Rethinking Small Business Failure
Over several decades working in, on, and around small business and entrepreneurship, I’ve heard a lot of small business failure statistics thrown around. I should really put “small business failure” in quotes, because in my observation, the statistics thrown around mix apples and oranges, which only causes greater confusion. Let me explain.
First, how is failure defined? In most of the studies and statistics floating around, failure is defined as closure. The study looks at a “cohort” of companies starting in, let’s say 2005, then for several years thereafter, checks to see how many are still open. So, you hear statistics like, “80 percent of all small businesses fail within ten years,” or “50 percent of all small businesses fail within five years”.
Second, what types of small businesses are we talking about? As I’ve discussed elsewhere, there’s a wide range of types of businesses you can start and run, from lifestyle businesses, to franchises, to venture-backed growth businesses. This range of businesses can go from the relatively simple, one-person professional service provider, to the very complex biotech startup teaming with scientists and other advanced degree types.
Let’s tackle the issue of how failure is defined. How do you define success or failure in your own businesses? Is it simply based on whether you stay open a certain period of time? I hope not! Most entrepreneurs start their businesses with at least some idea of the financial results they’d like to see. Even if they don’t have clear written goals, as many don’t, they don’t simply say to themselves, “I hope I can keep this thing open for five years”!
Taking it a step further, let’s look at definitions of small business failure in the context of the different types of businesses mentioned above. Is failure (or success) in a lifestyle business the same as it is in a venture-backed business? Of course not! How about in a franchise? Many franchises will tell you that your probability of “success” is much higher because they’ve worked out all the systems for you. By mixing lifestyle businesses, with franchises, with investor-backed growth ventures, with other types of ventures, the statistics providers are mixing apples, oranges, and a bunch of other kinds of fruit. It’s like a mixed fruit cocktail, with ingredients so varied, you don’t even know what kind of “juice” you’re drinking.
Small business failure statistics going forward must be segmented by business type, and if they are going to be calculated on the same basis as before, they should be called “closure statistics” instead. It would also be great to see success and failure measured along other dimensions, rather than just the binary “still open” or “closed”. Looking at a dimension such as profitability, even if it had to be averaged, for confidentiality purposes, could be quite interesting. Magazines such as Inc. look at sales growth over a certain period of time, and while this is certainly interesting and a better metric than open/closed, it’s well known that sales growth doesn’t necessarily correlate perfectly with profitability or sustainability.
In my opinion, based on experience and observation, most of the startups and existing small businesses that fail, never should have been started in the first place. With a minimal amount of upfront analysis, the entrepreneurs who started the businesses could have determined that their startup had a low probability of “success”. Such basic steps as a break-even analysis can provide a reality check on what has to take place from a sales volume perspective in order for the business even to reach profitability. These simple steps often are not taken. I say this not to discourage entrepreneurs, as I am probably one of your biggest advocates. Rather, I say it so that you will take the simple steps necessary to increase the odds that the business you are starting will not become a “failure” statistic, not by the open/closed failure definition, but by your own definition. Make sure you know what that definition is, before you ever open the doors of your small business.
A few of the many questions you should ask yourself before you start your business, to make sure you don’t become another “failure” statistic:
- What will success be for me in this business (i.e. what are my objectives)?
- Is there truly demand for what I’m offering, or am I just selling what I understand and want to sell?
- What is the break-even point, based on my fixed costs, variable costs and selling price?
- What can I do from a cost perspective to improve my break-even point?
- Will customers pay the selling price I am estimating for my products and services?
- How long do I think it will take me to reach break-even?
- Can I sustain myself and the business until the business starts generating, instead of consuming, cash?
- Are my estimates of marketing and selling costs realistic in the context of the sales volume I am expecting to generate?
- What will differentiate my company and offerings in the marketplace, so that I will not become commoditized and have to compete on price?
- Is the potential upside of this business worth the risk I’m taking?
- Am I passionate enough about this business to persevere through the tough times and inevitable challenges that will arise?
I look forward to your thoughts and questions. Please leave a comment (“response”) below or in the upper right corner of this post.
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Paul,
The only other thoughts I would encourage are:
1. What would my plans for re-investment into the company be?
2. How will I handle/afford necessary updates to structure, technology, or equipment down the road?
Great post! I’ve shared it on my Facebook Page.
