigger premises and more staff. As more staff are recruited and trained so that staffing levels approach 100, the business decides to expand its management team to include a dedicated personnel manager who will look after this function of the business.

If the company’s sales had increased but it had not expanded its other supporting functions and resources at the same time, eventually the company would get into difficulties in supplying its customers and might well run out of cash.

4. The approach should be consistent across all areas of the business

You should generally aim to have a consistent approach to your recipe across all areas of your business. If you are looking to deliver a high-quality service to your clients, you will more than likely need high-quality staff who are well trained and who have good backup support systems. If you want to deliver a cheap and cheerful service, you are unlikely to want or need a prestigious office block from which to operate.

THE FIVE KEY AREAS

The causes behind normal business failure can be broken down into five key areas:

• 1.The business’s management structure.
• 2.The strategy challenges (the big problems that must be managed).
• 3.Lack of financial control.
• 4.Lack of operational control.
• 5.One-off projects or special circumstances that place a heavy demand on the business’s resources.

All these circumstances (except, perhaps, for strategy challenges) arise purely as a result of internal factors that are completely within your control. And while strategy challenges generally come from external factors (such as the economy, technical developments or changes in the industry you are in), how your business reacts to and deals with these challenges is entirely up to you.

The remainder of this chapter goes on to look at each of these reasons for normal business failure in turn.

Management structure

The following are but a few of the problems the management structure of a business might inflict upon its performance.

1. The managing director is an autocrat

The managing director is an autocrat. While strong leadership is vital to give a business a clear sense of drive and direction, when such leadership is driving a business over a cliff, this type is fatal. Autocrats drive away others with independent views as they see them as challenges to their authority. Autocrats can prevent any form of constructive debate about the best way forward or about what changes need making.

2. Lack of leadership

If autocrats have a so-called ‘team’ around them, these will comprise either loyal drones, ‘yes’ men, or both. A managing director who leads a team where each person has something meaningful to contribute to the business and whose role is recognised, will be far stronger for it. Conversely, a lack of leadership will create the opposite problems. Where the managing director is weak, no one will be quite sure who is really in charge.

3. Lack of management experience and depth

A lack of management experience and depth is a problem typical of ‘boards’ where membership is limited to people with experience of their own functional areas only (typically sales or production). In such cases the board takes the view that other skills are incidental to the business’s success (‘after all we have managed without them so far’), and is unwilling to incur the expense of hiring these skills in as managers or to dilute the board’s equity by recruiting appropriate new board members.

4. Unwillingness to seek/take external advice

Where there is a skills problem at board level, there are likely to be more severe problems at the next level down. Such boards are also unwilling to seek or to take external advice, and are certainly reluctant to pay for it.

5. Failure to change the management structure/culture or to manage change

The same boards may also fail to change the management structure/culture (i.e. to manage change), particularly as the business changes in size. How big a business do you think you can sensibly control as a lone entrepreneur? One employee? Ten employees? A hundred? A thousand? As businesses grow, they need to change the way they work and are controlled by bringing in professional management or directors and, generally, by moving from an entrepreneurial power structure/culture to a functional one. The structure and culture of a business must work together (see Chapter 10). The entrepreneur, therefore, has to decide whether to stay small or to face up to delegating control to others (and if so, the entrepreneur must manage the process of changing to working in this way in a successful manner).

6. Failure to plan for succession

Managements may similarly fail to plan for succession and to allow for generational changes to happen. In 50 years’ time, will the survivors of today’s thirty-somethings e-business start-ups still be headed by those now eighty-somethings? If not, why not?

7. Shareholder/board disputes

Where there are major disputes between the owners or managers of a business (or both), effective business management will go to the wall, there is nothing more destructive than a civil war.

8. Failure to face up to problems and to take necessary action.

Managements that fail to face up to problems and to take necessary action in the unrealistic or unjustifiable hope or belief that things will simply get better are putting their faith in the non-existent ‘turnaround fairy’. The view that there is ‘nothing we can do’ as ‘everyone in the whole industry is in difficulties’ will be dispelled by an afternoon doing credit searches or by looking at the accounts of a half a dozen competitors. In any industry in difficulty there are going to be survivors and failures; the trick is to be in the right category.

