s6 E8 Why Start Ups Fail? - Jeremy Gray

Season 6 Show 8
Advice from business’s best thought leaders made easy to understand and practical to implement

IBGR.Network - PROFIT Radio. Everything a business owner needs to start, grow or exit a business. GROW WITH US. 
​
Today we  continue to explore the theme, Why Start Ups Fail?

It is well-known that most startups 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 well 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? Although I have used the word failure during this introduction because it is commonly used and is in the title of book on which this show is based, I do not think failure is the right word. If only 10% of businesses succeed, are you a failure because you did not succeed? Where possible I will try to remember to use the phrase did not succeed rather than failure. Is an athlete who comes fourth or lower in an Olympic event a failure? I do not think so, to my mind just getting the Olympics represents success.

This week I will continue to review case studies from Professor Eisenmann research. Unlike last week where the cases came from an HBR article, this week’s case is included in Professors Eisenmann’s book Why StartUps Fail.  If you would like to know more you will need to purchase the book. It cost me $3 for the Kindle version, and the book contains a lot more useful information. It's well worth the investment. The Kindle App is available free of charge for Android and iOS mobile devices so there is no need to purchase any hardware if you have a suitable device.

In our case today Professor Eisenmann identifies the dangers of false positives and how they can lead a startup astray. The company concerned was called Baroo, a pet care provider founded by Lindsay Hyde in 2014. Apparently a baroo is the movement a dog makes when he tilts his head inquisitively in response to a human’s voice. I think there is more to the story of Baroo than being lured into poor decisions by false positives. Listen to their journey and see what you think.

Ms Hyde’s original idea was a pet daycare in an office setting. She conducted research and found that demand from office workers would be limited. Her minimum viable product test of 25 Harvard University employees no one was willing to pay $20 for a day of pet care at work. While owners thought it would be fun to see their pets during the day, it was a hassle to bring them to work. It was easier to leave the dog or cat at home and arrange for a pet carer to visit during the day. I do wonder if the sample may have skewed the result. Only sampling folks working in an academic institution may not have been representative of the US working population as a whole. For example, Harvard University is in the center of Cambridge MA where parking is difficult so many folks take the T to work. Taking a pet to work via public transport is certainly a hassle, but if you are able to drive to work, taking Fido the dog along is not such a challenge. When conducting research, it is important to cover as many types of potential customers as possible.

This led to the idea of providing pet care close to home in the underutilized space in basements of apartment buildings. Residential property managers were interested, as such a service would make their properties more appealing to potential tenants with pets. Research showed that 80% of pet owners interviewed were not satisfied with their dog walkers and a similar percentage said they would use a pet day care in their building.

Hyde recruited a cofounder who had worked with her in the past and raised $1.2M and with her cofounder launched her business at a newly converted 315 unit luxury apartment building in the South End of Boston. Hyde planned to start small and use in house profits to fund expansion. She wished to avoid being pressured for hypergrowth for VCs. Her original backers were angel investors who would be happy with solid returns with moderate risk.

Baroo offered a range of high touch services such as dog walking, grooming, feeding, in-house sitting. Owners could book services using text, email, phone or an off the shelf scheduling app. Baroo’s care providers kept in touch with the pet owners using the same channels. Baroo provided care for any type of pet, not just dogs and cats. Fees charged were similar to those charged by other pet providers. Unlike other pet care services who hired their staff as contract workers, Baroo decided their staff would be employees, mostly part time. It was hoped that this would reduce staff turnover, lower training costs, and allow consistent processes and standards.

Baroo’s workforce would be professional, their backgrounds checked and wear uniforms. The cost of bringing a new staff member on board was around $500. And as their staff were employees they had to be paid whether there was work for them or not. Baroo’s competitors only paid their contractors for work done.

Rather than traditional paid marketing, Baroo relied on support from building apartment partners and word of mouth referrals. Building would distribute a gift from Baroo such as a chew toy to new residents who owned a pet. Building concierge staff would recommend Baroo and in return the building owners received a percentage of the revenue Baroo earned from their residents.

