S6 E7 Advice from business’s best thought leaders made easy to understand - Why Startups Fail - Jeremy Gray
Season 6 Show 7
Advice from business’s best thought leaders made easy to understand and practical to implement
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Today we explore the theme, Why Start Ups Fail?
It is well-known that most starts up will not succeed, a 90% failure rate is the most common estimate. 10% fail in the ﬁrst year. 70% fail in years two to ﬁve. This is known by most who decided to start a business, and the common reasons for failure are also well known. Yet despite knowing the dangers that lie ahead, most entrepreneurs repeat the mistakes of others and are forced out of business. Why should this be? Why do smart folks fail to see the warning signs in their businesses and lead them to failure?
It is a fact that air travel has become safer due to lessons learned from the investigation of tragic aviation accidents. A similar approach is used for general aviation. When I was learning to ﬂy, I would pour over articles such as “Aftermath” and “I learned about ﬂying from that” published in Flying Magazine so I could improve my ﬂying skills and avoid becoming a statistic. I decided for this show I would take a similar approach to avoid failure by learning from the mistakes of others. And taking an idea for most leading business schools. I began to research case studies in startup failures. I found an excellent article Why startups fail written by Tom Eisenmann and published in Harvard Business Review May 2021 edition. This will be the lead article for this show.
Tom Eisenman is a professor at Harvard Business School who came to a realization that although he was teaching his students on all aspects of how to launch a business, he really did not have a good understanding of why so many businesses failed. He decided to get to the bottom of this question. From his extensive research in this article, he shares in detail two cases studies of failure that cover:
The case studies I will be covering are of ventures that showed promise at the start but subsequently failed because of errors that could have been avoided.
Next week I will cover four other causes of failure that his research identiﬁed. Mr. Eisenman has published a book that provides more detail. It cost me three bucks to get the Kindle Version. If you want to know more, it’s worth a few dollars of your money.
Let’s get some terminology clariﬁed. Venture Capitalists talk about horses and jockeys. Horses are the opportunities that the startup is targeting, and Jockeys are the founders. Both are important but most VCs will choose an able founder over an attractive opportunity. When a promising new venture stumbles there is a tendency to blame the founders. Singling out the founders often oversimpliﬁes a complex situation which does not help understand all the factors that led to failure. Added to this is what psychologists call the fundamental attribution error. That is why observers, in this case the VCs, tend to blame the jockeys, the founders. While those directly involved will blame situational factors outside their control. For example, irrational moves by a competitor.
Just as an aside, how often have you wondered why a competitor is behaving the way they are? It just does not make any sense you tell yourself. It may not make sense to you, but it clearly makes sense to your competitor.
Let’s get started and dive into our ﬁrst case study which the Author titles, “Good Idea, Bad Bedfellows”. The company was called Quincy Apparel and was founded by two of Professor Eisenmann’s students, Alexandra Nelson and Christina Wallace. Nelson and Wallace had identiﬁed an unmet need; young professional women had a hard time ﬁnding affordable and stylish work clothes that ﬁt them well. They came up with a novel solution, a sizing system that allowed customers to specify four separate garment measurements, similar to the approach used in tailoring men's suits.
Sensibly the founders elected to follow the lean startup method by developing the minimum viable product of MVP. A minimum viable product is a product that is the simplest product that will yield reliable customer feedback. They held six shows where women could try on sample outﬁts and place orders. Two hundred women attended these shows and 25% made purchases.
Based on this success the co-founders quit their jobs, managed to raise just under $1 million in venture capital, recruited a team and launched Quincy Apparel. The business went online selling directly to consumers. Orders were strong and 39% of customers who bought items made repeat purchased. But strong sales meant high inventories which began to drain cash. Production problems resulted in poorly ﬁtting garments on some customers, this meant a higher expected rate of returns which incurred processing costs. Correcting the production problems put pressure on the company’s margins further reducing the company’s cash reserves. The company trimmed its product line with the goal of simplifying operations and improving efﬁciency. But there was not enough cash to see them through the transition; the business closed less than twelve months after its launch.
Why did Quincy fail? Most articles on why startups fail would say they ran out of cash. Which of course they did. But why did a company that had a good idea, an attractive value proposition, a sound plan for making a proﬁt over the longer term fail? The business projections were credible, they estimated the lifetime value of over half their customers would be $1,000 well over the cost of acquisition of $100.
