Introduction
In the fast-paced and high-stakes world of startups, success is far from guaranteed. Many entrepreneurs embark on their journey with high hopes and innovative ideas, only to see their dreams crumble before their eyes. But what if there was a way to navigate the treacherous waters of entrepreneurship with a clearer map? What if founders could identify and avoid the common pitfalls that lead to startup failure?
In his book "Why Startups Fail," Tom Eisenmann, a professor at Harvard Business School and an expert on startups, sets out to answer these crucial questions. Drawing from over two decades of research and personal experience, Eisenmann provides a comprehensive framework for evaluating startup health and identifying potential risks. This book is not just a cautionary tale of failed ventures, but a practical guide for entrepreneurs looking to increase their chances of success.
The Four Crucial Opportunities
At the heart of Eisenmann's framework are four crucial opportunities that every startup must capitalize on to achieve success. These opportunities form the foundation of a healthy startup and work together to create, build, manage, and sell a product or service profitably.
The Brilliant Idea: This is the unique solution that meets a specific customer need. It's the spark that ignites the startup journey – a product or service that effectively solves an important problem and stands out from anything else on the market.
Technology and Operations: These are the systems and processes needed to build the product, deliver it to customers, and maintain it after sale. This includes inventory management, shipping logistics, and customer-facing platforms for sales and bookings.
Profit Formula: This is the financial roadmap that projects revenue from sales and outlines the costs associated with earning that revenue. A solid profit formula is essential for managing cash flow and ensuring long-term viability.
Marketing: This encompasses all strategies for communicating with potential customers and enticing them to buy the product. Effective marketing not only drives initial sales but also turns customers into loyal brand ambassadors who generate repeat business.
These four opportunities are supported by the people involved in the startup – the founders, the team, investors, and partners. Like a jockey guiding a racehorse, these individuals need to work in harmony with each other and the startup as a whole to achieve success.
The Perils of Lacking Industry Knowledge
One of the most common reasons startups fail is a lack of industry knowledge among the founders. This was the case with Quincy Apparel, a startup launched by Harvard Business School graduates Alexandra Nelson and Christina Wallace. Their company promised to provide women with well-fitting business clothes through a unique sizing system.
On paper, Nelson and Wallace seemed like the perfect founding team. Wallace was charismatic and could sell the vision, while Nelson, a trained engineer, was analytical and well-suited for managing strategy and operations. They had even done market research, held trunk shows, and raised nearly a million dollars in seed capital.
However, neither founder truly understood the intricacies of garment manufacturing. They lacked knowledge of specialized roles like pattern making, sample making, and technical design. This gap in their expertise led to a series of operational issues, from ordering unsuitable fabric to misunderstanding sizing conventions.
The consequences were dire. Quincy's garment return rate was 15 percent higher than projected, with 68 percent of returns due to poor fit. This not only ate into profit margins but also meant that Quincy had failed to deliver on its core promise of well-fitting business attire.
This case study illustrates the importance of having deep industry knowledge when launching a startup. If your venture belongs to a sector outside your expertise, it's crucial to compensate for this lack of knowledge. This can be done by bringing on a cofounder with relevant experience, developing partnerships with industry experts, or equipping yourself with enough knowledge to guide your recruitment strategy effectively.
The Danger of Misunderstanding Customers
Another common pitfall for startups is a failure to truly understand their target customers. This was the downfall of Triangulate, a startup founded by Sunil Nagaraj while studying at Harvard Business School. Nagaraj's idea was to create software that matched potentially compatible singles based on behavioral data from their internet usage.
Nagaraj's enthusiasm led him to commit a classic mistake – the false start. He invested time and money into developing his product before confirming whether there was genuine consumer interest. Instead of conducting thorough market research, he made assumptions about his customers, including their willingness to pay a premium for his matching service.
In reality, Nagaraj failed to consider several crucial factors. First, people don't typically find algorithms useful when deciding which dating profiles they like. Unlike choosing a financial service provider, where they might lack intuitive knowledge, dating decisions are often based on intangible factors that algorithms struggle to capture.
Second, Nagaraj didn't consider whether people would be comfortable with their internet usage being tracked for matchmaking purposes – a potential privacy concern for many users. These oversights meant that Triangulate's core idea, a crucial opportunity for any startup, was fundamentally flawed.
To avoid such false starts, it's essential for founders to resist the impulse to act prematurely. While it's tempting to rush into creating a minimum viable product (MVP), this should only happen after thoroughly understanding the intended customer base. Workshops, surveys, and in-depth market research should precede any significant investment in product development.
The Pitfall of Misinterpreting Early Success
Even when a startup experiences initial success, it's crucial not to misinterpret this as a guarantee of long-term viability. This was the mistake made by Lindsay Hyde, founder of Baroo, a pet-care company launched in 2014.
