Description
Understanding business failure presents an enormous theoretical challenge that still fundamentally remains to be met, probably because past efforts were more concerned with prediction than with understanding.
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Defining business decline, failure and turnaround: a content analysis
Marius Pretorius
Department of Business Management, University of Pretoria, South Africa
[email protected]
Abstract
In the past, researchers have often defined failure to suit their data. This has led to a lack of comparability in
research outputs. The overriding objective of this paper is to propose a universal definition for the failure
phenomenon. Clear definitions are a prerequisite for exploring major constructs, their relationship to failure
and the context and processes involved. The study reports on the core definitions of the failure phenomenon
and identifies core criteria for distinguishing between them. It places decline, failure and turnaround in
perspective and highlights level of distress and turnaround as key moderating elements. It distinguishes the
failure phenomenon from controversial synonyms such as closure, accidental bankruptcy and closure for
alternative motives.
Key words and phrases: business decline, failure, turnaround, level of distress
Introduction
Understanding business failure presents an enormous theoretical challenge that still
fundamentally remains to be met, probably because past efforts were more concerned with
prediction than with understanding. That such a challenge has largely gone unanswered is
fairly easily understood (Cybinski, 2001:39; Shepherd, 2005:126). The lack of understanding
of the concept is partly due to the lack of an adequate definition of failure. (Shepherd,
2005:124). Researching the failure arena quickly shows that various authors have different
interpretations of failure and that no one universal definition exists. Existing writings about
failure are dominated by prediction models but diverge into several fields, and the differing
focuses and objectives of researchers create an ill-defined domain, made up of several
overlapping fields (Shepherd, 2003). Existing research also appears problematic because of
the current definition of failure and the ways in which failures have been measured in the past
(De Castro, Alvares, Blasick & Ortiz, 1997:1). While financial prediction of failure (which
uses bankruptcy as dependent variable) takes up a large portion of failure-related research,
this study explores outside the limitations of prediction (Balcaen & Ooghe, 2005; Steyn
Bruwer & Hamman, 2006) by investigating the qualitative rather than the quantitative end of
the continuum.
If it is true that between 50 and 90 percent of entrepreneurial ventures fail (depending on the
author and statistics quoted), failure is probably the one thing that almost all entrepreneurs
will face somewhere in their endeavours. At the same time, failure is probably the last thing
on the mind of an entrepreneur starting out on the entrepreneurial process.
Given the “survival of the fittest”, failure is a natural step in the life cycle of business
ventures. Organisational ecology (as a metaphor) further asserts that the environment will
naturally weed out unfit organisations, and that the ability to survive over time is a function of
both an organisation’s suitability to the current environment and its ability to adapt
appropriately if the environment evolves. Misalignment with the environment may therefore
expose firms to different liabilities associated with failure (Barron, West & Hannon,
1994:381).
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There exists a limited but growing body of knowledge on the topic of failure on which
researchers can base their investigations, especially in the small business domain. The
research articles are, however, scattered across business, management, financial, psychology,
entrepreneurial and many other journals and no proof could be found that these works have
ever been comprehensively reviewed. There is no specific body of science to which failure
exclusively belongs. While this study focuses on failure in business ventures, it does not
ignore failure in other organisations, such as quasi- and government ventures. This study
prefers the term venture, but uses it interchangeably with business, firm and organisation as
terms, depending on how different authors have reported their research in the literature.
Business ventures hover somewhere between the extremes of the success-failure continuum,
which influences the decisions that ventures are faced with, and the potential consequences of
failure have significant and interesting impacts on business decisions (Cybinski, 2001:31).
Failures draw attention all the time, whether they occur during start-up or in mature ventures,
and it appears that failure is inherently part and parcel of the science of business management.
If failure is indeed central to the entrepreneurial thrust of ventures, better understanding of the
domain will benefit both the science and the practising entrepreneur overall. Recently there
have been two special editions of journals (Journal of Business Venturing and Long Range
Planning) that focused on failure, which also points to the resurgence of failure as a research
domain. There also appears an outcry for better understanding of the failure domain since the
onset of the world economic crisis in 2008.
The importance of failure in business has been acknowledged in reports of crises in
companies that have dominated the news in recent times. Several icons of business such as
Worldcom and Enron were not spared failure, leading to investors losing large portions of
their assets. Experts greet the news of these failures with post-mortems on what could have
been done to avoid the decline. Some reviewers, with the 20/20 vision of hindsight and
expensive financial prediction models, express amazement that management did not foresee
and respond to critical events in time to prevent termination. Obviously, it is easier to make
up prescriptions after events have occurred than it is to prescribe ways to avoid problems in
the future (Probst & Raisch, 2005:90).
It is also true that often one cannot really describe something without explaining what it is
not. In the search for the secret of venture success (lower failure rates), it helps us to look at
failure for improved understanding. The research question is therefore one of making sense of
the failure phenomenon in order to improve the understanding of successful business by
describing what it is not. Thus, this study aims to support not only researchers but also
entrepreneurs and practitioners. Entrepreneurs could benefit from this improved
understanding to reduce high failure rates of 80 to 90 percent, as reported by Knott and Posen
(2005:617). Distinguishing between decline and failure gives direction to entrepreneurs about
strategies to pursue when attempting recovery in their ventures.
Aim of this study
This study has one principal aim: It seeks to review the scientific literature on business failure
through grounded theory methodology and to identify the universal constructs of the failure
phenomenon. It therefore attempts to advance research at this promising intersection of
entrepreneurship, business management and the cognition sciences by mapping the territory
meaningfully in order to direct entrepreneurs and researchers through the failure domain.
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The overriding objective is therefore to propose a universal definition of the failure
phenomenon as a first step in exploring the major constructs, their relationship to failure and
the context and processes involved, thus providing a better understanding of the phenomenon
that goes beyond a descriptive account.
Method of review
The specific research need identified in this study is to better understand and make sense of
failure, rather than predict failure, although the two focuses are related and a large number of
recently published works have been in the field of failure prediction, as reported by Sharma
(2001:5). The specific methodology (emulating that of Forbes, 1999) adopted in this study
was selected because secondary sources of failure are limited (especially in developing
countries), as failed firms disappear and entrepreneurs of failed ventures rarely like to talk
about the reasons that led to failure. Even when they do speak out, such explanations are
likely to have self-reporting and retrospective reporting biases (Shepherd, 2005:126).
Scientific resources from the ABI-Inform, Ebsco-host, Proquest, Blackwell and other
databases were searched for titles published since 1985. The date was somewhat arbitrarily
determined (though not necessarily adhered to) and based on convenience, as this was the
earliest date for which most databases had downloadable electronic titles, abstracts and full
texts readily available. For apparently major works, the date was not a limitation, especially
when an article was referenced widely. Age of publication was not considered important, but
relevance and contribution to the body of knowledge of failure were paramount.
At first a search for failure, combined with business, venture, firm or organisation was
conducted. Initial searches were keyword-based and narrowed down by using the different
keyword variants identified during the process. As the articles (data) were obtained, searches
were extended to include terms such as crisis, decline, discontinuance, distress and more. All
articles were scanned based on titles and abstracts that led to a first complete reading of each
article that was deemed to cover failure-related issues, using a method similar to that
described by Forbes (1999:417). When prediction was used in conjunction with failure, a
plethora of articles were found in a range of financial and accounting journals and it was clear
at this early junction that failure prediction (from the financial perspective) made up a large
part of the total research base associated with failure. Balcaen and Ooghe (2005:24) confirm
that corporate failure prediction has become a major research domain within corporate
finance.
