Why Startups Fail: A New Roadmap for Entrepreneurial Success
Tags: #business #entrepreneurship #startups #failure #investment #risk management
Authors: Tom Eisenmann
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Overview
Why do so many startups fail? That question has haunted me for years. More than two-thirds of new ventures fail, and while there are many possible reasons for any given startup’s demise, the causes of startup failure have been difficult to pin down definitively. In this book, I set out to identify the underlying causes of startup failure and to offer entrepreneurs practical advice for avoiding the most common pitfalls.
Drawing upon my experience teaching entrepreneurship at Harvard Business School and my research on startup failure, this book is geared towards entrepreneurs and investors, especially those who are involved with early-stage ventures. I identify six distinct failure patterns, each of which explains a large portion of startup failures. The first three patterns are common among early-stage ventures: Good Idea, Bad Bedfellows, False Starts, and False Positives. The remaining three failure patterns – Speed Trap, Help Wanted, and Cascading Miracles – are more common among resource-rich, later stage ventures.
For each of the failure patterns, I provide examples of startups that fell prey to them and describe actions that other entrepreneurs took to avoid similar mistakes. I also analyze how entrepreneurs handle failure, offering advice for preserving relationships when shutting down a venture, dealing with emotional fallout, learning from one’s mistakes, and bouncing back from the experience.
Book Outline
1. What Is Failure?
Defining startup failure as simply falling short of expectations is too broad. To accurately analyze startup failure, we need to understand what ‘failure’ means and determine whose expectations matter. This chapter introduces a standard for labeling a startup a failure: whether early investors earned a return on their investment.
Key concept: A venture has failed if its early investors did not—or never will—get back more money than they put in.
2. Catch-22
Entrepreneurs face a Catch-22: they can’t pursue a novel opportunity without resources and they can’t attract resources without having pursued the opportunity. There are four common tactics entrepreneurs can use to navigate this dilemma. This chapter introduces those tactics and explains how to assess whether an opportunity is attractive and what resources are needed to capitalize upon it.
Key concept: The Diamond-and-Square Framework: This framework helps founders identify attractive opportunities and determine what types of resources are required to successfully capitalize upon them. The framework’s diamond breaks down the startup’s opportunity into four parts: its customer value proposition, technology and operations, marketing, and profit formula. The diamond is framed by a square, whose corners denote the venture’s key resource providers: its founders, team members, outside investors, and strategic partners.
3. Good Idea, Bad Bedfellows
This chapter introduces a common early-stage startup failure pattern, Good Idea, Bad Bedfellows. This pattern stems from a startup’s failure to attract the resources needed to successfully capitalize on a promising opportunity. Founders who lack industry experience often struggle to assemble the right team, find investors with compatible goals, and manage partnerships with larger companies effectively.
Key concept: Good Idea, Bad Bedfellows: This pattern of dysfunctional relationships with key resource providers can contribute to a venture’s downfall.
4. False Starts
This chapter introduces another common early-stage failure pattern, False Starts, which occurs when entrepreneurs bypass important early customer research that informs their understanding of customer needs and whether their envisioned solution will meet them. I explain how entrepreneurs can avoid false starts by undertaking a thorough design process before commencing engineering work.
Key concept: False Starts: A false start occurs when a startup rushes to launch its first product before conducting enough customer research – only to find that the opportunities they’ve identified are rife with problems.
5. False Positives
This chapter introduces the third early-stage failure pattern, False Positive. False Positives occur when entrepreneurs, beguiled by strong demand from early adopters, incorrectly extrapolate that demand to the mainstream market. I explain how entrepreneurs can avoid false positives by conducting early customer research that exposes any differences between likely early adopters and mainstream customers. I also highlight ways in which founders’ psychology makes them vulnerable to this pattern.
Key concept: False Positive: False Positives occur when entrepreneurs, beguiled by the enthusiasm of a few early adopters, incorrectly extrapolate strong demand to the mainstream market and step on the gas.
7. Speed Trap
This chapter shifts the focus from early-stage startups to those in later stages that have already achieved product-market fit and are scaling rapidly. I introduce the Speed Trap failure pattern, explaining that startups often run into trouble by expanding faster than is warranted by their resources and capabilities. Specifically, if they try to grow too fast into a customer segment that does not find the company’s value proposition compelling, the startup’s customer acquisition costs will increase, while its customer lifetime value will decline, resulting in an LTV/CAC squeeze.