Baroo started strong, offering "high-touch" pet services like grooming, dog walking, and feeding in the basement of a residential building in South Boston. The service was an instant hit, with 70 percent of pet owners in the building using Baroo's services. Encouraged by this success, Hyde rapidly expanded to more buildings and cities.
However, by mid-2017, despite the rapid expansion, Baroo was in dire financial straits. Hyde's mistake was failing to recognize that the early adopters in South Boston didn't represent the broader market.
This phenomenon is known as a false positive – when founders misinterpret their startup's early success and assume the mainstream market will embrace their product or services with the same enthusiasm as initial customers. In Hyde's case, she believed that around 70 percent of pet owners in every building would use Baroo's services, but this wasn't the case.
Hyde had failed to consider the specific circumstances that led to the initial hype. The building in South Boston was new, so pet owners hadn't established relationships with local pet care services. Many residents were part of a temporary film crew, with disposable income and a need for pet care services. This clientele didn't represent the mainstream market at all.
To avoid misinterpreting early success, it's crucial to analyze whether early adopters truly represent mainstream customers or if the initial success resulted from exceptional circumstances. Scaling too quickly based on false positives can lead to complete ruin, as it did in Baroo's case. Before attempting to scale, ensure there's genuine mainstream market demand for your product or service.
The Speed Trap: When Scaling Too Quickly Leads to Failure
While rapid growth might seem like a dream come true for many startups, scaling too quickly can actually lead to failure. This was the case with Fab.com, a flash-sale site for quirky furniture and household items.
Fab.com seemed to have everything going for it. Founded by experienced entrepreneur Jason Goldberg, who had already successfully launched another startup, Fab raised over $170 million in venture capital. In its first 12 days, it sold $600,000 worth of products. Within three years, the company had expanded into Europe.
However, this rapid expansion came at a cost. Fab was burning through $14 million a month just to stay afloat. Despite laying off 80 percent of its US workforce and focusing on the European market, the company couldn't sustain its operations. By its fourth year, Goldberg had to shut down US operations completely.
Fab fell victim to what Eisenmann calls the speed trap. This occurs when there's strong initial success coupled with plentiful investment that finances rapid growth. However, sometimes that initial success represents a saturation of the market. In Fab's case, even spending $40 million on advertising in its second year didn't significantly expand its customer base, which had plateaued.
To avoid the speed trap, Eisenmann recommends using the RAWI test:
Ready: Does your startup have a proven business model, a customer base with scope for growth, and a high enough profit margin to survive if customer growth rates are lower than expected?
Able: Can your startup access the resources needed to scale quickly, including staff? Can you train and manage a larger workforce effectively?
Willing: As a founder, are you prepared for the increased workload and stress that comes with scaling? Are you willing to dilute your equity by raising more venture capital?
Impelled: Are you scaling only because competitors have emerged and you want to win market share? If so, ensure the cost of gaining new customers doesn't outweigh profit.
By reviewing these points regularly, founders can better evaluate whether it's the right time to scale. It's crucial not to charge ahead if there's limited scope for growth, even if there's pressure from investors or competitors.
The Importance of the Right Senior Management
Having the right senior management team is crucial for a startup's success, especially as it scales. This was a lesson learned the hard way by Dot & Bo, an e-commerce company selling home decor as curated packages.
Founded by Anthony Soohoo in early 2013, Dot & Bo experienced rapid growth, generating $15 million in revenue in 2014 alone. However, this huge demand placed extraordinary pressure on the warehouse and shipping teams. To address this, Soohoo hired a Vice President of Operations. While the chosen candidate had an impressive CV, they lacked experience in e-commerce operations. This lack of specialized knowledge ultimately undermined the entire company.
The new VP's first task was to select an enterprise resource planning (ERP) system to manage operations like inventory tracking and deliveries. However, the system chosen couldn't handle the variations between different suppliers' delivery times. This led to a cascade of problems: the customer service team was overwhelmed with queries about missing or late deliveries, email response times stretched to eleven days, and staff often couldn't track where deliveries were.
To compensate for delays, staff resorted to express-shipping orders, which cut into profit margins. Meanwhile, social media hype increased sales, placing even more pressure on the already strained operations.
While it might be tempting to blame technology for Dot & Bo's operational problems, the root cause was the VP's lack of sector-specific experience. Someone with specialized knowledge would have chosen a more suitable ERP system that could handle Dot & Bo's complex supplier model.
This case underscores the importance of hiring specialists over generalists for senior management positions, even if the generalists have impressive experience in other areas. Without the right expertise at the top, a startup can quickly find itself in trouble, especially during periods of rapid growth.
If budget constraints prevent hiring senior specialists, consider bringing in mid-level specialists instead. They may come with a lower price tag while still providing the crucial expertise your company needs to support its growth.