Second- and third-round searches were conducted using author names in addition to keywords
for cross-referencing. Thereafter specific journals were searched. Key journals included
Journal of Business Venturing, Entrepreneurship Theory and Practice, Academy of
Management Review, Sloan’s Management Review, Academy of Management Executive,
British Journal of Management, Administrative Science Quarterly, Long Range Planning,
Strategic Management Review, The British Accounting Review, Organisational Science,
Journal of Small Business Management, but were not limited to these. References of
important articles were then searched and accessed to build up an extensive list of articles.
The definitions of failure were mapped through a snowball process where references in one
article lead to the search for the next articles with definitions. Articles covering all failure-
related terms were investigated to identify more references. These articles were then obtained
and the process repeated to identify the key works referenced by the different authors.
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Borrowing from Corbin and Strauss’s (1990) method on grounded theory research, concepts
for each definition were identified and through repetitive scrutiny and comparison within the
“conditions” for each definition, the concepts were categorised towards building a definition
of failure. The categories were the cornerstones of the definitions eventually developed.
After reading (analysing) the abstracts of the articles, papers that in fact represented failure-
related issues were selected based on personal understanding of the issues. Thereafter each
article was assessed for definitions and identified and key concepts reported. Categorising the
concepts into sub-domains (categories) of failure-related issues (Pretorius, 2008b) was
followed by reporting them individually with their specific contributions, based on Corbin
and Strauss’s method (1990:7). Articles without clear definitions were discarded for reporting
in this study.
Eventually a list of key references was assembled. The process of adding articles was never
officially stopped but drifted towards closure as no more “useful new information” came
forth, in accordance with the principles suggested by the grounded theory research process.
This meant that the real number of articles screened became less important than initially
anticipated when I embarked on the study.
Findings
The report of the findings of the research covers, firstly, the outcome of the definitional
approach. Secondly, it explores the criteria for constructs contained in the definitions. Thirdly,
it proposes definitions and finally highlights key elements. The final definition of turnaround
is proposed to suggest the key difference between decline and failure.
While many authors failed to propose a definition to guide their research and depended on the
general understanding that readers might have about the phenomenon, many definitions with
varying viewpoints were found. The variations confirm Shepherd’s (2005:124) statement that
the lack of a single definition of failure is partly responsible for the poor understanding of the
phenomenon. Failure is defined in as many ways as there are researchers. Watson and Everett
(1999:9) report that many of the differences in reports of sectoral failure rates may be driven
by choice of failure definition. Balcaen and Ooghe (2005:23) state that the assumption of
dichotomous datasets (failure vs. success or non-failure) to enable accurate predictions
neglects the multidimensional nature of failure and is in conflict with the reality of failure
situations. Steyn et al. (2006:11) also report a list of definitions by South African authors that
underscores the lack of a definition outside those dichotomous types used for prediction
purposes.
As the research progressed and while probing the different databases, it was found that failure
is associated with bankruptcy, liquidation, insolvency, crisis, decline in performance,
decision-making, collapse, crashing, accounting practices, project failure, distress, trouble,
systems failure, franchise failure, being non-successful, and more. Therefore the eventual
search terms focused mainly on business, organisational, corporate, venture, and enterprise
decline, failure and turnaround and less on prediction. Table 1 shows the variation in
definitions and how they are influenced by the researchers’ focuses during investigation.
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Table 1: Synthesis of principal works based on the definitional perspective
Definition Key definition constructs Apparent Researcher focus Type of
study
Reference
Decline focused definitions
Decline: Degeneration of organisational performance in sales,
profitability, market share and technological leadership
Performing worse Decline signs, causes and
preventative strategies
Theory Lorange & Nelson, (1987)
Performance decline: Decrease in some measurement such as
sales, workforce, profits or profit ratios (ROI or ROE) that has
continued for some time.
Measurement and duration (time) of
decline
Performance decline Weitzel & Jonsson, (1989)
Decline: Refers to decreasing internal resource munificence
over time with respect to two critical resources: financial and
human (managerial) resources.
Decrease in internal ability to survive
Time
Aftermath of decline compared
with non-decliners. Patterns of
decline.
E D’Aveni (1989:578)
Decline: Organisations enter a stage of decline when they fail
to anticipate, recognise, avoid, neutralise or adapt external or
internal pressures that threaten the organisation’s long-term
survival.
Management stages and signs and actions
Trigger point
Internal systems to detect
conditions that may lead to
decline
Case Weitzel & Jonsson, (1991)
Decline and crisis are the low and high extremes of the rate of
performance deterioration.
Level and rate of performance
deterioration
Decline and crisis impact on
turnaround and debt financing
Chowdhury & Lang
(1993:8)
Financial distress: Fall of a firm from a superior performance
position to an extremely poor position on any appropriate
performance criterion – specifically Taffler’s Z-value.
Decline from superior position to poor
position. Rule = +, +, -. Two years’ good
performance followed by poor.
Turnaround strategies Sudarsanam & Lai
(2001:190)
Decline and deteriorating financial performance measured by
bankruptcy and dramatic fall in market value
Decline
Deterioration of financial performance
Crisis, crashing and collapse Probst & Raisch (2005:90)
Failure focused definitions
Failure: Firms that filed bankruptcy after having their shares
trading publicly in the years prior to bankruptcy
Bankruptcy after being successful Leadership change during
decline
Schwartz & Menon (1985:
681)
Failure: Bankruptcy (excluding intentional bankruptcy that
was used as a legal tactic).
Bankruptcy Consequences of decline
compared with non-decliners.
E D’Aveni (1989:585)
Failure or severe form of financial distress such as loan
default or non-repayment of creditors.
Severity
Default
Prediction models Literature
review
Keasey & Watson
(1991:89)
Failure occurs when the level of organisation capital reaches
zero. It is no longer able to meet its financial obligations to
debt holders, employees, or suppliers and resorts to or is
forced into bankruptcy or liquidation.
Organisational capital Model for understanding
resource buffer and mortality
relationship
Theory Levinthal (1991:401)
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Table 1 continues
Failure means closure of a unit but not total closure (within a
franchise organisation)
Closure Franchise failure comparison Castrogiovanni, Justis &
Julian (1993:106)
Failure: A firm that has gone out of business with losses to its
creditors
Not operating any longer
Losses
Duncan & Handler
(1994:7)
Business dissolution refers to single business corporations that
shut down and multiple business corporations that shut down
a single business and includes both voluntary liquidation and
involuntary bankruptcy.
Shut down
Choice vs forced bankruptcy
Effects of business sales and
age dissolution and divestiture
E Mitchell (1994:576)
Failure: Business failing organisations are those that will
become insolvent unless appropriate management actions are
taken to effect a turnaround in financial performance
Pending insolvency
Requirement for alternative management
action
Configurations of factors
leading to failure
Richardson, Nwankwo &
Richardson (1994:9).
Failure: Firms involved in court procedures or voluntary
actions which result in losses to creditors excluding
discontinued ventures
Losses to creditors Non financial failure prediction E Lussier (1995:9)
Failure: Ceased operations due to outright insolvency, and/or
when a firm has ceased operations in order to stop continued
losses
Ceased operations
Outright insolvency. Continued losses
Closing vs disappearance vs
failure
De Castro, Alvarez,
Blasick & Ortiz (1997:4)
Financial crisis: Closure of the firm resulting in large-scale
social and economic costs
Ceased operations Crisis in banks that led to
closure (failure)
Stead & Smallman
(1999:13)
Failure is defined as bankruptcy Bankruptcy Comparing failure attribution
between venture capitalists and
entrepreneurs
6 Cases Zacharakis, Meyer &
DeCastro (1999:5)
Failures refer to deaths of entire firms and industry exits by
multiple business companies.
Closing or exiting the industry Strategy and age dependence E Henderson (1999:291)
Discontinuance (ceasing of operations) of business for any
reason or bankruptcy or failing to “make a go of it”.
