Fail­ure

Finweek English Edition - - MONEY -

TPICKING THE WRONG IN­DUS­TRY: If you want to eas­ily start a busi­ness, then you should pick an in­dus­try where bar­ri­ers to en­try are low, right? WRONG. US Cen­sus data shows that the rate at which en­trepreneurs start busi­nesses in dif­fer­ent in­dus­tries cor­re­lates 0.77 with the rate at which busi­nesses fail in those in­dus­tries. That is, en­trepreneurs choose to start in the very in­dus­tries in which busi­nesses are most likely to go un­der.

The rea­son is that the new en­trant stands very lit­tle chance of out-com­pet­ing other busi­nesses. Data from the Panel Study of En­tre­pre­neur­ial Dy­nam­ics re­veals that nearly 40% of founders don’t think that their busi­nesses have a com­pet­i­tive ad­van­tage. SO WHY DO THEY BOTHER? Well, per­haps be­cause they don’t know bet­ter: not enough en­trepreneurs have ex­pe­ri­ence in the in­dus­tries in which they are start­ing their busi­nesses. Aca­demic re­search shows that work­ing in an in­dus­try for sev­eral years be­fore start­ing a busi­ness en­hances the sur­vival prospects of a startup, but a siz­able frac­tion of en­trepreneurs start busi­nesses in in­dus­tries in which they have no work ex­pe­ri­ence.

It’s one thing to be op­ti­mistic; it ’s another to be un­re­al­is­tic. If you are choos­ing to start a new busi­ness in an in­dus­try where you have no work ex­pe­ri­ence and where bar­ri­ers to en­try are low, chances are you will die. I just hope it’s quick. here are a lot of the­o­ries as to why start-ups and busi­nesses in gen­eral fail. The ones listed be­low are those that res­onate most strongly with my own ex­pe­ri­ence. Of­ten a busi­ness will find that there is not enough de­mand at a price that can make a profit for the com­pany. You can’t eas­ily com­pete against big firms who have economies of scale, es­pe­cially if that gives them pur­chas­ing power with sup­pli­ers. The other side of num­bers that don’t work comes when the life­time value of your cus­tomer is lower than the cost it re­quires to ac­quire them. De­pend­ing on the pay­ment cy­cle, this sit­u­a­tion may be ini­tially sus­tain­able, but the mo­ment your growth starts to f lat­ten you’ll run out of cash. Suc­ces­sive years of prof­itable growth are very hard to achieve. Growth places huge bur­dens on man­age­ment sys­tems and forces busi­nesses to change modal­ity. Serv­ing a lo­cal mar­ket is hard enough, but split­ting a busi­ness into two or three mar­kets presents many ad­di­tional chal­lenges, all of which end up in an over­head struc­ture at some point. The re­sult is that many suc­cess­ful busi­nesses are ru­ined by over­ex­pan­sion.

This would in­clude mov­ing into mar­kets that are not as prof­itable, ex­pe­ri­enc­ing grow­ing pains that dam­age the busi­ness, or bor­row­ing too much money in an at­tempt to keep growth at a par­tic­u­lar rate. Some­times less is more. Reg­u­lar read­ers of this col­umn will know we favour the use of the sus­tain­able growth rate as a cal­cu­la­tion in your fi­nan­cial plan­ning. It shows how fast you can grow with­out chang­ing your prof­itabil­ity, div­i­dend pol­icy, cap­i­tal struc­ture or re­turn on as­sets. Busi­ness is cycli­cal and bad things can and will hap­pen over time, such as the loss of an im­por­tant cus­tomer or crit­i­cal em­ployee, the ar­rival of a new com­peti­tor, or the f il­ing of a law­suit. Th­ese things can all stress the fi­nances of a com­pany. If that com­pany is al­ready out of cash (and bor­row­ing po­ten­tial), it will al­most cer­tainly fail. Your liq­uid­ity ra­tios will quickly point out whether you are run­ning into trou­ble or not. In­cluded in this are poor ac­count­ing, op­er­a­tional medi­ocrity, and op­er­a­tional in­ef­fi­cien­cies. They are all closely re­lated. With­out good ac­count­ing (and your watch­ful eye over it, not your ac­coun­tant’s) you prob­a­bly won’t know when you’re be­ing waste­ful or in­ef­fi­cient else­where. So your busi­ness must have its ac­counts in or­der and you must track ev­ery­thing. There is al­ways fat to cut. There are al­ways im­prove­ments to be made. Suc­cess­ful en­trepreneurs fig­ure th­ese things out and grow from strength to strength. Poorly-run busi­nesses die. As the old ex­pres­sion goes, you only know who was swim­ming naked when the tide goes out. Book­stores, mu­sic stores, print­ing busi­nesses and many oth­ers are deal­ing with changes in tech­nol­ogy, con­sumer de­mand, and com­pe­ti­tion from huge com­pa­nies with more buy­ing power and ad­ver­tis­ing dol­lars. Their tide has gone out and those re­main­ing are strug­gling to sur­vive. The savvy en­trepreneurs have al­ready sold, changed busi­ness model, or re-or­gan­ised to face this new chaos.

What’s most in­ter­est­ing about th­ese rea­sons is that they put the blame for fail­ure largely on the en­tre­pre­neur, not on the Gov­ern­ment, big busi­ness, or Bri­tish im­pe­ri­al­ism. It ’s time for en­trepreneurs to ac­knowl­edge re­spon­si­bil­ity for their own fail­ure. Ev­ery sin­gle one of the fac­tors above is pre­ventable with some cau­tion, plan­ning and sys­tems. Don’t ac­cept medi­ocrity in your busi­ness and half your bat­tle is al­ready won.

Gareth Ochse is founder of Valu­a­tionUp.com – a f inan­cial anal­y­sis and strat­egy tool that shows how a busi­ness is be­ing run, what it’s worth, what it could be worth and how to get it there. Email fin­week@valu­a­tionup.com with any feed­back/ques­tions.

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