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The Daily. Wednesday, February 16, 2000

Failure rates for new firms

At least half of new companies in Canada go out of business before their third anniversary, and only one-fifth of them survive a decade, according to a new study investigating the factors that are related to success and failure in young enterprises.

In fact, roughly one out of every four new firms (23%) won't make it past their first birthday, according to the study which examined 1.3 million businesses that began operations during the 10 years between 1984 and 1994. The study found that new businesses have short lives, about six years on average.

Using multivariate analysis, the study examines how business size, age of entrant, competition, macroeconomic conditions and location jointly affect the probability of survival for new firms. It concludes that there is no single reason why some new firms fail while others succeed. The underlying dynamics of failure are varied and complex. They reflect the specific characteristics of individual firms, the structural characteristics of particular markets and the overall performance of the economy.

Firm's size, business experience affect failure rates

A firm's size, in terms of employees, as well as its business experience have a strong impact on a company's chance for success. First-year businesses that are among the very smallest (when their size is measured in relation to the average start-up size in their industry) are 11% more likely to fail than first-year firms that are among the very largest.

Note to readers This release is based on a new analytical study released today titled "Failure rates for new Canadian firms: New perspectives on entry and exit." This study is the fourth in a series that investigates dynamic changes in key sectors of the economy. This study focuses on commercial enterprises, with employees, that started operations between 1984 and 1994, and analyzes differences in failure rates across several variables, such as a firm's province or industry of origin. It examines the role that firm size plays in determining success or failure, along with factors that relate to the intensity of competition. The study also examines how the determinants of failure differ across new firms at different stages of their life cycle, and whether the factors that influence failure are consistent across different entry periods. Technically, the report focuses on changes in the probability of survival brought about by a change in a particular factor such as firm size or age, while simultaneously controlling for the effects of other factors that are related to survival. To do this, the study compares the probability of survival for firms that are "much smaller than the average" to firms that are "much larger than the average", or between firms that are "young and inexperienced" versus those "older and more mature". All of these comparisons focus on the value of the variable under consideration at two extreme points in its distribution (the 5th and 95th percentiles) while holding all other variables constant at their means. Data for this study came from an administrative data source developed at Statistics Canada that is used to investigate entry and exit patterns.

In general, larger firms in relation to the first-year average in their industry have better chances of survival. Large firms make more substantial investments to start businesses, and are better prepared to solve the problems associated with running a new business.

The importance of these size characteristics increases with age. Five-year old firms that are among the smallest in relation to the average start-up size in their industry are 20% more likely to fail than five-year old firms that are among the largest. Compared with other factors, a firm's size characteristics are the most telling predictor of its success.

The chances of a new firm succeeding also increase as it acquires market experience. Older, mature companies - those that have acquired substantial business experience - are about 12% less likely to fail than young, inexperienced companies. This suggests that there is a strong learning-by-doing component to survival.

Young firms in certain industries are more likely to fail

Certain industries are more competitive than others, with more firms vying for customers, and with rapidly changing employment shares. The competitive forces within an industry influence failure rates, but to a lesser extent than firm-specific factors such as size and age.

After controlling for firm size, macroeconomic climate and province of origin, new firms in certain industries fare better than those in others. Among goods-producing industries, new firms in manufacturing and mining have among the highest overall survival rates. For example, first-year firms in manufacturing have only a 21% chance of failing in their first year, while first-year firms in mining industries have a 23% chance of failing during their initial year.

In the services sector, new firms in wholesale trade, real estate industries and business services fare relatively well. First-year firms in wholesale trade have only an 18% chance of failing during the first year, while first-year firms in both business services and real estate industries have a 19% chance. In comparison, first-year firms in communications have a 28% chance of failing during their initial year.

The nature of these industry differences changes over the course of a new company's life cycle. Among five-year-old entrants, the chance of failing in year five is basically the same in all industries.

Young firms in certain provinces are more likely to fail

After controlling for firm size, industry competition and the macroeconomic climate, there are sharp differences in failure rates across provinces for the very youngest new firms. In terms of overall survival rates, new firms in Ontario, British Columbia, Quebec and Alberta fare better than those in other provinces. In these four provinces, between 20% and 25% of firms in their first year will go under, compared with roughly 35% of new companies in the Atlantic provinces.

For firms that have survived their early years, a different pattern emerges. Firms that reach their fifth anniversary in Ontario are no more likely to survive than their counterparts in other provinces. Regardless of the province in which they are located, five-year-old firms have a uniform one-in-ten chance of failing during that year.

New firms were slightly better off in the 1980s than in the early 1990s

Companies that began operations during the 1980s had a slightly better chance of survival than those that started during the early 1990s.

The economy grew more strongly in gross domestic product during the mid-to-late 1980s than during the early 1990s. The macroeconomic climate influenced failure rates for new firms, which was most evident in first-year firms that were among the very smallest relative to their competitors.

During the 1984-89 period, these firms had a slightly lower failure rate (25%) than similar firms that entered in the 1990-94 period (30%). A strong economy keeps more new firms afloat, while a weaker economy does not.

The analytical study, Failure rates for new Canadian firms: New perspectives on entry and exit, (61-526-XPE, $35; 61-526-XIE, $26) is now available. See How to order publications.

For more information, or to enquire about the concepts, methods or data quality of this release, contact Guy Gellatly (613-951-3758), Micro-Economic Analysis Division.