End of operations Failure rates and defining
failure
E Watson & Everett (1999:5)
An initiative can be said to have failed when it is terminated
as a consequence of actual or anticipated performance below a
critical threshold (fallen short of its goals)
Termination
Performance below critical threshold
Real options reasoning and
anti-failure bias
McGrath (1999:14)
Failure is “not having made profit for the previous three
years”
Losing money Non-financial prediction E Lussier & Pfeifer
(2001:232)
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Table 1 continues
When fall in revenue and/or rise in expenses are of such
magnitude that the firm becomes insolvent and is unable to
attract new debt or equity funding; consequently it cannot
continue to operate under the current ownership and
management.
Insolvency and involuntary change in
ownership and management.
Grief of owner and recovery
after losing a business, Failure
research
T Shepherd (2003:318),
Shepherd (2005:124)
Bankruptcy is the ultimate reason for exiting the economy and
happens when firms lack sufficient capital to cover their
obligations. Firms that are insolvent to the point of legal
proceedings have clearly failed to meet the market’s
performance threshold of fulfilling their financial obligations.
Exiting the economy or not meeting the
“performance threshold” of the market.
Resource-based view of failure
with age of firm as proxy for
resource differences between
firms.
Thornhill & Amit
(2003:497)
..success and failure were identifiable as “end states” … End state Small business failure Single
case
Ritchie & Richardson
(2004:236)
Organisation failure is the end result of a decline Failure follows decline Turnaround Case
applicatio
n
Sheppard & Chowdhury
(2005:241)
Failure, in organisations and elsewhere, is deviation from
expected and desired results.
Deviation from goals Learning Theory Cannon & Edmondson
(2005:300)
At the time of failure the “legal status” of the firm was
bankrupt, meaning it had suspended payments against
creditors and had lost all credit
Legal status
Credit loss
Prediction E Pompe & Bilderbeek
(2005:851)
A major loss of value rather than bankruptcy Value loss Board role in renewal Qualitativ
e
Hass & Pryor (2005:12)
Failure occurs when a firm’s value falls below the opportunity
cost of staying in business
Performance decline Measuring decline Theory Cressy (2006:103)
… firms whose stocks are delisted as a result of either
bankruptcy or liquidation elections.
Distress Prediction Joseph & Lipka (2006:296)
Turnaround focused definitions
Turnaround situation is when a firm has had two successive
years of ROI and ROS growth followed by: absolute
simultaneous declines in both for a minimum of two years and
a rate of decline greater than the industry average over the two
year period.
Decline in ROI and ROS for two years
after success for two years
Turnaround: retrenchment and
recovery
Robbins & Pearce
(1992:295)
Turnaround management is a process whereby managers
actively seek to save distressed firm from failure.
Save distressed firms from failure Difference between distress and
failure
E Fredenberger & Bonnicic
(1994:59)
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Table 1 continues
A successful turnaround is when a firm undergoes a survival-
threatening performance decline over a period of years but is
able to reverse the performance decline, end the threat to firm
survival and achieve sustained profitability.
Reverse performance decline Turnaround process E Barker & Duhaime
(1997:18)
Turnaround is a concerted and organised effort by top
management to respond to the firm’s performance problems.
Top management induced effort Turnaround E Barker & Moné
(1998:1239)
Once profitable firms that have suffered firm-threatening
performance declines and are attempting, either successfully
or unsuccessfully, to turn around.
Once profitable
Now decline
Performance decline E Barker & Barr (2002:968)
Organisations that are not demonstrating performance that is
acceptable to stakeholders, analysts, vendors and employees.
require a turnaround intervention.
Unacceptable performance Performance Theory Kow (2004:229)
Turnaround has occurred when the firm recovers adequately
to resume normal operations, often defined as having survived
a threat to survival and regained sustained profitability.
Survived decline
Normal operations
Profitability
Recovery to normal operations Theory Lohrke et al. (2004:65)
The actions taken to bring about a recovery in performance in
a failing organisation where failure is defined as “existence
threatening decline” in performance.
Actions for recovery in performance Action to recover from decline Theory Walshe et al. (2004:201)
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Table 1 contains the main definitions found in the literature; due to space constraints,
definitions such as those using bankruptcy as criterion were not repeated ad infinitum. Three
main categories were distinguishable, suggesting that researchers use definitions as required
for specific problems. There were more definitions for failure than for decline and turnaround,
a possible reason being the large sub-domain of prediction research reported in the literature.
The table also shows the key constructs of the definitions used and the apparent focus of the
specific authors.
Table 1 reports many different terminologies within definitions, depending on the choice of
the authors reporting it. Liao (2004:134) confirms that in general many different terms are
related to business failure, such as closures, exit, dissolution, discontinuance, insolvency,
organisational mortality, bankruptcy and organisational failure. It was therefore deemed
necessary to identify and list the different criteria for the definitions, as they make up the key
constructs required to propose the universal definitions. The key criteria are reported in Table
2.
Table 2: Core criteria that distinguish between the definitions for decline, failure and
turnaround
Construct Criteria Supporting
Reference
Worsening performance criterion - ROI decline for two
consecutive years. Average pre-tax ROI of less than 10% for the
same two consecutive years.
The performance decline must be independent of the
performance of the industry in which they operated.
Chowdhury &
Lang (1993:11)
Value destruction criterion - Loss of company value and
changing from being profitable.
Distress criterion - Accumulation of debt that seriously
threatens survival. Changing market leadership position towards
becoming unprofitable and becoming a player only.
Probst & Raisch
(2005:91)
Decreasing internal resource munificence criterion – over time
in both financial and human resources.
D’Aveni
(1989:578)
Decline
Direction criterion – Changing from good to bad performance.
Discontinuance criterion – includes exit or closure for any
reason, excluding deliberate exits for alternative motives.
Bankruptcy criterion – occurs when the firm is deemed to be
legally bankrupt or has ceased operation with resulting losses to
creditors.
Liao (2004:134).
Bankruptcy, to include sudden, voluntary, strategic, accidental,
and liquidity bankruptcy as types of this criterion.
Balcaen & Ooghe
(2005:11)
Loss-cutting criterion – where firms are disposed of with a loss
to avoid further losses.
Liao (2004:134)
Loss-cutting appears similar to exiting at threshold performance. Gimeno et al.
(1997:750)
Failure
Earning criterion – a firm is viewed as a failure if it is not
earning an adequate return on invested capital, which is
significantly and continually below prevailing rates on similar
investments.
Liao (2004:134)
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Table 2 continues
There is a shifting of resource application from the ceased
operation to a more profitable opportunity.
Fredland & Morris
(1976:7)
Shareholder loss criterion – whether the loss applies to
creditors, owners or any other relevant constituency (this
appears as an extension of the loss criterion).
Keasy & Watson
(1991:89) and
Lussier (1995:9)
Recovery/reversal criterion – from decline in performance or a
life-threatening situation towards acceptable performance
Barker & Duhaime
(1997:18)
Resumption of normal operations criterion – such as sustained
profitability.
Lorkhe et al.
(2004:65)
Turnaround
Reorientation criterion – Whether it is through strategic,
structure, control system or power distribution interventions as
determined by the specificity of the situation.
The criteria from Table 2 guided the research towards constructing definitions for both decline
and failure. On the basis of Tables 1and 2, it is possible to propose at least two main
definitions for universal use by entrepreneurs and researchers: These are:
Decline – A venture is in decline when its performance worsens (decreasing resource slack)
over consecutive periods and it experiences distress in continuing operations. Decline is a
natural precursor in the process to failure.