At their launch location 60% of residents owned a pet and an impressive 70% of them used Baroo’s services. Lindsay Hyde was delighted at this adoption rate. She anticipated that a similar adoption rate would be achieved at other locations. Ms Hyde fell victim to the false positive effect; early successes which appear more promising than they really are. The danger of false positives is that they can lead to expansion on a level that is not warranted.

What led to this false positive? In Baroo’s case there were three factors. Firstly because the initial location was new, 100% of the apartments had been filled at the same time. The new residents did not have a preferred pet care service provider, so they faced no switching costs by adopting Baroo. The second and this is unusual, the many of the new occupants were members of a Hollywood production crew in Boston to shoot a film. They had brought their pets, had no time to care for them and had generous per diems which meant they had plenty of cash to pay for Baroo’s services.

Finally, as Baroo launched Boston had record breaking snowfall, a little over 2 meters, 8 feet in 30 days. As a result no one wanted to walk their dog, so they would be called out several times a day by the same household. Looking back Ms Hyde realized instead of understanding this was a false positive, Baroo took it as a sign that if they could operate in these conditions, they could do anything.

Business boomed for Baroo and word got around about Boston’s new pet service. The leasing team at the original block told their counterparts, the residents told their neighbors. Baroo was flooded with requests for their services and quickly signed up four new buildings. Their original plan to avoid VC and rapid expansion were set aside. The original angel investors who sat on the board decided to expand into a second city, Chicago. They grew quickly in Chicago and eventually served 25 apartment buildings in downtown Chicago.

They were able to find an apartment block that had space for a dog day care which they leased to Baroo for free. This enabled the team to test their original concept of a care center at the owner’s home. A challenge of the expansion into Chicago was to find the right General Manager.  The first GM was a property management veteran but was a poor fit with the start ups culture.

A year after starting in Chicago Baroo raised an additional $2.25 Million in capital from new angel investors and small VC funds and launched in Washington DC.  Washington DC delivered some surprises, and not of the good kind. Customer losses spiked when a change in administration, Trump replaced Obama, and many employees appointed by Obama left town. Apartment buildings were more spread out in DC than Boston or Chicago which added to travel time between jobs for Baroo’s employees.

Managing three geographically diverse locations stretched the team to the limit. Despite this Baroo expanded into New York City, raising another $1 Million.

By now the expansion was delivering some major growing pains. The personalized service that was such a hit with early customers was getting difficult to deliver. Pet owners could no longer request their favorite walker, or phone with a last-minute request. Systems such as the off the shelf scheduling app could not keep up. The decision to hire care providers as employees created problems. It skewed incentives, an employee could spend more time doing a fun job, such as playing with a cute puppy and then run late on other jobs, or even miss the last job of the day. Being paid by the hour meant that missing that last job had no impact of the employees earnings.

The rapid growth made it difficult to hire enough careers, made more difficult by a 120% turnover rate. Good employees were being stretched, working 12 hour days. Baroo was burning out its employees and burning through their cash.

The financials were not great, in the first six months of 2017 Baroo had revenues of $600,000 and operating losses of $800,000. It was not clear how long it wouId take Baroo to reach breakeven. It was decision time, sell the company or go for the Series A funding. Ms Hyde pitched VC firms, but none were interested. So with 3 months cash remaining potential merger partners were approached. Three companies made offers but each deal unraveled. In February 2018 Baroo was shut down.

It is clear that early success in Boston, success based to some extent on luck, a new building with tenants on allowances and freak weather, led to an affirmation bias, we got it right. This encouraged the team to abandon their original plan of growing slowly using in house earnings and instead to accelerate growth. The false start syndrome identified by Professor Eisenmann.

As business people we tend to spend a lot of time analyzing the bad so we can correct it. And less time examining the good. If something is good, take the time to understand why, you may find it is not real, or on the other hand you might identify an opportunity you can build on. If you are seeing great growth ask yourself is it by strategy? Or is it by luck?