Were the founders at fault? They had the right temperament, they were sharp, resourceful and had complementary strengths. But there were problems. Unwilling to strain their close friendship, the two shared decision making authority equally with respect to strategy, product design and other key choices. This slowed down the decision-making process. If you listened to last week’s show you may remember that one of the lessons we, as entrepreneurs, can learn from the challenges of a political machine transitioning from campaigning to governing is to decide who decides. The reasons why that is important were explained in the show, listen to the podcast for more.
The other issue that the founders faced was their lack of experience in clothing design and manufacturer. They were aware of this weakness, to address this they some industry veterans. As well as bringing knowledge, the founders expected these folks would fulﬁll multiple functions, as team members do in most early stage startups. But the employees they hired were used to the high level of specialization found in established apparel companies and were not ﬂexible about tackling tasks outside their area of expertise.
Operations played a role in the failure. As is common in the clothing industry manufacturing was outsourced to third party factories. But these third parties were slow to meet their commitments for a startup with no industry reputation which needed unusual sizes orders in small quantities.
What about the role played by the investors in the company’s failure? The founders were unable to raise their targeted funding, they had aimed to raise $1.5 million, but only managed to secure $950,000. That was enough to fund the company for two seasons; the founders had correctly estimated that it would take three seasons to iron out the issues in the business. The business had some traction after two seasons but not enough to attract new investors. And the original backers did not have the ability to increase their investment. The original VC pressured the founders to grow rapidly, like the tech companies they are used to dealing with. This forced them to build inventory which increased the burn rate, leaving them less time to ﬁx the production problems. These backers are the bad bedfellows of the article’s title.
Could this failure have been avoided? And if so how?
The founders lack of knowledge of the fashion industry was the root cause of many of the problems. It took time for the founders to understand how the industry worked. Without industry connections they did not have the network to recruit the right team members. They lacked relationships with factory managers they could leverage to ensure prompt delivery. A lack of industry experience made it harder to ﬁnd investors willing to back two ﬁrst time founders.
What could have made a difference?
The ideal solution would have been to ﬁnd a co-founder with industry knowledge, but the founders were unable to ﬁnd anyone willing to partner with them. They did have some advisors who provided guidance. But the folks they hired did not have the right attitude to operate in a startup.
The founders, when conducting a post mortem on the business concluded they could have avoided the operational problems by outsourcing the design and production process to a single factory partner.
There may have been better sources of funding available rather than a VC funding. Funding from a clothing factory would have given them a partner with a stake in the future of their company and good strong reasons to ﬁx problems and ensure on time delivery.
The author concludes that the challenges of lack of industry experience and learning by doing can result in expensive mistakes. The preference of investors to provide capital in chunks based on success rather than make the necessary commitment up front to increase the chances of success does not help.
Based on the article and reading the book I cannot disagree with the author’s conclusions, but I do have some thoughts I will share with you.
Firstly, going into business with friends does present challenges. The author mentioned that in this instance it slowed down the decision making process. It also makes those difﬁcult conversations about what needs to be done when things are going wrong even more difﬁcult.
Starting as friends you do not take the time to draw up formal agreements such as who does what, what level of commitment is required etc. that you would when entering a business venture with a stranger. These agreements are crucial, I have seen businesses fall apart because the friends had different, unspoken, expectations. If you are going to go into business with a friend do take the time to draw up a formal agreement and have a third party look it over.
Personally, I would never go into a serious business with a friend. In the book I learned that Alex and Christina, despite vowing not to let conﬂicts over the business threaten their close friendship, ended up not being on speaking terms.
My second thought is that they failed to hire the right people. They hired for experience which they desperately needed but they did not hire for attitude. The author mentions that the folks they hired were not willing to muck in and help outside their hired role. Try to hire folks with the right attitude. Low salaries and an equity stake are a good motivator to align your staff’s goals with your company’s success. Of course, the founders may have done this, it is not clear from the book.
My third thought is that the founders were too much in a hurry to get started. They knew that they did not have enough cash to get the business through the inevitable start up pains but launched anyway. Maybe they should have been more patient in ﬁnding backers, and the right backers, folks with industry knowledge. They appear to have had the overconﬁdence that many leaders have, and I confess I am one of them, that they have the ability to overcome obstacles that they know will arise.
Listen to the podcast of show 4 of this season when I covered Why do executives move forward with Strategic Initiatives even when they see pitfalls ahead? from Gartner to learn more about this common leadership failing.
Before the next case study a few minutes on the lean startup approach. As mentioned earlier the lean startup approach is based
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