Failure – A venture fails when it involuntarily becomes unable to attract new debt or equity
funding to reverse decline; consequently, it cannot continue to operate under the current
ownership and management. Failure is the endpoint at discontinuance (bankruptcy) and when
it is reached, operations cease and judicial proceedings take effect.
Key to the proposed definitions for decline and failure are distinctly different manifestations,
namely:
• Decline implies operating under distress which, if the causes are corrected, leads to
continued operation, and if not corrected, will lead to eventual failure. Associated
terms include underperforming firms, “living dead” firms, lingering firms, “failure
avoidance” firms and “persistent technical insolvent” firms.
• Intervention through alternative management and financial injection could keep a
declining venture operating, albeit not in its current form and depending on the
suddenness and severity of the distress (crisis).
• Decline has categories of severity that can be described as underperformance, decline,
distress and crisis as a slide towards the point of failure (Pretorius, 2004:90). These
categories are determined by the degree of severity, which generally depends on
environmental munificence (capacity to support growth) and dynamism (variability in
key external factors), strategic alignment (adapting), and available resource slack
(Lohrke, Bedeian & Palmer, 2004:64).
• It is acknowledged that in decline, failure could result from a single shock event, such
as losing a major account or environmental disaster, although this applies in a minority
of cases.
• Failure connotes finality about the inability to operate any further.
• This study distinguishes decline and failure from “closure”, concurring with Fredland
and Morris (1976:7); Stokes and Blackburn (2002:18) and Bates (2005:343), who
postulate that failure and closure are not synonymous, as many ventures close while
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their owners report them as successful at the time of closure, or for alternative
motives.
• Similarly voluntary, strategic, and accidental bankruptcy (Balcaen & Ooghe, 2005:11)
should be appraised differently from failure as defined in this text, where failure is
associated with involuntary circumstances.
The reports of D’Aveni (1989), Lorange and Nelson (1987), Weitzel and Jonsson (1991),
Pretorius and Holtzhauzen (2008) and Pretorius (2008a) support the differentiation of decline
and failure. Synthesising the two definitions of decline and failure confirms their
heterogeneity despite their interrelatedness. A third definition is proposed for turnaround
(rescue) to support the definitions for decline and failure. It further serves as a measure of
differentiation between them. The proposed definition is:
Turnaround – A venture has been turned around when it has recovered from a “decline that
threatened its existence” to resume normal operations and achieve performance acceptable to
its stakeholders (constituents) through reorientation of positioning, strategy, structure,
control systems and power distribution. Return to positive cash flow is associated with
achievement of “normal operations”.
The turnaround definition implies that a declining firm can be turned around, while a firm that
has failed cannot. Judicial actions are often associated with failed firms but less often with
those in decline and very small ventures, which enter and exit informally. While it is true that
decline and failure are often used interchangeably, it is valuable to distinguish between them,
as this may influence the strategies that will be pursued for each. Their strong interrelationship
is also obvious; in the next section both terms are explored and the proposed definitions
confirmed.
Discussions, observations and conclusions
Financial prediction models depend heavily on data integrity, while they mainly use
bankruptcy as the criterion of failure. A lack of definitions of decline and failure is not
uncommon in the research articles used as data for these studies. Moss-Kanter (2003) reports
on turnaround and decline by describing cases and scenarios rather than stating any formal
definitions, thereby suggesting that readers can form their own pictures of what the key terms
entail. In the same way, Raina, Chanda, Metha and Maheshwari (2003) immediately direct
attention to the causes of decline, without giving a formal definition. Often failure is also the
secondary focus of research papers, while the primary focus is on prediction models, causes,
signs, conditions or effects of failure rather than failure itself. This approach confirms
Shepherd’s (2005) postulation of variation in the understanding of the failure phenomenon.
Consequently, this article has attempted to improve clarity and congruence of definition.
A second contributing factor to variation in definition is that different researchers formulate
definitions to suit their specific research problem. While it is acceptable to do so, the practice
means that results are not easily and meaningfully comparable unless exactly similar
methodologies are followed. Examples include cases where failure has been equated with
non-performance, unsuccessful closures (Bates, 2005); and not demonstrating performance
(Kow, 2004:229). Finding a definition for failure thus contributes to better comparability of
various results.
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Defining decline separately adds an additional dimension as it eliminates previous confusion
to some extent. Researchers who attempt to predict forthcoming failure have shown
remarkable homogeneity in their definition, as they use bankruptcy and insolvency as the
principal measurement criteria. Prediction is usually based on financial ratios, which are
measurable, which is probably the reason for the use of bankruptcy as criterion. Few works on
non-financial prediction were found during this research, probably because of the difficulty of
measuring the relevant variables used for prediction. Those who predict failure do so using
data from the period of decline that precedes the failure, which is subject to decision-making
and interventions of turnaround attempts that probably distort the figures used in any case.
Finally, searching for articles on failure-related subjects reveals an apparent lack of recent
failure literature, especially from the late 1990s. Since the new millennium, however, some
new research findings have been reported, though they have not flooded the literature.
On the basis of the definitional approach to understanding failure, one can conclude that
decline precedes failure, which is the end state of deteriorating performance. Turnaround
focuses on signs and causes of decline, while learning from failure depends on the post-
mortem approach. While one can learn from both, the turning around of ventures during
decline has more general value for both entrepreneurs and the economy as a whole.
Contribution of the research to entrepreneurship
What set out as a study in the field of entrepreneurship ended in the heart of the business
management domain, covering more than failure and as such including both decline and
turnaround. This confirms the importance to entrepreneurship development of better
knowledge of failure and shows that the origins and reach of decline and failure are extensive.
As with the grounded theory research approach, this study proved a successful application of
the research method of setting out on a course whose destination is not clear on departure.
Developed on the basis of grounded theory principles (Corbin & Strauss, 1990:18), two key
definitions were arrived at in this study: decline and failure. They should be viewed as
constructs that are differentiated by the conditions, context, actions/interactions, directional
movement and consequences determined by the configuration of relevant variables at the
time.
Limitations of this research
Limitations of one study serve as challenges for the next.
Definitions per se suggest guidelines for classification of variables. Classification requires
homogeneity within categories and heterogeneity between categories to allow for
generalisation. The definitions show a clear distinction between decline and failure, with the
turnaround definition directing the categorisation process.
The literature acknowledges the complexity of the failure phenomenon. Thus, the definitional
approach can only be the first step – a crucial first step – in the process of mapping the
territory for venture failure research. Defining the phenomena does not explain the constructs
that are involved when they do arise, nor do definitions identify the governing principles to be
considered when decline and failure take place.
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A final limitation was probably the exclusion of some works by delineating the research as
reviewing the scientific literature, thus excluding some sources. However, those excluded
were mostly popular how-to-do-it books that are not necessarily driven by the scientific
research focus required for this study, and conference proceedings, which normally end up as
refereed papers in any case.
Future Research
This study identified the criteria that distinguish business decline from failure and suggested a
platform for understanding a previously ill-defined phenomenon. Extension of this research is
required, firstly in the direction of classification of critical failure variables and secondly to
ascertain the governing principles of the failure domain. It is hoped that scholars will find the
proposed definitions useful to guide research, while entrepreneurs will be assisted in choosing
the relevant strategies after quantifying their specific contexts.
Some of the findings may still appear vague and, to some, of little moment, but nevertheless
the researcher found this an enriching (yet humbling) experience. It contributes to the body of
knowledge by proposing a framework of thinking about failure. If it leads to discussion or
disagreement it will have served its purpose well. Other researchers are specifically invited to
critique this review and challenged to assess the proposed definitions.
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doc_225344564.pdf
Understanding business failure presents an enormous theoretical challenge that still fundamentally remains to be met, probably because past efforts were more concerned with prediction than with understanding.