9.Family business run in the interests of family members

Family businesses run in the interests of family members and not the business will likewise suffer (see Chapter 8 for a fuller discussion of the issues surrounding family businesses).

10. Failure to focus on profit

Businesses that fail to focus on running the business for a profit will also fail. Businesses need to be run on a commercial basis with an eye on cash and with a constant review of performance, opportunities and costs so that margins (and hence profits) and, ultimately, cash are maximised (i.e. to produce reserves of profit to be ploughed back into the growth and development of the business for the future). Some businesses are run by people in business rather than business people.

11. The bluebottle syndome

The bluebottle syndrome occurs where management actually thrives on, or is unable to manage in any other way than, total chaos.

12. The goldfish syndrome

The goldfish syndrome means failing to understand exactly where you are and where you are going (e.g. the last financial information is the accounts filed two years ago).

13. The ostrich syndrome

The ostrich syndrome means failing to face up to known problems with either operations or the business recipe. (See Figure 8 for a summary of these problems.)

Strategy challenges

There are many large, often externally created challenges that present threats as well as opportunities to businesses and their recipes, such as significant changes in the nature of an industry which, if not dealt with by updating the recipe to ensure sustained competitive advantage (see Chapter 8), will result in long-term failure.

1. Failure to spot and adapt to changes in the sector/market’s needs

The first strategic challenge is a failure to spot and adapt to changes in the sector/market’s needs. The business recipe may be very successful at the moment but a quick look at what happened to Marks & Spencer will show what happens when a business fails to adjust its recipe to move with the times.

2. End of a business’s natural lifecycle

Similarly, products or businesses reach the end of their natural lifecycles. Goods and services are introduced as something new, are accepted as the norm and then fade away to be replaced by the new. The timespans of some of these lifecycles can be extremely short (e.g. in fashion and electronic products) due to the increasing rate of change and speed of innovation in a particular sector.

You should continuously review your products and services to ensure you are not left behind and so that you can either ‘reinvent’ your offering or replace it with the next ‘big thing’.

3. Failure to prepare for trade cycles

Businesses might also fail to prepare themselves for changes in trade cycles. Over time, an economy must be expected to go through periods of growth and recession. Businesses have to prepare for these cycles and to set their strategy accordingly. (As a recession looms, do you decide to build up your cash reserves or do you go ahead with launching that high-cost luxury version of your product?)

4. Failure to face up to the need for step changes

In most cases the best way to manage change and development is to make them an integral part of your business recipe. Changes will happen with minimal disruption as long as the changes are generally all heading in the same direction. In this way you will minimise the risks of change to your business. But there will be some occasions (e.g. when you have fallen badly behind for some reason) where incremental change is not enough and you will have to face up to making major changes.

5. High cost structure

A high cost structure means it is costing you more to do something than it does your competitors. This can be the result of differences in scale. For example, if you are building 100 cars a year, your costs per car are going to be higher than Toyota, who enjoys ‘economies of scale’. Firstly, Toyota’s volume means it can buy parts more cheaply than you can. Secondly, Toyota’s managing director’s salary, advertising budget and all its overheads are being absorbed across millions of cars per year, whilst yours are only spread over 100. Thirdly, in building millions of cars Toyota has gone further down the learning curve of how to make cars efficiently.

Alternatively, a high cost structure might arise as a result of fundamental structural factors. For example, if you are based in the southeast of England you will be paying higher wages and rents than a competitor based in the northeast of England where wages and rents will be lower. Either way, being uncompetitive on costs is usually a recipe for failure – unless you can persuade customers to buy, irrespective of the costs to them.

6. Lack of investment for the future

A lack of investment for the future (in new products, marketing, staff training, plant and equipment or new technology) is a particular problem for ‘lifestyle’ businesses designed to support an individual business person’s chosen lifestyle which fail to realise they need to reinvest in developing the business’s skills, products and contacts to ensure its long-term survival.