Key concept: Speed Trap: Ventures that fall victim to a Speed Trap have identified an attractive opportunity. Early adopters embrace the product and spread the word about it. This rapid early growth also lures enthusiastic investors. To justify the high price they paid for equity, investors push for aggressive expansion. After marketing intensively, the startup eventually saturates its original target market, meaning that further growth requires broadening the customer base to encompass new segments. This next wave of customers, however, doesn’t find the company’s value proposition nearly as compelling as the early adopters did.
8. Help Wanted
This chapter introduces another late-stage failure pattern, Help Wanted. Startups that fall victim to this pattern struggle due to resource shortfalls, either because investors suddenly shun their sector, or because they can’t recruit the management talent needed to effectively lead the venture’s increasingly complex operations.
Key concept: Help Wanted: Hypergrowth leads to resource shortfalls in two areas. The first relates to financing risk: An entire industry sector suddenly falls out of favor with venture capital firms. In the extreme, even healthy startups caught in a downdraft cannot attract new funds. The second type relates to gaps in the senior management team. Scaling startups typically need senior executives with deep functional expertise who can manage rapidly expanding pools of employees. Delaying the hiring of these executives or recruiting the wrong individuals can lead to strategic drift, spiraling costs, and a dysfunctional culture.
9. Moonshots and Miracles
This chapter examines a third late-stage failure pattern, Cascading Miracles. Startups that fall prey to this pattern pursue an incredibly ambitious vision, and in doing so they face multiple daunting challenges. Missing the mark on any of these challenges dooms the venture. After profiling the electric vehicle startup Better Place, I discuss common problems faced by moonshot ventures and strategies that entrepreneurs can employ to increase their odds of success.
Key concept: Cascading Miracles: These ventures are often launched by charismatic founders who seduce employees, investors, and strategic partners with an opportunity to help usher in a dazzling future. The startup faces multiple, daunting challenges, including: 1) persuading a critical mass of customers to fundamentally change their behavior; 2) mastering new technologies; 3) partnering with powerful corporations who’d prospered from the status quo; 4) securing regulatory relief or other government support; and 5) raising vast amounts of capital. Each challenge represents a ‘do or die’ proposition: Missing the mark on any of them would doom the venture.
10. Running on Empty
This chapter shifts the focus from why startups fail to how entrepreneurs handle failure. This chapter examines Running on Empty, a startup failure pattern that stems from the fact that the decision to pull the plug on a struggling venture is so nettlesome. Many founders persist, past the point where the odds of a turnaround have become minuscule, even though postponing the inevitable is costly. I also explain how founders can determine when to call it quits and offer advice for managing a shutdown responsibly.
Key concept: Running on Empty: Many founders are inclined to persist, past the point where the odds of a turnaround have become minuscule, even though postponing the inevitable is costly for them and those around them.
11. Bouncing Back
This chapter explores how founders can handle the emotional and professional fallout from failure and bounce back from the experience. It outlines a three-phase framework for recovery: 1) Recovery from the emotional battering that the shutdown inflicts, 2) Reflection on what happened and what lessons can be learned, and 3) Reentry into the professional world, whether as an entrepreneur or with a different career path.
Key concept: Recovery, Reflection, Reentry: After a startup fails, its founder typically cycles through three phases. First, they must recover from the emotional battering that the shutdown inflicts. Next, through introspection, they can gain a deeper understanding of what went wrong, what role they played in their venture’s demise, and what they might have done differently. In the final phase, founders leverage these insights to decide whether to pursue another startup or choose a different career track.
Essential Questions
1. How does the author define ‘startup failure’ and why does he focus on early investors’ returns?
Eisenmann defines entrepreneurial failure as a situation where the venture does not return more money to its early investors than they put in. He argues that focusing on early investors’ returns is critical because they typically receive less than later-stage investors when a venture fails. This definition allows him to analyze ventures that might be considered ‘successful’ by other measures, such as positive social impact or valuable learning experiences for the founder, but ultimately did not deliver financial returns.