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Defining business decline, failure and turnaround: a content analysis
Marius Pretorius
Department of Business Management, University of Pretoria, South Africa
[email protected]
Abstract
In the past, researchers have often defined failure to suit their data. This has led to a lack of comparability in
research outputs. The overriding objective of this paper is to propose a universal definition for the failure
phenomenon. Clear definitions are a prerequisite for exploring major constructs, their relationship to failure
and the context and processes involved. The study reports on the core definitions of the failure phenomenon
and identifies core criteria for distinguishing between them. It places decline, failure and turnaround in
perspective and highlights level of distress and turnaround as key moderating elements. It distinguishes the
failure phenomenon from controversial synonyms such as closure, accidental bankruptcy and closure for
alternative motives.
Key words and phrases: business decline, failure, turnaround, level of distress
Introduction
Understanding business failure presents an enormous theoretical challenge that still
fundamentally remains to be met, probably because past efforts were more concerned with
prediction than with understanding. That such a challenge has largely gone unanswered is
fairly easily understood (Cybinski, 2001:39; Shepherd, 2005:126). The lack of understanding
of the concept is partly due to the lack of an adequate definition of failure. (Shepherd,
2005:124). Researching the failure arena quickly shows that various authors have different
interpretations of failure and that no one universal definition exists. Existing writings about
failure are dominated by prediction models but diverge into several fields, and the differing
focuses and objectives of researchers create an ill-defined domain, made up of several
overlapping fields (Shepherd, 2003). Existing research also appears problematic because of
the current definition of failure and the ways in which failures have been measured in the past
(De Castro, Alvares, Blasick & Ortiz, 1997:1). While financial prediction of failure (which
uses bankruptcy as dependent variable) takes up a large portion of failure-related research,
this study explores outside the limitations of prediction (Balcaen & Ooghe, 2005; Steyn
Bruwer & Hamman, 2006) by investigating the qualitative rather than the quantitative end of
the continuum.
If it is true that between 50 and 90 percent of entrepreneurial ventures fail (depending on the
author and statistics quoted), failure is probably the one thing that almost all entrepreneurs
will face somewhere in their endeavours. At the same time, failure is probably the last thing
on the mind of an entrepreneur starting out on the entrepreneurial process.
Given the “survival of the fittest”, failure is a natural step in the life cycle of business
ventures. Organisational ecology (as a metaphor) further asserts that the environment will
naturally weed out unfit organisations, and that the ability to survive over time is a function of
both an organisation’s suitability to the current environment and its ability to adapt
appropriately if the environment evolves. Misalignment with the environment may therefore
expose firms to different liabilities associated with failure (Barron, West & Hannon,
1994:381).
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There exists a limited but growing body of knowledge on the topic of failure on which
researchers can base their investigations, especially in the small business domain. The
research articles are, however, scattered across business, management, financial, psychology,
entrepreneurial and many other journals and no proof could be found that these works have
ever been comprehensively reviewed. There is no specific body of science to which failure
exclusively belongs. While this study focuses on failure in business ventures, it does not
ignore failure in other organisations, such as quasi- and government ventures. This study
prefers the term venture, but uses it interchangeably with business, firm and organisation as
terms, depending on how different authors have reported their research in the literature.
Business ventures hover somewhere between the extremes of the success-failure continuum,
which influences the decisions that ventures are faced with, and the potential consequences of
failure have significant and interesting impacts on business decisions (Cybinski, 2001:31).
Failures draw attention all the time, whether they occur during start-up or in mature ventures,
and it appears that failure is inherently part and parcel of the science of business management.
If failure is indeed central to the entrepreneurial thrust of ventures, better understanding of the
domain will benefit both the science and the practising entrepreneur overall. Recently there
have been two special editions of journals (Journal of Business Venturing and Long Range
Planning) that focused on failure, which also points to the resurgence of failure as a research
domain. There also appears an outcry for better understanding of the failure domain since the
onset of the world economic crisis in 2008.
The importance of failure in business has been acknowledged in reports of crises in
companies that have dominated the news in recent times. Several icons of business such as
Worldcom and Enron were not spared failure, leading to investors losing large portions of
their assets. Experts greet the news of these failures with post-mortems on what could have
been done to avoid the decline. Some reviewers, with the 20/20 vision of hindsight and
expensive financial prediction models, express amazement that management did not foresee
and respond to critical events in time to prevent termination. Obviously, it is easier to make
up prescriptions after events have occurred than it is to prescribe ways to avoid problems in
the future (Probst & Raisch, 2005:90).
It is also true that often one cannot really describe something without explaining what it is
not. In the search for the secret of venture success (lower failure rates), it helps us to look at
failure for improved understanding. The research question is therefore one of making sense of
the failure phenomenon in order to improve the understanding of successful business by
describing what it is not. Thus, this study aims to support not only researchers but also
entrepreneurs and practitioners. Entrepreneurs could benefit from this improved
understanding to reduce high failure rates of 80 to 90 percent, as reported by Knott and Posen
(2005:617). Distinguishing between decline and failure gives direction to entrepreneurs about
strategies to pursue when attempting recovery in their ventures.
Aim of this study
This study has one principal aim: It seeks to review the scientific literature on business failure
through grounded theory methodology and to identify the universal constructs of the failure
phenomenon. It therefore attempts to advance research at this promising intersection of
entrepreneurship, business management and the cognition sciences by mapping the territory
meaningfully in order to direct entrepreneurs and researchers through the failure domain.
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The overriding objective is therefore to propose a universal definition of the failure
phenomenon as a first step in exploring the major constructs, their relationship to failure and
the context and processes involved, thus providing a better understanding of the phenomenon
that goes beyond a descriptive account.
Method of review
The specific research need identified in this study is to better understand and make sense of
failure, rather than predict failure, although the two focuses are related and a large number of
recently published works have been in the field of failure prediction, as reported by Sharma
(2001:5). The specific methodology (emulating that of Forbes, 1999) adopted in this study
was selected because secondary sources of failure are limited (especially in developing
countries), as failed firms disappear and entrepreneurs of failed ventures rarely like to talk
about the reasons that led to failure. Even when they do speak out, such explanations are
likely to have self-reporting and retrospective reporting biases (Shepherd, 2005:126).
Scientific resources from the ABI-Inform, Ebsco-host, Proquest, Blackwell and other
databases were searched for titles published since 1985. The date was somewhat arbitrarily
determined (though not necessarily adhered to) and based on convenience, as this was the
earliest date for which most databases had downloadable electronic titles, abstracts and full
texts readily available. For apparently major works, the date was not a limitation, especially
when an article was referenced widely. Age of publication was not considered important, but
relevance and contribution to the body of knowledge of failure were paramount.
At first a search for failure, combined with business, venture, firm or organisation was
conducted. Initial searches were keyword-based and narrowed down by using the different
keyword variants identified during the process. As the articles (data) were obtained, searches
were extended to include terms such as crisis, decline, discontinuance, distress and more. All
articles were scanned based on titles and abstracts that led to a first complete reading of each
article that was deemed to cover failure-related issues, using a method similar to that
described by Forbes (1999:417). When prediction was used in conjunction with failure, a
plethora of articles were found in a range of financial and accounting journals and it was clear
at this early junction that failure prediction (from the financial perspective) made up a large
part of the total research base associated with failure. Balcaen and Ooghe (2005:24) confirm
that corporate failure prediction has become a major research domain within corporate
finance.
Second- and third-round searches were conducted using author names in addition to keywords
for cross-referencing. Thereafter specific journals were searched. Key journals included
Journal of Business Venturing, Entrepreneurship Theory and Practice, Academy of
Management Review, Sloan’s Management Review, Academy of Management Executive,
British Journal of Management, Administrative Science Quarterly, Long Range Planning,
Strategic Management Review, The British Accounting Review, Organisational Science,
Journal of Small Business Management, but were not limited to these. References of
important articles were then searched and accessed to build up an extensive list of articles.
