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 firstname.lastname@example.org with any feedback/questions.