Management Perspectives

In the ever-evolving landscape of businesses, companies rise and fall with remarkable frequency. Behind every successful enterprise lies a multitude of factors contributing to its triumph, just as behind every failure lies a series of missteps and oversights. Understanding why companies fail is crucial for aspiring entrepreneurs, seasoned executives, and policymakers alike. By dissecting the root causes of these failures and identifying effective solutions, we can pave the way for a more resilient and prosperous business environment.

India as on date has over 24.2 lakh registered companies out of which only 14.92 lakh are going concerns (active). At any given time there are thousands of companies being shut down and lakhs who have not filed their annual accounts. This small bit of statistics indicates the failure of business. The failure rate increases during a recession, but even during periods of buoyant economic conditions many businesses fail.

Although the reasons for failure of a business are many and the details differ from case to case, however the underlying causes can be traced to the five fundamental factors The first reason for business failure is the loading of the firm with a heavy debt burden (usually to carry out merger and acquisition at overpriced terms). This affects the firm’s strength at the time of recession or market downturn. There were many reasons for the sub-prime crisis in USA and one of them was cheap money. It encourages banks, investment banks, hedge funds, corporate and individuals to borrow more and place bets.

This can happen when interest rates are low and lending procedures slack leading individuals and companies to leverage themselves to unsustainable levels. The table below shows the leverage level of US companies which failed during the 2008 financial crisis. The leverage indicates that—for every $1 invested by the promoter, $33 was raised through debt. Eventually these were the two mighty corporates that collapsed first and set the domino reaction to the financial crisis of 2008. Any economic activity with a high borrowing is vulnerable to shocks. The table indicates this concept for a Company A.

Once the capital (equity) of the promoters is wiped out, there is tendency for the promoters to take greater risks to make up for the losses. There is something in finance called the ‘gambling for resurrection’. It is when you are down so far that you don’t have much more to lose, so you are willing to take big risks in the hope of recouping your losses. The debt-equity ratio is a very useful leverage indicator. High leverage reduces the pay-out to equity investors and the interest payments are legal obligations and part of the profit. The table below shows Indian companies with high leverage.

The numbers are indicative, taken from the books of account. However, leverage is what matters. The second reason many businesses fail is because decision-makers do not fully understand the fundamentals of their business or the core expertise required. Then the firm drifts (through diversification and merger & acquisition) into areas where it has very little expertise. In any business, the promoters are the main persons sponsoring the business because there is a match between the promoter’s competency and the competency requirement of the business.

The diagram below indicates this proposition and only when it is correlated that the business becomes a success. The match between the two is a fundamental requirement. Unrelated diversification without competencies will result in failure of projects/organisations unless the business entity has acquired the talent or through creation of JVs, to manage a conglomerate. A good example could be NTPC creating a wholly owned subsidiary Renewable Energy Company called NTPC Renewable Energy Limited. The vision of this company is to be world’s leading renewable energy company accelerating India’s energy transition. The challenge is that these subsidiaries thus created should become self-reliant in terms of revenue, cash flow, profitability and growth at the earliest.

The failure of the United Breweries Group’s venture into airline industry is another case in point. Kingfisher Airlines was a subsidiary of the United Breweries Group, which holds 30.25 per cent of the paid up capital. It was an unrelated diversification from the distillery to airline industry. The promoter’s competency did not match the business competency required in an industry which is very competitive and service-oriented. The second example is the Videocon Group, the first company to acquire license to manufacture colour TVs in India. They became a household name in electronic goods, but subsequently ventured into oil & gas, telecom and other verticals. The company went bankrupt in 2018 and referred to NCLT (bankruptcy court).

The third reason for businesses failure is lack of vision or the inability of the top management to anticipate or foresee the serious problems (risks) the business will face down the road. US automakers comprising General Motors, Chrysler, and Ford, at an early stage, failed to understand the seriousness of the competitive challenge posed by Japan in the US car market and conceded the small car space to the more agile and nimble auto makers from Japan. US auto majors believed that the Japanese were no challenge to them. This was an erroneous belief. The Japanese auto manufacturers have captured a market share of 43 per cent in the US auto industry.

The fourth reason for business failure is that firms vainly trying to recapture their past glories and getting stuck on obsolete strategies are unable to respond to new and major competitive challenges. An example is Kodak, which stuck to photo films. Nokia is another example of a firm not transitioning quickly in the smart phone segment. Recently, Honda Cars India inability to introduce compact SUVs has resulted in conceding the market to KIA and MG. Finally, a company may fail as a result of unhappy employees. This may be as a result of strikes, hostilities, unionisation, loss of key managerial personnel, data theft, indiscipline, loss of remuneration, etc. The failure of manufacturing sector and textile sector in India is a result of the above factors.