The definitions of failure were mapped through a snowball process where references in one
article lead to the search for the next articles with definitions. Articles covering all failure-
related terms were investigated to identify more references. These articles were then obtained
and the process repeated to identify the key works referenced by the different authors.
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Borrowing from Corbin and Strauss’s (1990) method on grounded theory research, concepts
for each definition were identified and through repetitive scrutiny and comparison within the
“conditions” for each definition, the concepts were categorised towards building a definition
of failure. The categories were the cornerstones of the definitions eventually developed.
After reading (analysing) the abstracts of the articles, papers that in fact represented failure-
related issues were selected based on personal understanding of the issues. Thereafter each
article was assessed for definitions and identified and key concepts reported. Categorising the
concepts into sub-domains (categories) of failure-related issues (Pretorius, 2008b) was
followed by reporting them individually with their specific contributions, based on Corbin
and Strauss’s method (1990:7). Articles without clear definitions were discarded for reporting
in this study.
Eventually a list of key references was assembled. The process of adding articles was never
officially stopped but drifted towards closure as no more “useful new information” came
forth, in accordance with the principles suggested by the grounded theory research process.
This meant that the real number of articles screened became less important than initially
anticipated when I embarked on the study.
Findings
The report of the findings of the research covers, firstly, the outcome of the definitional
approach. Secondly, it explores the criteria for constructs contained in the definitions. Thirdly,
it proposes definitions and finally highlights key elements. The final definition of turnaround
is proposed to suggest the key difference between decline and failure.
While many authors failed to propose a definition to guide their research and depended on the
general understanding that readers might have about the phenomenon, many definitions with
varying viewpoints were found. The variations confirm Shepherd’s (2005:124) statement that
the lack of a single definition of failure is partly responsible for the poor understanding of the
phenomenon. Failure is defined in as many ways as there are researchers. Watson and Everett
(1999:9) report that many of the differences in reports of sectoral failure rates may be driven
by choice of failure definition. Balcaen and Ooghe (2005:23) state that the assumption of
dichotomous datasets (failure vs. success or non-failure) to enable accurate predictions
neglects the multidimensional nature of failure and is in conflict with the reality of failure
situations. Steyn et al. (2006:11) also report a list of definitions by South African authors that
underscores the lack of a definition outside those dichotomous types used for prediction
purposes.
As the research progressed and while probing the different databases, it was found that failure
is associated with bankruptcy, liquidation, insolvency, crisis, decline in performance,
decision-making, collapse, crashing, accounting practices, project failure, distress, trouble,
systems failure, franchise failure, being non-successful, and more. Therefore the eventual
search terms focused mainly on business, organisational, corporate, venture, and enterprise
decline, failure and turnaround and less on prediction. Table 1 shows the variation in
definitions and how they are influenced by the researchers’ focuses during investigation.
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Table 1: Synthesis of principal works based on the definitional perspective
Definition Key definition constructs Apparent Researcher focus Type of
study
Reference
Decline focused definitions
Decline: Degeneration of organisational performance in sales,
profitability, market share and technological leadership
Performing worse Decline signs, causes and
preventative strategies
Theory Lorange & Nelson, (1987)
Performance decline: Decrease in some measurement such as
sales, workforce, profits or profit ratios (ROI or ROE) that has
continued for some time.
Measurement and duration (time) of
decline
Performance decline Weitzel & Jonsson, (1989)
Decline: Refers to decreasing internal resource munificence
over time with respect to two critical resources: financial and
human (managerial) resources.
Decrease in internal ability to survive
Time
Aftermath of decline compared
with non-decliners. Patterns of
decline.
E D’Aveni (1989:578)
Decline: Organisations enter a stage of decline when they fail
to anticipate, recognise, avoid, neutralise or adapt external or
internal pressures that threaten the organisation’s long-term
survival.
Management stages and signs and actions
Trigger point
Internal systems to detect
conditions that may lead to
decline
Case Weitzel & Jonsson, (1991)
Decline and crisis are the low and high extremes of the rate of
performance deterioration.
Level and rate of performance
deterioration
Decline and crisis impact on
turnaround and debt financing
Chowdhury & Lang
(1993:8)
Financial distress: Fall of a firm from a superior performance
position to an extremely poor position on any appropriate
performance criterion – specifically Taffler’s Z-value.
Decline from superior position to poor
position. Rule = +, +, -. Two years’ good
performance followed by poor.
Turnaround strategies Sudarsanam & Lai
(2001:190)
Decline and deteriorating financial performance measured by
bankruptcy and dramatic fall in market value
Decline
Deterioration of financial performance
Crisis, crashing and collapse Probst & Raisch (2005:90)
Failure focused definitions
Failure: Firms that filed bankruptcy after having their shares
trading publicly in the years prior to bankruptcy
Bankruptcy after being successful Leadership change during
decline
Schwartz & Menon (1985:
681)
Failure: Bankruptcy (excluding intentional bankruptcy that
was used as a legal tactic).
Bankruptcy Consequences of decline
compared with non-decliners.
E D’Aveni (1989:585)
Failure or severe form of financial distress such as loan
default or non-repayment of creditors.
Severity
Default
Prediction models Literature
review
Keasey & Watson
(1991:89)
Failure occurs when the level of organisation capital reaches
zero. It is no longer able to meet its financial obligations to
debt holders, employees, or suppliers and resorts to or is
forced into bankruptcy or liquidation.
Organisational capital Model for understanding
resource buffer and mortality
relationship
Theory Levinthal (1991:401)
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Table 1 continues
Failure means closure of a unit but not total closure (within a
franchise organisation)
Closure Franchise failure comparison Castrogiovanni, Justis &
Julian (1993:106)
Failure: A firm that has gone out of business with losses to its
creditors
Not operating any longer
Losses
Duncan & Handler
(1994:7)
Business dissolution refers to single business corporations that
shut down and multiple business corporations that shut down
a single business and includes both voluntary liquidation and
involuntary bankruptcy.
Shut down
Choice vs forced bankruptcy
Effects of business sales and
age dissolution and divestiture
E Mitchell (1994:576)
Failure: Business failing organisations are those that will
become insolvent unless appropriate management actions are
taken to effect a turnaround in financial performance
Pending insolvency
Requirement for alternative management
action
Configurations of factors
leading to failure
Richardson, Nwankwo &
Richardson (1994:9).
Failure: Firms involved in court procedures or voluntary
actions which result in losses to creditors excluding
discontinued ventures
Losses to creditors Non financial failure prediction E Lussier (1995:9)
Failure: Ceased operations due to outright insolvency, and/or
when a firm has ceased operations in order to stop continued
losses
Ceased operations
Outright insolvency. Continued losses
Closing vs disappearance vs
failure
De Castro, Alvarez,
Blasick & Ortiz (1997:4)
Financial crisis: Closure of the firm resulting in large-scale
social and economic costs
Ceased operations Crisis in banks that led to
closure (failure)
Stead & Smallman
(1999:13)
Failure is defined as bankruptcy Bankruptcy Comparing failure attribution
between venture capitalists and
entrepreneurs
6 Cases Zacharakis, Meyer &
DeCastro (1999:5)
Failures refer to deaths of entire firms and industry exits by
multiple business companies.
Closing or exiting the industry Strategy and age dependence E Henderson (1999:291)
Discontinuance (ceasing of operations) of business for any
reason or bankruptcy or failing to “make a go of it”.