Thank you,
~Keri
You make some very good points here. As a business consultant dealing with small business on a daily basis, I see a full range of these questions that have been left unanswered prior to entering my office.
The one that I would include is, “Am I willing to seek out the help that I need to make my business a valuable, successful money maker?” Realizing that many businesses fail because they are treated like a hobby, I would ask a question that answers whether a business is really just a hobby, being presented as a business.
Thanks for your post. I agree that some businesses should not have been opened, or at least been presented as a hobby and not a serious business. This activity skews the numbers.
In my experience from running my own small business and helping others, I would 100% agree with your suggestion ‘most of the startups and existing small businesses that fail, never should have been started in the first place’ . Research is just so important.
Really helpful article for start ups – and no it is not discouraging.
Hi Paul,
That is a great list of questions to run through before any business start up.
I am particular interested in the aspect of market analysis. In your opinion, what are the best ways for a aspiring entrepreneur to do market analysis to gauge demand for his products or services? Are they any methods?
Recently, I read about Steve Jobs having a practice to shelf all kinds of focused groups on products. He mentioned to his team to looking within and ask themselves about their thoughts of the products. If the feedback internally is good, there is a good chance that people will want what they are selling. What’s you thoughts here?
Good points, Paul! I also think throwing restaurants in the mix also shifts the failure percentage higher. They are notorious for the chance of failing unless it’s a franchise. I remember one restaurant building, seemingly in a great location right off the freeway, had restaurant turnover every two or three years. Comparisons do need to be make by business type based on the very nature of their history and types of owners.
Sherrie
What a great blog — I am going to do a kind of take on this blog from the financial prospective in the next couple weeks when my blog gets back up. You have some great insights in this blog.
Thanks for sharing!!
Thanks, Wendy! I’m happy you found some helpful insights on the blog! Paul
Hi, Sherrie. Yes, restaurants are known for sometimes being revolving doors, with new owners coming in and failing every couple of years. I agree that mixing restaurants and so many other types of businesses in the same statistics provides relatively meaningless information. It’s key that the statistics be provided by segment/type of business. Paul
Thanks, Yosien. Agreed! Research is key! It is important not to cook up a business plan in a vacuum and just hope customers will come. It absolutely does not work that way! Though it may be a bit time consuming to do some basic research and analysis up front, it’s critically important! Paul
Hi, Jimmy.
The further I go in my entrepreneurial career, the more I believe that while secondary market research can be useful to give you general market size and “taste” parameters, for specific product development and launch planning, it is not very helpful. So that gets us to primary market research, which would include focus groups, surveys and other approaches where you interact directly with prospective customers/clients. That research too can be misleading, particularly if you are asking simply about buying behavior and not the feelings and emotions that drive that behavior.
At the end of the day, what works is highly context dependent. The key, I think, is to maintain as much of an “open dialogue” as you can with your existing and prospective customers regarding their fears, concerns, desires, and frustrations. This can help provide the foundation of great customer service and product/service development. Then, if the products and services are developed correctly, the marketing and sales process becomes a lot easier.
Paul
Thanks, Keri. Excellent questions that all entrepreneurs should consider. Understanding the reinvestment policy and future CAPEX needs certainly is important! Paul
Hi, Lauri. You make an excellent point. Many “businesses” are actually hobbies and the founder most likely does not intend to make them anything else. I wrote about the different types of businesses that one can start and I think entrepreneurs often either get them confused, or simply don’t have a clear vision for what they’re trying to create. I also agree that hobby businesses definitely can skew the “failure” statistics, though it’s not clear in which direction; hobby “businesses” tend to stay open for quite a while, whether they make economic sense or not. Paul
Hi Paul,
This is a great post, and I like your list of questions to ask, ideally before starting a new business.I always wonder where the statistics of small business failure come from. If a business reorganizes, rebrands or segues into a different market because the original market yielded too little revenue, is that a failure? I would add that any time an entrepreneur faces the fact that a business is not working and chooses to close, rebrand, reorganize, etc., the lessons learned along the way are invaluable. The business owner could probably have spent the same on higher education and not learned as much.
Thanks, Jayna. I agree that the lessons that can be learned from small business “failures” often are much more valuable than those that can be picked up in “formal education”.