GROWTH SECRETS: Avoid the major hurdles

Established firms have a huge advantage in engineering growth into their business, as they usually have the resources to devote to a change project.

Even if the early stage entrepreneur knew what to do, they often don’t have the management slack or the financial muscle to implement the change. On the other hand, if they did have the resources to implement changes in the business, many entrepreneurs struggle with driving growth because they don’t have the theoretical frameworks to know where to start. Few start up entrepreneurs go into business fully trained on business disciplines.

For most, however, they are often going forward with a double hurdle, a lack of business knowledge and a lack of resources to refine the business to drive growth.

If these hurdles were not enough to inhibit growth, early stage ventures are also characterised by high levels of uncertainty due to a combination of factors:

• The product is often unproven
• The management team is inexperienced
• There are gaps in the management team
• The market is developing and yet to be established
• Competition is still uncertain with new products emerging.

Many early stage ventures start with a lack of business acumen, a shortage of resources to drive change and an internal and external environment which is full of uncertainty. No wonder so many fail to grow.

In order to get beyond start up the business has to first survive and secondly, develop the knowledge and resources to implement growth driver attributes. What we know from common observations is that a large number of small ventures fail to develop critical mass to enable them to grow and many fail on route. You only have to visit a shopping mall or walk in a shopping high street to see the number of shops opening and closing to wonder what determines survival.

Some industries seem to have higher failure rates than others but without a comprehensive growth framework it’s hard to pinpoint why one industry should have higher failure rates than others.

So why do companies fail and why is growth so hard to achieve? Let’s start with an understanding of what causes early stage firms to fail. What we want to understand is the major flaws in business strategy and the major pitfalls to avoid.

Understanding the causes of failure

The major causes of business failure are now well documented and there are modelling techniques which are able to predict with considerable accuracy whether a particular business will fail. While there is no one characteristic of a business that will, by itself, cause a business to fail, a combination of weaknesses can create a situation where failure is highly likely.

Let’s start with some data on failures.

Although there are definitional problems in measuring what is meant by “failure”, the data on the rate of failure is open to speculation. Even so, while “exits” are not the same as failures, the data is enlightening. Most developed market based economies demonstrate similar patterns and so available data from Australia is typical of private enterprise size and life cycle in the major developed economies.

The 1997 Australian Bureau of Statistics (ABS) report of business exits in Australia, revealed that exits accounted for 8.5% of all businesses per annum (their definition of exits included cessation, liquidation, receivership, change of ownership and mergers). They report a much higher exit rate in new businesses.

The ABS data provide the following rate of exits of new ventures: 18% exit after 2 years, 24% after 3 years, 35% after 5 years, 55% after 10 years and 65% after 15 years.

Several Australian and overseas studies have measured start up failures. David A. Garvin writing in the Harvard Business Review (July 2004) in an article entitled ‘What every CEO should know about creating new businesses’ states that, during the 70s and 80s, 60% of small business start ups failed in their first six years. Similar studies over different periods and in different countries have found similar rates of failure.

There is, however, some level of disagreement across all these different studies as to the primary causes of failure. It is thus difficult to be definitive and arrive at a simple predictive model which could be universally applied. There also appears to be distinct differences between the causes of start up failures and failures of established businesses. Even with this reservation, it is instructive to see some of the conclusions. David A. Garvin stated in his HBR article that start up failures demonstrated one or more of the following problems:

• Customer failure (unwillingness of customers to pay for product or service, or insufficient demand).
• Technological failures (inability to deliver the promised functionality).
• Operational failures (inability to deliver at the required cost or quality levels).
• Regulatory failures (institutional barriers to doing what’s desired.
• Competitive failures (a competitor’s entry changes the rules of the game).

He concluded that success rates rise substantially when a new business targets familiar customers and is staffed by people well acquainted with the market. His test of survival was being able to clearly answer the following question: “What’s the pain point for customers and how does our offering overcome that pain?” I will return to this point when I discuss the underlying drivers of high growth, especially an attribute termed ‘the compelling need to buy’.

In more established businesses, the consensus of opinion suggests that the primary causes of failure are: a lack of adequate funding, a failure to recruit good quality personnel, the lack of a written business plan and a failure to use professional advice. Characteristics such as being the sole founder, not having parents who own a business, a lack of prior management experience and the younger age of owners have all been found to explain venture failure in some studies but are not supported in others and thus do not seem to have general applicability.

What all these studies do show is that there are some very good predictors of failure. While individual characteristics might not be decisive, there can be no question that the more of these deficiencies a firm has, the higher the likelihood of failure.

The overwhelming evidence does show that it is possible to predict in advance that a specific business idea has a limited chance of success. Thus a market which has too few potential customers, where the customers don’t have any money, where the technology is unproven, where competition is fierce, where costs are highly uncertain or where the entry costs are prohibitive, are situations where the idea should be rejected. Opportunity screening models or ‘investor ready’ models and checklists used by angels and VC investors greatly help avoid investment decisions which have low probabilities of success. Even so, market conditions can change, especially in emerging markets and thus failures often cannot be avoided.

Given our knowledge of business failure, the more knowledgeable entrepreneurs should be able to avoid the obvious mistakes. Even so, some ventures do fall into these traps, perhaps due to unforeseen changes in market conditions. Ventures which fail end up being closed down or the business written off or put into a fire sale where the entrepreneur and founding shareholders lose most of their investment.

Smart entrepreneurs can usually avoid these basic flaws. Their risks are much more to do with aggressive growth. However, as we will see, high rates of growth are difficult to achieve. What is often forgotten in the drive for high rates of growth is that growth itself is a high-risk game and is often the cause of business failure.