The Risks of Overly Ambitious Ventures
While ambition is a crucial trait for entrepreneurs, ventures that are too ambitious can be particularly susceptible to failure. This was the case with Better Place, a company founded by Shai Agassi in 2007 with the noble goal of making electric cars mainstream and reducing the environmental impact of household vehicles.
Despite raising $900 million in investment, Better Place sold fewer than 1,500 cars before failing. The problem wasn't Agassi's vision, but rather the sheer scale of what he was trying to achieve.
To succeed, Better Place needed to align multiple factors outside of Agassi's control. He needed enough customers to embrace his electric vehicle to make it affordable. He needed them to have confidence in recharging and battery exchange stations. He also needed several car manufacturing partners to collaborate because not every customer wanted the same car model.
In the end, Agassi couldn't create a product with enough market appeal and the required infrastructure at a price point that would yield returns. Initial research had shown that 20 percent of households in Israel, where Better Place was launching, would consider buying one of his vehicles – even if it cost 10 percent more than a regular car. Agassi had been banking on selling to at least half of those households, but he didn't even manage that.
For entrepreneurs pursuing high-risk, ambitious concepts, there are steps to mitigate some of the risks:
Moderate the innovation: Remember that humans are often resistant to radical change, even when it's for a good cause. Try to innovate in a way that doesn't require customers to go too far out of their comfort zones.
Create prototypes and get feedback: Develop non-functioning prototypes and present them to focus groups. This can help guide the next stage of design while also gauging people's interest in the product.
Be realistic about market demand: Don't inflate potential market demand just to impress investors. This will only lead to unrealistic sales targets. Be honest about your potential customer pool to make more accurate projections about how long it will take to recoup investments.
By taking these steps, ambitious entrepreneurs can increase their chances of success while still pursuing innovative, world-changing ideas.
Recovering from Failure
Despite best efforts and careful planning, the reality is that most startups fail. However, failure doesn't have to be the end of an entrepreneur's journey. Take the case of Christina Wallace, co-founder of the failed startup Quincy Apparel. After the collapse of her company, Wallace found herself at rock bottom, with a failed startup, a broken dream, and crippling debt.
However, Wallace's story didn't end there. She took a job at the Startup Institute, an immersive training program in New York City. This first step led her to found another startup, an EdTech company supporting women in science, before eventually landing a teaching position at Harvard Business School. Her initial failure didn't hamper her long-term success at all.
Eisenmann outlines a three-step process for recovering from startup failure, which he calls the Three Rs:
Recovery: This is the immediate aftermath of failure, often characterized by financial ruin and deteriorated personal relationships due to the all-consuming nature of running a startup. Founders may experience intense negative emotions like grief, shame, or guilt. During this phase, it's crucial to implement healthy lifestyle habits, consider therapy, and reconnect with activities you enjoy to avoid falling into depression.
Reflection: Once the initial emotional turmoil has settled, it's time to objectively analyze what went wrong. This can be challenging, as our egos often try to protect us by blaming others for our mistakes. However, overcoming this tendency and gaining valuable insights from the experience is crucial for future success.
Reentry: Despite the hardship of failure, about 50 percent of unsuccessful entrepreneurs go on to found new startups. When reentering the startup world, it's important to articulate how the lessons learned from previous failures have informed the new business plan. This demonstrates to potential investors that you're starting from a place of experience and wisdom.
It's worth noting that failure in the startup world doesn't carry the same stigma it might in other industries. Many investors view failure as a valuable learning experience, provided the entrepreneur can demonstrate they've gained insights from it. By following the Three Rs, failed founders can turn their setbacks into stepping stones for future success.
Final Thoughts
"Why Startups Fail" offers a comprehensive framework for understanding and avoiding the common pitfalls that lead to startup failure. By focusing on the four crucial opportunities – the brilliant idea, technology and operations, profit formula, and marketing – and ensuring they work in harmony, entrepreneurs can significantly increase their chances of success.
The book emphasizes the importance of thorough market research, deep industry knowledge, and careful analysis of early success. It warns against the dangers of scaling too quickly and highlights the need for the right senior management team.
Perhaps most importantly, Eisenmann's work reminds us that failure, while painful, is not the end of the road. With the right approach, entrepreneurs can recover from failure, learn valuable lessons, and go on to achieve great success in future ventures.
For aspiring entrepreneurs and seasoned founders alike, "Why Startups Fail" serves as both a cautionary tale and a roadmap to success. By understanding the common reasons for failure and implementing strategies to avoid them, entrepreneurs can navigate the treacherous waters of the startup world with greater confidence and resilience.
In the end, while there are no guarantees in the world of startups, knowledge and preparation can significantly tip the scales in favor of success. By learning from the failures of others and applying these lessons to their own ventures, entrepreneurs can increase their chances of turning their innovative ideas into thriving, sustainable businesses.