2. How does the author challenge conventional wisdom about what makes a ‘great entrepreneur’ and how can blindly following this advice lead to failure?
Eisenmann argues that entrepreneurs should not blindly follow conventional wisdom that emphasizes action, persistence, passion, growth, focus, and scrappiness. While these principles are generally sound, applying them without considering the specific context of a venture can increase the risk of failure. He emphasizes the importance of deliberate planning, thorough customer research, understanding the needs of both early adopters and mainstream customers, and building a strong team with the right skills and experience.
3. What are the six distinct failure patterns that the author identifies and how can understanding these patterns help entrepreneurs?
The book identifies six distinct failure patterns: Good Idea, Bad Bedfellows, False Starts, False Positives, Speed Trap, Help Wanted, and Cascading Miracles. Each pattern stems from a different combination of challenges related to opportunity and resources. Understanding these patterns helps entrepreneurs to identify potential risks and develop strategies to avoid them.
4. What are some key strategies that entrepreneurs can use to increase their odds of success and avoid the most common pitfalls that lead to failure?
To avoid the common pitfalls that lead to startup failure, entrepreneurs need to be willing to embrace a more ‘scientific’ approach to building a company. This involves conducting thorough customer research, testing assumptions with MVPs, rigorously analyzing data on cohort performance and LTV/CAC ratios, and building a strong team with the right skills and experience. Equally important, entrepreneurs need to be self-aware, willing to learn from their mistakes, and able to adapt their strategies as circumstances change.
5. What is the author’s overall message about the role of failure in entrepreneurship?
The book concludes with a call to action for entrepreneurs to embrace failure as a learning opportunity. Even when a venture fails, its founder can emerge stronger and wiser, equipped with valuable insights and experience that will help him succeed with his next venture or with a different career path.
Key Takeaways
1. Start Narrow and Deep Before Expanding Broadly
Startups often face pressure to expand quickly, but broadening their scope too early can lead to a lack of focus and resource constraints. By initially targeting a single customer segment, startups can hone their solution, build a strong reputation, and attract resources more effectively. This allows them to establish a solid foundation before expanding into adjacent markets.
Practical Application:
A startup developing a new AI-powered medical diagnosis tool could initially focus on a specific type of cancer, refining the algorithm and building a strong track record before expanding to other types of cancer and medical conditions.
2. Conduct Thorough Customer Research Before Building a Product
Skipping early customer research and rushing to build a product often leads to a ‘False Start.’ The book emphasizes the importance of a thorough design process that includes customer interviews, user testing, competitor analysis, and iterative prototyping. By investing in early research, entrepreneurs can validate their assumptions, refine their solution, and avoid costly rework later on.
Practical Application:
When developing a new AI assistant, conduct thorough user research to understand users’ needs and preferences, rather than relying solely on the engineering team’s assumptions about what users want. Use A/B testing to experiment with different features and user interfaces, and iteratively refine the product based on user feedback.
3. Be Wary of Investor Exuberance and the ‘Winner’s Curse’
The book highlights the risks of investor exuberance and the ‘winner’s curse’ in rapidly growing markets. When investors compete for the right to invest in a promising startup, they may drive up the valuation to unsustainable levels. This puts pressure on the startup to grow even faster to justify the high valuation, potentially leading to reckless spending and strategic missteps.
Practical Application:
When evaluating a potential investment in an AI startup, conduct thorough due diligence on the market size and growth rate. Carefully analyze customer acquisition costs and customer lifetime value to ensure that the startup has a viable path to profitability. Avoid overpaying for equity in a ‘hot’ sector where investor sentiment has become irrationally exuberant.
4. Monitor Customer Cohort Performance Carefully as Your Company Scales
The Speed Trap failure pattern illustrates the importance of carefully monitoring customer cohort performance. As a startup scales, it needs to track key metrics such as customer acquisition costs, customer lifetime value, and retention rates. If these metrics start to deteriorate, it may be a sign that the company is losing product-market fit as it expands into new customer segments.
Practical Application:
When faced with declining customer satisfaction or retention in an AI product, don’t just assume that the product is not good enough. Conduct cohort analysis to understand the underlying reasons for customer churn. It might be that the product’s features are not well-suited for the needs of newly acquired customer segments, or that the company is not providing adequate customer support as it scales.
