Predictable Failures

The economist Scott Shane, in his book “The Illusions of Entrepreneurship,” … says … failed entrepreneurs … violate all kids of established principles of new-business formation.  New-business success is clearly correlated with the size of initial capitalization.  But failed entrepreneurs tend to be wildly undercapitalized.  The data show that organizing as a corporation is best.  But failed entrepreneurs tend to organize as sole proprietorships.  Writing a business plan is a must; failed entrepreneurs rarely take that step. Taking over an existing business is always the best bet; failed entrepreneurs prefer to start from scratch. Ninety percent of the fastest-growing companies in the country sell to other businesses: failed entrepreneurs usually try sell to consumers, and, rather than serving consumers that other business have missed, they chase the same people as their competitors do.  The list goes on: they underemphasize marketing; they don’t understand the importance of financial controls; they try to complete on price.

More here.  But don’t worry, you are the exception; none of these rules apply to your business.

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  • http://www.amirrorclear.net Toby Ord

    Of course there is something of a selection bias here: the failed entrepreneurs are the ones who got things wrong…

  • Timothy Brownawell

    How much is causation vs correlation, and how much are these factors correlated with eachother?

    Suppose the real causative factors are prior business experience and amount of funding:

    Funding comes from either personal wealth, or investors. Investors will want to see a business plan. So having a business plan increases your chance of having enough money, which increases your chance of success. Having a business plan is not a separate factor from having enough money.

    If you have investors, you’ll want to be a corporation instead of a sole proprietorship. If you have lots of personal wealth, you’re probably already familiar with corporate structures and more comfortable with them than with a sole proprietorship. So having enough money increases your chance of being a corporation, as well as your chance of success. Being a corporation is not causative.

    • brazil84

      I think this is a good point. For example, if Joe Sixpack opens a cordless tomato store as a sole proprieter, I doubt it will improve his chances of success much if he incorporates. Or if he prepares a business plan. Or if he tries to sell cordless tomatoes to corporate America.

  • http://eucalculia.blogspot.com John Faben

    Like Toby, I can’t really see how this is interesting. “Successful businesses tend to have property P; failed businesses tend not to have property P”… is there any way this could not be true?

    • Jess Riedel

      The point is that if there was a strong (presumably) causal connection between P and success, then almost all start ups should adopt P. But they don’t.

      If you are analyzing your personal start-up, all of its properties under your control should be configured to maximize success. You shouldn’t ever be able to flip a switch (from ~P to P) and have your probability of success increase.

      The fact that a majority of start-up are ~P means these entrepreneurs are making predictable/avoidable mistakes. By his last sentence, Robin Hanson is suggesting that entrepreneurs make this mistake because they are foolishly overconfident that they are on the far side of the curve, much like how the majority of drivers think they are better than the median driver.

      • Shae

        “The point is that if there was a strong (presumably) causal connection between P and success, then almost all start ups should adopt P. But they don’t. ”

        But adopting P and adopting not P aren’t equal choices where you can grab one as easily as the other.

        I fail to believe that a given entrepreneur doesn’t realize that more capital would help. They have chosen not to pursue more capital (or a corporation, etc) for other reasons (including not having the personal charm, communication skills, risk tolerance or resources to acquire these things).

        On the other hand, anyone can open a shoestring business, an Ebay shop, an Etsy shop, a lemonade stand, or what have you, without those resources, and why not? If they fail you’re not in any worse shape than you were before you began.

      • http://eucalculia.blogspot.com John Faben

        The point is that if there was a strong (presumably) causal connection between P and success, then almost all start ups should adopt P. But they don’t.

        If that’s what the post said, it would make sense, but it’s not. It says “P is correlated with success, but failed businesses tend not to have property P”. I still don’t see how this could fail to be true.

  • bjk

    Predictably, the first comments are about methodology, not substance . . . Why do so many failed businesses tend to cluster in undercapitalized retail businesses? Because that’s what people know – not a big surprise, but obviously a surprise to the failed businesses people. This must mean that there are alot of missed opportunities in business services that are underexploited. In my limited experience, this is true, but the opportunities are not as evident.

    • Timothy Brownawell

      Predictably, the first comments are about methodology, not substance . . .

      Lousy methodology can mean there is no substance, are you familiar with the phrase “lies, damn lies, and statistics”?

      Why do so many failed businesses tend to cluster in undercapitalized retail businesses? Because that’s what people know – not a big surprise, but obviously a surprise to the failed businesses people. This must mean that there are alot of missed opportunities in business services that are underexploited.
      What are the success rates in retail vs. business services, and how does this vary with different prior experience? Given that failed businesses are “usually” in retail, does this just mean that new businesses overall are “usually” in retail? The fasted-growing business are selling to other businesses… does this mean that there’s overall market growth and room for newcomers,,or is the market consolidating from many competitors to just a few oligarchs?

  • Andrew

    The importance and value of many of these elements are significantly dependent on the nature of the business when first starting out. Experienced entrepreneurs usually ignore those aspects that don’t apply to their current venture even though everyone “knows” that it those aspects are essential to success. There is not a generic formula for entrepreneurial success, and for some markets the reasons for rules of thumb don’t manifest in a traditional way. Eventually these things converge, but that is a year or two down the road.

    A failure mode I see at least as often as not doing something essential is prioritizing these activities based on experience with a venture that is structurally different. It is not that they do not know the elements of success but that they misprioritize those elements early on when the prioritization needs to closely match the nature of the current venture. This is why, among other reasons, serial entrepreneurs that stick to the same type of venture can frequently produce a string of successes rather than the hit and miss pattern that is more common when they diversify.

  • Eric Falkenstein

    Most academics write articles that are not much read, and even currently popular articles turn out, with hindsight, to be irrelevant (eg,input-output matrix models, large-scale macro models). So, why bother? Anything creative has a low success rate, and this applies to people using their special ‘alpha’ to generate above average investment returns (where, results are objectively negative in expected return, with higher risk!).

    I think these forays might be rational (I haven’t formally modeled this) as part of an ‘optimal stopping problem’. Consider creative efforts as your best metric of any comparative advantage you might have in that field. You try writing poetry, creating websites, applying GMM to 19th century exchange rates, and one of them generates the highest feedback. You then specialize there, mainly doing conventional stuff better than everyone else (eg, Gregg Mankiw wrote a now pretty clearly irrelevant paper on menu costs and business cycles, but now he’s rich and successful because he wrote a nice textbook for undergrads). So, trying something with low objective odds is not stupid if it is merely a costly datapoint for you to guide your vocational (or avocational) focus.

  • http://ahappinessexperiment.wordpress.com/ Bock

    I’ve often wished one could short sell private businesses.

    What if prediction markets existed where speculators could bet on the success of private businesses? Wouldn’t this give entrepreneurs valuable feedback on whether they are making good decisions?

  • Ryan Vann

    Bock, I’d imagine dimishing revenues would transmit that feedback much better than any prediction market might. It could serve as a good caution against a start up, but I don’t see much additional value after the decision to start up is made.

  • Stockle

    Maybe you should stop reading Gladwell.

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