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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