Why Startups Fail: Six Issues to Avoid

THE FACT IS most startups fail. More than two-thirds of them never deliver a positive return to investors.

Tim Eisenmann is a professor at Harvard Business School, where he’s led The Entrepreneurial Manager, a required course for all of their MBAs. While he taught students how to build winning startups, he felt he wasn't giving them the full picture if he couldn’t identify why so many were failing. So, he set out to find out. The result is Why Startups Fail: A New Roadmap for Entrepreneurial Success.

Eisenmann introduces the Diamond-and-Square framework to help aspiring entrepreneurs know whether they have actually identified an attractive opportunity and determine what types of resources are required to successfully capitalize on it.

The four elements in the diamond collectively specify the opportunity: what the venture will offer and to whom; its plan for technology and operations; its marketing approach; and how the venture will make money.

• Customer Value Proposition: This is the most important. A new venture absolutely must offer a sustainably differentiated solution for strong, unmet customer needs.
• Technology and Operations: A startup must be able to fulfill its value promise, which entails actually inventing the product, building git, physically delivering it, and servicing it after it’s been sold.
• Marketing: How much to spend on marketing. Premature scaling of marketing and product development efforts is a widespread cause of startup failure.
• Profit Formula: This is your plan for making money. The other three elements of the venture’s opportunity dictate revenue and costs.

To capture this opportunity, the venture will need the right resources in the right amounts as indicated by the four outside “square” elements.

• Founders: The founder fit can have a decisive impact on venture outcomes. Co-founder conflict can tear a startup apart.
• Team: If the other elements in the diamond-and-square framework are aligned, a weak team is unlikely to deal a death blow to the venture.
• Investors: Founders must decide when to raise money, how much to raise, and from whom. Mistakes here can have grave consequences.
• Partners: As with decisions about team members, bad choices about partners rarely are the primary cause of a startup’s demise. But they are more likely to boost the odds of failure by creating yet one more serious problem for management to deal with.

It is easy to blame the founders. Eisenmann went deeper and identified six patterns of failure, looking at ventures that initially showed promise but subsequently crashed to earth because of errors that could have been averted.

The vast majority of startup failures can be attributed to these six reasons and can be divided into three cases for early-stage failures and three cases for late-stage failures. Eisenmann explains each using examples of startups that fell prey to these sources of failure.

Good Idea, Bad Bedfellows

People are the most common cause of failure. Although startup success is thought to rest mainly on the founder’s talents and instincts, the wrong team, investors, or partners can sink a venture just as quickly.

Entrepreneurs sometimes identify an attractive opportunity but fail to mobilize the resources needed to capitalize upon it. Deficiencies may include poor founder fit — due, for example, to conflict between cofounders or their lack of relevant experience; other team members’ shortcomings; low value-added by investors; and lack of alignment between the venture’s priorities and those of strategic partners.

Startups are more likely to be vulnerable to the Good Idea, Bad Bellows failure pattern when they pursue opportunities that involve 1) complex operations requiring tight coordination of different specialists’ work; 2) inventory of physical goods; and 3) large, lumpy capital requirements.

False Starts

Many early-stage startups fail after their founders rush their first product to market, skipping upfront research that would determine whether they have identified strong, unmet customer needs and the best solution for those problems. As a consequence, the venture’s first product is likely to miss the mark. The entrepreneur can pivot, but they have boosted their failure odds by wasting time and money on a flawed first product.

Entrepreneurs can avoid false starts by undertaking a thorough and thoughtful design process before commencing engineering work. Iteration should stop only when you’re confident you have formulated a compelling customer value proposition.

False Positives

Early adopters and mainstream customers have different needs, and both need to be tested. Crowdfunding campaigns may demonstrate a product’s appeal to product category enthusiasts, but they don’t provide data on mass-market demand.

Success with early adopters can be misleading and give founders unwarranted confidence to expand. Success with early adopters can be misleading and give founders undue confidence to expand prematurely — or, if the needs of mainstream customers differ from those of early adopters — head in the wrong direction. Once the mistake is evident, the venture can correct course, but pivots can be costly once resources have been committed.

Speed Trap

Despite the pressure to “get big fast,” hypergrowth can spell disaster for even the most promising ventures. Hypergrowth can put great strains on a startup, and these strains can prove fatal when growth is not profitable — that is, when the marketing costs incurred to acquire a new customer exceed the profit the venture can expect to earn, over time, from that customer.

To avoid you need to ask four categories of questions—known as the RAWI test—to determine if you are ready to scale successfully:

1. Ready? Does that startup have a proven business model?
2. Able? Can the startup access the resources necessary to expand rapidly?
3. Willing? Are the founders eager to grow the business?
4. Impelled? Does the startup have aggressive rivals?

Help Wanted

Rapidly scaling startups need lots of capital and talent, but they can make mistakes that leave them suddenly in short supply of both.

In contrast to Speed Trap victims, some startups manage to sustain product-market fit as they scale but stumble due to shortfalls in management talent or capital — or both. Delays or mistakes in recruiting senior leaders for mission-critical roles can derail a venture, as can the sudden shifts in investor sentiment that can foreclose access to capital — even for healthy startups.

Cascading Miracles

The bigger the vision, the more challenges you face, and a shortfall with any one of them could be enough to kill the vision, thus requiring a cascade of miracles to succeed—a moonshot. How much innovation is too much?

Some entrepreneurs pursue audaciously ambitious venture concepts that require many years of product development, coupled with breakthroughs on several fronts, for example: radical shifts in customer behavior; the cooperation of established corporations that have benefited from the status quo; government support in the form of subsidies or favorable regulation; or investors willing to commit vast amounts of capital over extended periods. If any requirements are not met, the venture may fail. Consequently, the entrepreneur needs a cascade of miracles to succeed.

Dealing with Failure

Should you call it quits? Failure is typically a slow-motion affair, so it’s easy to hang on to false hope. And there is the founder’s ego that takes a hit. If you are faced with this decision, there are four questions you need to ask yourself:

1. Are you out of moves?
2. Are you miserable?
3. Do you still believe in the vision?
4. Is the window for a “graceful” shutdown closing?

Eisenmann covers how to shut down and how to bounce back. For those that want to try their hand at a new venture, the good news is that for those “who preserved relationships with team members and investors by engineering a graceful shutdown,” most will not experience any meaningful stigmatization or rejection. Take responsibility for the failure and know what you learned that can be applied to your next venture.

Eisenmann says it is “an amazing ride, creating something out of nothing. So go build something great.”

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Posted by Michael McKinney at 07:35 AM
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