End of operations Failure rates and defining
failure
E Watson & Everett (1999:5)
An initiative can be said to have failed when it is terminated
as a consequence of actual or anticipated performance below a
critical threshold (fallen short of its goals)
Termination
Performance below critical threshold
Real options reasoning and
anti-failure bias
McGrath (1999:14)
Failure is “not having made profit for the previous three
years”
Losing money Non-financial prediction E Lussier & Pfeifer
(2001:232)
SAJESBM NS Volume 2 (2009) Issue 1 7
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Table 1 continues
When fall in revenue and/or rise in expenses are of such
magnitude that the firm becomes insolvent and is unable to
attract new debt or equity funding; consequently it cannot
continue to operate under the current ownership and
management.
Insolvency and involuntary change in
ownership and management.
Grief of owner and recovery
after losing a business, Failure
research
T Shepherd (2003:318),
Shepherd (2005:124)
Bankruptcy is the ultimate reason for exiting the economy and
happens when firms lack sufficient capital to cover their
obligations. Firms that are insolvent to the point of legal
proceedings have clearly failed to meet the market’s
performance threshold of fulfilling their financial obligations.
Exiting the economy or not meeting the
“performance threshold” of the market.
Resource-based view of failure
with age of firm as proxy for
resource differences between
firms.
Thornhill & Amit
(2003:497)
..success and failure were identifiable as “end states” … End state Small business failure Single
case
Ritchie & Richardson
(2004:236)
Organisation failure is the end result of a decline Failure follows decline Turnaround Case
applicatio
n
Sheppard & Chowdhury
(2005:241)
Failure, in organisations and elsewhere, is deviation from
expected and desired results.
Deviation from goals Learning Theory Cannon & Edmondson
(2005:300)
At the time of failure the “legal status” of the firm was
bankrupt, meaning it had suspended payments against
creditors and had lost all credit
Legal status
Credit loss
Prediction E Pompe & Bilderbeek
(2005:851)
A major loss of value rather than bankruptcy Value loss Board role in renewal Qualitativ
e
Hass & Pryor (2005:12)
Failure occurs when a firm’s value falls below the opportunity
cost of staying in business
Performance decline Measuring decline Theory Cressy (2006:103)
… firms whose stocks are delisted as a result of either
bankruptcy or liquidation elections.
Distress Prediction Joseph & Lipka (2006:296)
Turnaround focused definitions
Turnaround situation is when a firm has had two successive
years of ROI and ROS growth followed by: absolute
simultaneous declines in both for a minimum of two years and
a rate of decline greater than the industry average over the two
year period.
Decline in ROI and ROS for two years
after success for two years
Turnaround: retrenchment and
recovery
Robbins & Pearce
(1992:295)
Turnaround management is a process whereby managers
actively seek to save distressed firm from failure.
Save distressed firms from failure Difference between distress and
failure
E Fredenberger & Bonnicic
(1994:59)
SAJESBM NS Volume 2 (2009) Issue 1 8
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Table 1 continues
A successful turnaround is when a firm undergoes a survival-
threatening performance decline over a period of years but is
able to reverse the performance decline, end the threat to firm
survival and achieve sustained profitability.
Reverse performance decline Turnaround process E Barker & Duhaime
(1997:18)
Turnaround is a concerted and organised effort by top
management to respond to the firm’s performance problems.
Top management induced effort Turnaround E Barker & Moné
(1998:1239)
Once profitable firms that have suffered firm-threatening
performance declines and are attempting, either successfully
or unsuccessfully, to turn around.
Once profitable
Now decline
Performance decline E Barker & Barr (2002:968)
Organisations that are not demonstrating performance that is
acceptable to stakeholders, analysts, vendors and employees.
require a turnaround intervention.
Unacceptable performance Performance Theory Kow (2004:229)
Turnaround has occurred when the firm recovers adequately
to resume normal operations, often defined as having survived
a threat to survival and regained sustained profitability.
Survived decline
Normal operations
Profitability
Recovery to normal operations Theory Lohrke et al. (2004:65)
The actions taken to bring about a recovery in performance in
a failing organisation where failure is defined as “existence
threatening decline” in performance.
Actions for recovery in performance Action to recover from decline Theory Walshe et al. (2004:201)
SAJESBM NS Volume 2 (2009) Issue 1 9
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Table 1 contains the main definitions found in the literature; due to space constraints,
definitions such as those using bankruptcy as criterion were not repeated ad infinitum. Three
main categories were distinguishable, suggesting that researchers use definitions as required
for specific problems. There were more definitions for failure than for decline and turnaround,
a possible reason being the large sub-domain of prediction research reported in the literature.
The table also shows the key constructs of the definitions used and the apparent focus of the
specific authors.
Table 1 reports many different terminologies within definitions, depending on the choice of
the authors reporting it. Liao (2004:134) confirms that in general many different terms are
related to business failure, such as closures, exit, dissolution, discontinuance, insolvency,
organisational mortality, bankruptcy and organisational failure. It was therefore deemed
necessary to identify and list the different criteria for the definitions, as they make up the key
constructs required to propose the universal definitions. The key criteria are reported in Table
2.
Table 2: Core criteria that distinguish between the definitions for decline, failure and
turnaround
Construct Criteria Supporting
Reference
Worsening performance criterion - ROI decline for two
consecutive years. Average pre-tax ROI of less than 10% for the
same two consecutive years.
The performance decline must be independent of the
performance of the industry in which they operated.
Chowdhury &
Lang (1993:11)
Value destruction criterion - Loss of company value and
changing from being profitable.
Distress criterion - Accumulation of debt that seriously
threatens survival. Changing market leadership position towards
becoming unprofitable and becoming a player only.
Probst & Raisch
(2005:91)
Decreasing internal resource munificence criterion – over time
in both financial and human resources.
D’Aveni
(1989:578)
Decline
Direction criterion – Changing from good to bad performance.
Discontinuance criterion – includes exit or closure for any
reason, excluding deliberate exits for alternative motives.
Bankruptcy criterion – occurs when the firm is deemed to be
legally bankrupt or has ceased operation with resulting losses to
creditors.
Liao (2004:134).
Bankruptcy, to include sudden, voluntary, strategic, accidental,
and liquidity bankruptcy as types of this criterion.
Balcaen & Ooghe
(2005:11)
Loss-cutting criterion – where firms are disposed of with a loss
to avoid further losses.
Liao (2004:134)
Loss-cutting appears similar to exiting at threshold performance. Gimeno et al.
(1997:750)
Failure
Earning criterion – a firm is viewed as a failure if it is not
earning an adequate return on invested capital, which is
significantly and continually below prevailing rates on similar
investments.
Liao (2004:134)
SAJESBM NS Volume 2 (2009) Issue 1 10
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Table 2 continues
There is a shifting of resource application from the ceased
operation to a more profitable opportunity.
Fredland & Morris
(1976:7)
Shareholder loss criterion – whether the loss applies to
creditors, owners or any other relevant constituency (this
appears as an extension of the loss criterion).
Keasy & Watson
(1991:89) and
Lussier (1995:9)
Recovery/reversal criterion – from decline in performance or a
life-threatening situation towards acceptable performance
Barker & Duhaime
(1997:18)
Resumption of normal operations criterion – such as sustained
profitability.
Lorkhe et al.
(2004:65)
Turnaround
Reorientation criterion – Whether it is through strategic,
structure, control system or power distribution interventions as
determined by the specificity of the situation.
The criteria from Table 2 guided the research towards constructing definitions for both decline
and failure. On the basis of Tables 1and 2, it is possible to propose at least two main
definitions for universal use by entrepreneurs and researchers: These are:
Decline – A venture is in decline when its performance worsens (decreasing resource slack)
over consecutive periods and it experiences distress in continuing operations. Decline is a
natural precursor in the process to failure.