But was the Boston experience really a false start? Recall they had good success in their first expansion target Chicago, and it seems they managed that expansion without raising additional capital. So maybe the mistake was abandoning their plan to grow using profits generated by operations? Taking the additional funding increased the expectations of the investors. And these increased expectations put pressure on the founders.

In the west we tell our children three big lies. There is a Santa Claus, the tooth fairy exists, and you can succeed at anything if you try hard enough. The last lie is maybe the most dangerous. It is patently untrue,  maybe I would have loved to be a rock and roll star, but I have no musical ability, as many false starts to try to learn a musical instrument attests, and I cannot sing. Never mind how hard I worked, I would never have been good enough.  But the belief that if only you work hard enough you will succeed is ingrained in our society. And this can lead to false expectations in your ability. In academic speak it is the Dunning Krugger effect and we all are impacted by this belief.

The rapid expansion put great strains on the startup team. In my opinion they had two choices, admit they were out of their depth and hire more experienced talent. It is hard to admit to yourself that you are not up to the task in hand. Your ego gets in the way, it is not uncommon for businesses to go under because they grew too big for the founders to manage effectively. The other choice was to retrench the business, maybe shut down the New York and Washington operations, regroup and start again. Again, it's hard to accept you have taken on more than you can manage. If I only work harder I can get through this, there must be a way to solve this problem.

Neither of these options are palatable but they would have been better than having to close the business.

When planning the business the founders intended to grow slowly. Not only would this avoid the need to raise money it would have given them time to learn the skills needed to run a larger organization, time to identify gaps in their knowledge and hire folks who could fill those gaps. As entrepreneurs we have to have a certain confidence, you cannot start a business without confidence. But please do recognize your own limitations. You do not need to admit them to others, you can always say I do not have the time to manage, say, operations and hire an ops manager.

The business also seems to have abandoned its operating philosophy, the philosophy which had brought it success, the philosophy that gave them a level of differentiation. In its early days customers were able to schedule their favorite dog walker and Baroo was able to accommodate one off requests. They could provide added value services such as pet parties. All this became near impossible as the business grew, and their technology could not keep up. This type of failure is insidious because it creeps up on you. You make a one off substitution sending an alternative carer because of extenuating circumstances. That makes the next substitution easier. And soon your commitment to your customer that they will be able to schedule their favorite walker is abandoned.

The decision to expand rapidly was solely in the hands of the founders and their backers. Lured by early successes they made the wrong decisions and lost their company. Was it the false start in Boston that led to this outcome? I am not sure, although I am sure it played a part. What do you think? You can always let me know your thoughts via the links on my show notes. If you are interested in the topic and missed last week's show, listen to the podcast and let me know your ideas on the two case studies discussed in show 7.

Facing the closure of your business venture a founder will feeling a range of difficult emotions but failure should not be one of them. You did not succeed but then again neither did the 90% of founders of other businesses. But emotions are not rational. In hindsight, a common refrain from founders of businesses that did not succeed was that they continued on too long after it should have been clear that closure was the only viable option.

There are many reasons why this happens, a reluctance to accept that it is time to quit, the well known continuation bias, the impact on employees, investors, and family. But one reason could be that entrepreneurs always need to present their business in the most positive ways possible, paint a rosy picture of the situation, that maybe they begin to think that it is the total truth. A C-Suite executive I used to work with had a saying, the problem with X is that he believes his own press releases.

I recently listened to a HBR podcast When Entrepreneurs Distort the Truth which I felt would be interesting to my listeners. There is also an HBR article on the same topic. Links to both are in the show notes.
The subtitle to the article is They (entrepreneurs) often bend it, but do not demonize them – the problem is systemic.

Most of you will be familiar with Elizabeth Holmes, the founder of Theranos, who at one time was lauded by Forbes in 2015 as the first female self made billionaire. But her business was allegedly based on fraud and deception marketing bogus blood tests. This is an extreme example of distorting the truth, not many entrepreneurs face criminal charges, although there have been others in the past Enron and Worldcom come to mind.