7. Concentration on the new to the detriment of the old

Alternatively, when you are developing a new part of the business, do not forget to manage the old part. After all, the old part is probably producing the cash needed to fund the new project, and you need to ensure that cash keeps flowing.

8. Eggs in one basket

The ‘eggs in one basket’ risk arises from overexposure to circumstances where failure will bring down the whole business. The first type of such risk is the ‘bet the company’ situation where one big project, one new business line, one acquisition or one contract has been taken on. Before entering into such projects, always look carefully at what the real costs and cashflows are going to be and take a long hard look at the skills you will need to pull the deal off. It is better not to do it than to get halfway through and find you cannot complete it.

Secondly, there are situations where a business is totally reliant on a single product, supplier or customer and its fate, therefore, is not in its own hands (e.g. 50% of sales are to or through one customer or distributor). In these cases, the message is ‘diversify or die’.

9. Lack of power in relationships

A similar problem to the one above is a lack of power in relationships, where over-reliance on a single supplier or customer means they, not you, determine the prices and terms of trade.

10. Operating in a difficult industry

Some businesses operate in difficult industries, and different industries have different characteristics which affect how difficult they are to operate in (see Chapter 8). Particular problems arise in industries with any of the following characteristics:

• High exposure to risks that are outside the business’s control except by expensive or complex hedging mechanisms (e.g. fluctuating commodity prices or foreign exchange risks).
• Declining markets, particularly in industries that require large investments in plant and equipment or where the costs of exiting the business are high. Ruinous competition can set in as a consequence of a large, fixed capacity chasing smaller and smaller demand.
• A reliance on sales of commodity products, as prices for commodities are set by the markets (unless you can differentiate your product as a brand which people will buy for reasons other than price).

11. Lack of bank/supplier/customer/staff support

The final type of strategy challenge arises as a result of a lack of bank, supplier, customer and staff support. (See Figure 9 for a summary of these challenges.)

Lack of financial control

Financial control problems fall into three main areas.

Information

To run a business and make sensible business decisions, you need financial information that is timely, meaningful and accurate. If you don’t have this you are just guessing at how you are doing or at how much your products really cost to make. You need timely, meaningful and accurate information if you are going to make crucial decisions about how to start to save your business, such as which products or markets to focus on because these are the most profitable ones.

Control

If you don’t want to suffer catastrophic failure through fraud, you must put in place adequate financial controls.

Management

You need to manage your business’s money, finance and financial strategy. Not doing so often leads to problems with the following:

• Poor credit control. Producing and selling your goods is only part of the story. Plenty of people will buy your goods if they don’t have to pay for them. Getting the money in after the sale is a vital function, as is making sure you do not sell to people who cannot, or will not, pay.
• High stock levels. Holding stock costs money (see Chapter 7).
• Inappropriate funding. You wouldn’t use your personal overdraft (repayable on demand) to buy a house you are going to live in for a long time. Why, then, should you expect your business to fund its long-term assets on an overdraft?
• Overgearing. If you borrow too heavily you become overexposed as those interest and capital payments have to be made month after month, whatever the trading results.
• Overtrading. If you grow faster than your supply of funds, your cash will run out.

Lack of operational control

All the day-to-day functions of the business must work and must work correctly if the business is to succeed.

Inefficient production can arise from a variety of causes:

• Is the factory poorly laid out?
• Is the equipment obsolete or poorly maintained?
• Are the workers poorly trained or undermotivated?
• Is production organised in the most appropriate way (single/batch/continuous)?
• Does the business manufacture too wide a range of products?

Quality is a factor in any sale. You may buy a box of matches based on their price, but if you find half the matches don’t light you are unlikely to buy another box from the same manufacturer. You must also have an effective salesforce who can get out and sell to customers, as well as an effective distribution system to deliver the goods.