Failure – A venture fails when it involuntarily becomes unable to attract new debt or equity
funding to reverse decline; consequently, it cannot continue to operate under the current
ownership and management. Failure is the endpoint at discontinuance (bankruptcy) and when
it is reached, operations cease and judicial proceedings take effect.
Key to the proposed definitions for decline and failure are distinctly different manifestations,
namely:
• Decline implies operating under distress which, if the causes are corrected, leads to
continued operation, and if not corrected, will lead to eventual failure. Associated
terms include underperforming firms, “living dead” firms, lingering firms, “failure
avoidance” firms and “persistent technical insolvent” firms.
• Intervention through alternative management and financial injection could keep a
declining venture operating, albeit not in its current form and depending on the
suddenness and severity of the distress (crisis).
• Decline has categories of severity that can be described as underperformance, decline,
distress and crisis as a slide towards the point of failure (Pretorius, 2004:90). These
categories are determined by the degree of severity, which generally depends on
environmental munificence (capacity to support growth) and dynamism (variability in
key external factors), strategic alignment (adapting), and available resource slack
(Lohrke, Bedeian & Palmer, 2004:64).
• It is acknowledged that in decline, failure could result from a single shock event, such
as losing a major account or environmental disaster, although this applies in a minority
of cases.
• Failure connotes finality about the inability to operate any further.
• This study distinguishes decline and failure from “closure”, concurring with Fredland
and Morris (1976:7); Stokes and Blackburn (2002:18) and Bates (2005:343), who
postulate that failure and closure are not synonymous, as many ventures close while
SAJESBM NS Volume 2 (2009) Issue 1 11
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their owners report them as successful at the time of closure, or for alternative
motives.
• Similarly voluntary, strategic, and accidental bankruptcy (Balcaen & Ooghe, 2005:11)
should be appraised differently from failure as defined in this text, where failure is
associated with involuntary circumstances.
The reports of D’Aveni (1989), Lorange and Nelson (1987), Weitzel and Jonsson (1991),
Pretorius and Holtzhauzen (2008) and Pretorius (2008a) support the differentiation of decline
and failure. Synthesising the two definitions of decline and failure confirms their
heterogeneity despite their interrelatedness. A third definition is proposed for turnaround
(rescue) to support the definitions for decline and failure. It further serves as a measure of
differentiation between them. The proposed definition is:
Turnaround – A venture has been turned around when it has recovered from a “decline that
threatened its existence” to resume normal operations and achieve performance acceptable to
its stakeholders (constituents) through reorientation of positioning, strategy, structure,
control systems and power distribution. Return to positive cash flow is associated with
achievement of “normal operations”.
The turnaround definition implies that a declining firm can be turned around, while a firm that
has failed cannot. Judicial actions are often associated with failed firms but less often with
those in decline and very small ventures, which enter and exit informally. While it is true that
decline and failure are often used interchangeably, it is valuable to distinguish between them,
as this may influence the strategies that will be pursued for each. Their strong interrelationship
is also obvious; in the next section both terms are explored and the proposed definitions
confirmed.
Discussions, observations and conclusions
Financial prediction models depend heavily on data integrity, while they mainly use
bankruptcy as the criterion of failure. A lack of definitions of decline and failure is not
uncommon in the research articles used as data for these studies. Moss-Kanter (2003) reports
on turnaround and decline by describing cases and scenarios rather than stating any formal
definitions, thereby suggesting that readers can form their own pictures of what the key terms
entail. In the same way, Raina, Chanda, Metha and Maheshwari (2003) immediately direct
attention to the causes of decline, without giving a formal definition. Often failure is also the
secondary focus of research papers, while the primary focus is on prediction models, causes,
signs, conditions or effects of failure rather than failure itself. This approach confirms
Shepherd’s (2005) postulation of variation in the understanding of the failure phenomenon.
Consequently, this article has attempted to improve clarity and congruence of definition.
A second contributing factor to variation in definition is that different researchers formulate
definitions to suit their specific research problem. While it is acceptable to do so, the practice
means that results are not easily and meaningfully comparable unless exactly similar
methodologies are followed. Examples include cases where failure has been equated with
non-performance, unsuccessful closures (Bates, 2005); and not demonstrating performance
(Kow, 2004:229). Finding a definition for failure thus contributes to better comparability of
various results.
SAJESBM NS Volume 2 (2009) Issue 1 12
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Defining decline separately adds an additional dimension as it eliminates previous confusion
to some extent. Researchers who attempt to predict forthcoming failure have shown
remarkable homogeneity in their definition, as they use bankruptcy and insolvency as the
principal measurement criteria. Prediction is usually based on financial ratios, which are
measurable, which is probably the reason for the use of bankruptcy as criterion. Few works on
non-financial prediction were found during this research, probably because of the difficulty of
measuring the relevant variables used for prediction. Those who predict failure do so using
data from the period of decline that precedes the failure, which is subject to decision-making
and interventions of turnaround attempts that probably distort the figures used in any case.
Finally, searching for articles on failure-related subjects reveals an apparent lack of recent
failure literature, especially from the late 1990s. Since the new millennium, however, some
new research findings have been reported, though they have not flooded the literature.
On the basis of the definitional approach to understanding failure, one can conclude that
decline precedes failure, which is the end state of deteriorating performance. Turnaround
focuses on signs and causes of decline, while learning from failure depends on the post-
mortem approach. While one can learn from both, the turning around of ventures during
decline has more general value for both entrepreneurs and the economy as a whole.
Contribution of the research to entrepreneurship
What set out as a study in the field of entrepreneurship ended in the heart of the business
management domain, covering more than failure and as such including both decline and
turnaround. This confirms the importance to entrepreneurship development of better
knowledge of failure and shows that the origins and reach of decline and failure are extensive.
As with the grounded theory research approach, this study proved a successful application of
the research method of setting out on a course whose destination is not clear on departure.
Developed on the basis of grounded theory principles (Corbin & Strauss, 1990:18), two key
definitions were arrived at in this study: decline and failure. They should be viewed as
constructs that are differentiated by the conditions, context, actions/interactions, directional
movement and consequences determined by the configuration of relevant variables at the
time.
Limitations of this research
Limitations of one study serve as challenges for the next.
Definitions per se suggest guidelines for classification of variables. Classification requires
homogeneity within categories and heterogeneity between categories to allow for
generalisation. The definitions show a clear distinction between decline and failure, with the
turnaround definition directing the categorisation process.
The literature acknowledges the complexity of the failure phenomenon. Thus, the definitional
approach can only be the first step – a crucial first step – in the process of mapping the
territory for venture failure research. Defining the phenomena does not explain the constructs
that are involved when they do arise, nor do definitions identify the governing principles to be
considered when decline and failure take place.
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A final limitation was probably the exclusion of some works by delineating the research as
reviewing the scientific literature, thus excluding some sources. However, those excluded
were mostly popular how-to-do-it books that are not necessarily driven by the scientific
research focus required for this study, and conference proceedings, which normally end up as
refereed papers in any case.
Future Research
This study identified the criteria that distinguish business decline from failure and suggested a
platform for understanding a previously ill-defined phenomenon. Extension of this research is
required, firstly in the direction of classification of critical failure variables and secondly to
ascertain the governing principles of the failure domain. It is hoped that scholars will find the
proposed definitions useful to guide research, while entrepreneurs will be assisted in choosing
the relevant strategies after quantifying their specific contexts.
Some of the findings may still appear vague and, to some, of little moment, but nevertheless
the researcher found this an enriching (yet humbling) experience. It contributes to the body of
knowledge by proposing a framework of thinking about failure. If it leads to discussion or
disagreement it will have served its purpose well. Other researchers are specifically invited to
critique this review and challenged to assess the proposed definitions.
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