But many entrepreneurs do distort the truth. At the start of Vice Media co-founder Shane Smith sent a few copies of the Montreal based startups publication to a record store in Miami and a skate shop in Los Angeles so the company could tell advertisers that readership was distributed across North America.

Entrepreneurs have a lot at stake. As a group they have the opportunity to achieve great wealth. Although research shows that the median entrepreneur would have been better off working in the corporate environment or investing their funds in a diversified index fund, a small percentage of entrepreneurs become very wealthy indeed. Entrepreneurs dominate the ranks of the world’s richest people. So, it is no wonder there is a temptation to bend the truth.

Gary Hirshberg who built Stonyfield farm from a two person, seven cow operation into one the world’s leading sellers of organic yogurt. In 2018 Gary in an interview with Entrepreneur magazine told of the deceptions to vendors and lenders that saved his business.

Asymmetry of information provides the cover for distorting the truth, the entrepreneur knows more about his business than his backers, suppliers or even his staff.

According to the article entrepreneurs are a bit more ethical than their corporate counterparts. So how do they justify their shall we say exaggerations.

It's for the greater good. Hirshberg explained that it would not help his vendors if his business went under. It's OK to mislead if you ultimately deliver. This is the ends justify the means rationalization. The philosopher Jeremy Bentham who died in 1832 wrote, It is the greatest happiness of the greatest number that is the measure of right and wrong. Using this philosophy Hirshberg was ultimately justified, but only because he succeeded. Had he incurred greater debts and failed, could the same justification be applied?

I am protecting my people is another common refrain. We are fighting for our employee’s jobs and our friends’ investments. Fighting for our lives. And I think anything goes as long a syou are not hurting anybody.

Everybody does it, was another justification Hirshberg offered. Talking of his vendors he said it's not like they hadn’t seen it before. The article says sometimes the misleading statements are vague, during the tech bubble companies with only small IT component tried to classify themselves as tech companies. Sometimes it is more open, such as exaggerating the projected revenues, knowing that potential investors will discount the projections. Those entrepreneurs who do not exaggerate may rightly fear they are putting themselves at a disadvantage.

Gary Hirshberg today is a successful entrepreneur and a prolific philanthropist. His comments  reflect the pressure that all entrepreneurs feel and the rationale they use to justify their actions.
This is a difficult topic and a dilemma we all face. The concept of fake it until you make it which can lead to the imposter syndrome where you feel you are not justified in your claims, which is an uncomfortable place to be.

The article has a couple of suggestions.

Show your evidence and assumptions. All business projections should be an evidence based guess. By showing how you have reached your conclusions  you will reduce the potential that investors will automatically discount your projections.

Surround yourself with people who will help you be your best. Your choice of investor can be critical. The story of the rise and collapse of WeWork may be known to you. It was founded by Adam Neumann and backed by Japan’s Softbank. Softbank criticized Neumann’s level of intensity and encouraged him to be even crazier. Neuman obliged.

At the end of the day this is a personal choice you must make. I am certainly not going to take a stand on what is right and what is wrong. But I do think you should consider the potential impact of your actions. It may be one thing to deceive an experienced investor with significant assets and another to ask a small angel fund to support you based on false projections. Business will always be business, there are risks and rewards. How you balance that is a question for yourself.  

Links to today’s article:

• https://hbr.org/podcast/2021/08/when-entrepreneurs-distort-the-truth
• https://hbr.org/2021/07/entrepreneurs-and-the-truth
• https://www.entrepreneur.com/article/321494 (Link to article about Gary Hirshberg. Requires subscription.)

You can contact me via the following links:
mailto:jeremy@business-in-asia.org

Or schedule time via Calendly:
https://calendly.com/3-continents-consulting

My websites include:
https://business-in-asia.org/
https://thedentistscfo.com/

My LinkedIn URL
https://www.linkedin.com/in/jeremy-gray1

​