Nail McCarthy’s article in Forbes on the reason why startups fail joins a bevy of articles on this subject. Bill Gross of Idealab pinpointed the single most important reason, and it isn’t even listed in the CB Insights chart! According to his research it’s timing.
Either way you look at it the odds are against founders:
According to CB Insights, 70 percent of upstart tech companies fail, usually about 20 months after first raising financing. The failure rate is even worse for consumer hardware startups with 97 percent of seed crowdfunded companies failing or turning into “zombies”.
Let’s take a look at some of the reasons CB Insights discovered. The number one reason is No market need, at 42% it dwarfs all other factors. This jibes with research done by NSA on why scientists and researchers fail to commercialize their inventions or discoveries. MIT is one of several sites running the I-Corps program for post-docs.
The National Science Foundation (NSF) I-Corps program prepares scientists and engineers to extend their focus beyond the university laboratory, and accelerates the economic and societal benefits of NSF-funded, basic-research projects that are ready to move toward commercialization.
Through I-Corps, NSF grantees learn to identify valuable product opportunities that can emerge from academic research, and gain skills in entrepreneurship through training in customer discovery and guidance from established entrepreneurs.
Even if you are not a post-doc I highly recommend you study Steve Blank’s work on customer discovery which is a critical part of the I-Corps curriculum. He has several books, including The Startup Owner’s Manual: The Step-By-Step Guide for Building a Great Company. Steve’s web site has a wealth of resources for founders and many videos on YouTube about customer discovery. So as they say, an ounce of prevention is worth a pound of cure. In this case you need a pound of prevention in discovering who your customers are and why they would want your product. Don’t be a solution in search of a problem!
The second big reason startups fail is running out of cash, at 29%. But this is misleading. Obviously you run out of cash because your expenses exceed your cash on hand, which could be an investment or customer revenue. Not creating a product the market wants means you have zero customer revenue, so ipso facto, you will run out of cash eventually no matter how big your investment. So my advice to founders is start charging from the get-go. Meaning if you secure a pilot, get your customer to pay, even if you have to offer a hefty discount. And make it clear that after X period, if the pilot is a success the price needs to go up so you can re-invest it in the company. I’m very pleased to say one of my mentee companies just landed a paid pilot that could lead to significant revenues if it’s successful. Don’t just do a pilot as a proof of concept. Pilots need to be step one on the best way to stay cash flow positive: generate customer revenue.
Not the right team comes in third at 23%. Since this data comes from post mortems with failed companies keep in mind all hindsight is 20/20. Founders have two major responsibilities. The first is customer discovery. But the second is building the right team. And because no one bats 1.000 in hiring realize your team is going to change, for a variety of reasons. One way to be prepared for changes in the team is what I call talent tracking. One of the reasons for the enduring success of The New England Patriots is that they literally have a book on every single player in the NFL, including practice squads. So if they lose a player due to injury or cut him due to poor performance, they know exactly who to go after for a replacement. Keep in mind that founders must be aligned tightly on their personal and company goals or your company will indeed fail if you can’t replace a founder who isn’t a fit.
The next most frequently cited reason for failure is Got outcompeted. This is why virtually ever investor I’ve ever talked with asks “What is your barrier to entry?” The good news about startups is that it’s never been so cheap or so easy to pull together a team and build a product. And that’s the bad news as well. So you need to start thinking about how you will fend off competitors, which come in two flavors: incumbents and copy cat startups. You need a different strategy for each. Back in the last century every VC would ask me: But what if Microsoft decides to do this, how will you ever compete with them? Then the subject of that sentence became Google. Today it’s probably Facebook or Amazon. The reality is that the bigger the company the harder it is for them to justify going after what they think is a small market. The classic case of this was mobile apps. Both Microsoft and Facebook ignored mobile for years. The difference was Facebook woke up sooner and to Mark Zuckerberg’s credit he drove everyone in a mobile-first direction quickly and very successfully. Here’s where reading a book may help: Blue Ocean Strategy, Expanded Edition: How to Create Uncontested Market Space and Make the Competition Irrelevant by W. Chan Kin and Renee Mauborgne.
Rounding out the top five reasons startups fail is Pricing/Cost issues. This does not surprise me. For after customer acquisition the most common problem brought into mentoring sessions is How do I price my product or service? Obviously books have been written, seminars conducted, research papers published, etc. on this subject. I’d refer you to Steve Blank’s book mentioned above for help here. But one question should be answered: are you pricing to gain market share (which was Microsoft’s strategy for years) or to generate high margins (which was Apple Computer’s strategy, and still is despite their name change to Apple.) Get your customers to help you. Once you have captured their imaginations you need to ask them: “Ok, but what would you pay for this product? How does $XXXX a month sound? And would you prefer we offer on a monthly subscription basis or on a one-time sale basis, with charges for new versions? Like real estate, the best way to price a product is to look at comparables. And more specifically, the comparables purchased by your prospective customer. If you have enough prospects A-B testing can help you find the pricing sweet spot. In my experience startups under price their products and services, which leads to reason two for failure: running out of cash. Do not try to compete on price – it’s a race to the bottom. Keep a tight rein on your costs and make sure your pricing will cover your costs before you run out of cash!
One last comment. You’ll notice that Product mis-timed comes in at number 10 at only 13%. This is certainly contrary to Bill Gross’ finding that it’s the number one reason. From my experience many companies are too early and the market infrastructure wasn’t their (I was doing mobile apps in 2000) or you are too late and the market has a dominant player (Search – Google). So I believe timing is something founders need to look at as their startup is gestating.
One question I often ask founders is “If your company fails 2 years from now, what will be the major reason?” This bar chart can be turned into a checklist for founders – review it weekly and ensure that you and your team are taking the right steps to avoid these reasons for failure.