Some businesses also fail to manage ‘soft’ staff issues. For example, despite his qualifications and experience, is that bright, ambitious ideas man with a mind like a grasshopper and salesman’s bow tie, who responds well to praise, really suited to his job in process quality control, managing details day in, day out by the book? If not, why not? To overcome such problems you need to ask yourself the following questions:

• How are you organised? Who does, and reports, what and to whom? Draw an organisation chart for your business with brief job titles. How clear and logical is this chart?
• What are your organisation’s culture and structure (see Chapter 10)? Are they appropriate?
• What reward structures do you have in place to encourage specific behaviours (e.g. commission for sales staff)?
• Do you understand what motivates your workers? Are all your staff driven by the same things (praise, security, power, excitement) or do they vary in their needs?
• Do your staff tend naturally to fill different roles in a team (the new ideas person, the boss, the project manager or the tidier-up of loose ends)? Are you using your staff to your best advantage?
• Do your staff have particular characteristics that would suit them better in different jobs? Do these personality issues lead to conflicts (e.g. the salesperson who hates paperwork and who drives production up the wall because of his or her failure to record and specify properly what the customer wants)? What are you doing to manage these sorts of issues?
• What is your natural management style? Direct (a spade is a spade, be it good or bad), influencing (lots of praise for good behaviour, coaching for bad), formal and by the book, with lots of written memos, etc.? Does your style work equally well with everyone, or would it be more efficient for you to use different styles when managing different personality types?

Businesses run most efficiently:

• with ‘round’ pegs in ‘round’ holes;
• when managers know who is ‘round’ and who is ‘square’, and manage them in ‘round’ and ‘square’ ways; and
• by ensuring that systems mean that ‘round’ and ‘square’ individuals are used to complement each other and not to cause conflicts.

This can best be achieved by using some basic psychometric tests to assess personality types and preferred team roles.

One-off projects or special circumstances

These are situations that produce strains that weak management or financial controls are unable to deal with. They are, therefore, not usually the fundamental causes of failure as much as the straws that break the camel’s back. Typical examples are:

• a premises move;
• a big acquisition;
• committing a business to a big production contract;
• changing an accounting or computer system;
• developing and launching a new product.

KEY POINTS

Overall, the causes of business failure are, in the main, all management issues. To avoid failure you need to:

• monitor what is happening inside and outside the business and ensure the business is managed accordingly;
• take the risks needed to ensure continued growth and returns; and
• manage your business’s exposure to those risks.

HOW SERIOUS ARE YOUR PROBLEMS?

To assess how serious your problems are and whether you can save your business, complete the checklist on page 56. Tick each strength (or its opposite weakness) that applies to your business. How balanced are your strengths/weaknesses? To what extent are the weaknesses the result of issues under your control? What overview does this give you as to how easy or difficult it is likely to be to turn your business around? What does this exercise suggest you are going to need to focus on to achieve this?

Remember, it is possible to try to heal the sick; it is not possible to raise the dead. If there is no reasonable prospect of saving your business, you need to consider commencing insolvency proceedings now to protect your own position (see Chapter 11).

Weaknesses		Strengths
Management structure
Weak management		Strong management
Strategic challenges
Many causes of decline		Few causes of decline
Single plant, product, supplier or customer		Diversified plant, product suppliers and customers
Commodity product		Differentiated product
Customers can walk away		Customers locked in
Competitors price cutting		Identifiable niche markets
Industry overcapacity		Fragmented industry
Collapsing markets		Growing market
Order book weak (volume and/or margin)		Strong, profitable order book
Weakening market position		Strong market position
Large capital expenditure needed		No major investment required
Lack of bank or shareholder support		Bank and shareholder support
Suppliers unco-operative		Co-operative suppliers
Lack of customer support		Customer support
Financial control
Severe cash crisis		Mild cash crisis
Poor financial information		Good financial information
Poor costing information		Good costing information
Operational control
High fixed costs		Low fixed costs
Long-term loss contracts		Profitable contracts
Fundamental quality problems		Good quality products
Old or obsolete plant and equipment		Current adequate production facilities
One-off projects
A large project being undertaken (move, acquisition or product development)		No large distraction from core business