Suggested Deep Dive
Chapter: Chapter 4: False Starts
This chapter provides a detailed overview of the design process, highlighting the importance of thorough customer research and MVP testing. This is particularly relevant for AI product engineers, as AI product development often involves complex technical challenges and requires a deep understanding of user needs and preferences.
Memorable Quotes
Introduction. 6
"If you cannot fail, you cannot learn."
Defining Entrepreneurial Failure. 29
A venture has failed if its early investors did not—or never will—get back more money than they put in.
Catch-22. 45
A founder cannot pursue a novel opportunity in any meaningful way without resources, and she can’t attract resources until she’s actually pursued the opportunity—at least to the point where she can demonstrate to resource owners that the risks are reasonable.
False Starts. 98
A false start occurs when a startup rushes to launch its first product before conducting enough customer research—only to find that the opportunities they’ve identified are rife with problems.
False Positives. 129
In the context of startups, a false positive—early success rates that appear more promising than they actually are—can lead to expansion on a level that is not yet warranted.
Comparative Analysis
Unlike other books that attribute startup failure to individual founders’ flaws or poor product-market fit, “Why Startups Fail” offers a more nuanced and systematic approach. It echoes the concept of ‘Normal Accidents’ by Charles Perrow by illustrating how a convergence of internal and external factors can lead to failure, even in well-managed ventures. Eisenmann’s framework is particularly valuable in highlighting the ‘Bad Bedfellows’ pattern, a recurring theme that often gets overlooked in popular narratives of startup success and failure. While it complements the Lean Startup methodology, it also provides a critical counterpoint to the “Just Do It” and “Move Fast and Break Things” ethos by emphasizing the importance of deliberate planning and thorough customer research. The book stands apart from more anecdotal accounts of startup failure by incorporating data from a large-scale survey, grounding its insights in empirical evidence.
Reflection
Eisenmann’s “Why Startups Fail” provides a sobering yet valuable perspective on the challenges of entrepreneurship. While the book’s focus on investor returns might seem overly pragmatic, it reflects the reality that startups operate in a competitive market where capital is a scarce resource. The book’s strength lies in its systematic approach to analyzing failure, breaking down complex phenomena into understandable patterns. However, it’s important to remember that these patterns are not deterministic. Some ventures that exhibit characteristics of a failing startup might ultimately succeed, while others that seem to be on the right track might still fail. The book’s emphasis on the role of ‘luck’ and unforeseen circumstances is a welcome counterpoint to the often-mythologized narratives of startup success. While Eisenmann’s insights are primarily grounded in the context of consumer-facing startups, many of the principles and patterns he discusses are also relevant to B2B ventures and technology-driven startups in fields such as AI.
Flashcards
How does the author define startup failure?
A venture has failed if its early investors did not - or never will - get back more money than they put in.
What are the six distinct failure patterns identified in the book?
Good Idea, Bad Bedfellows, False Starts, False Positives, Speed Trap, Help Wanted, and Cascading Miracles.
What are some key strategies for avoiding startup failure?
Conduct thorough customer research, test assumptions with MVPs, rigorously analyze cohort performance and LTV/CAC ratios, and build a strong team.
What are the three phases of recovery for a founder after a startup failure?
Recovery, Reflection, Reentry
What is a False Start?
A startup rushes to launch its first product before conducting enough customer research.
What is a False Positive?
Strong early demand from early adopters leads entrepreneurs to incorrectly extrapolate that demand to the mainstream market.
What is a Speed Trap?
Rapid expansion outpaces a startup’s resources and capabilities, leading to an LTV/CAC squeeze.
What is ‘Help Wanted’?
A startup struggles due to resource shortfalls, either because investors shun its sector or it can’t find the right management talent.
What are ‘Cascading Miracles’?
A startup pursues a bold vision with multiple daunting challenges; a shortfall with any one challenge can kill the venture.
Describe the ‘Diamond and Square Framework’?
The venture’s diamond breaks down the startup’s opportunity into its customer value proposition, technology and operations, marketing, and profit formula, while the square outlines its key resource providers: its founders, team members, outside investors, and strategic partners.