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Why Companies Fail

Judgment calls, reality tests and mistakes of the heart that doom companies to failure.
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We're not talking cash flow here. Or a bad hire. Or inexperience. We're talking about judgment calls, reality tests, and mistakes of the heart

Nobody who has the courage and drive to launch a new business expects to see it crash and burn. Most entrepreneurs believe that if they follow their instincts and at the same time use their heads in such areas as marketing, finance, and hiring, they'll at least make a go of it. And maybe, just maybe, they'll create a winner.

Ironically, though, if you go back and do autopsies on companies that failed, technical or tactical errors rarely show up as the principal causes of trouble. The companies' products were almost always well constructed. The employees were hardworking and professional. The founders themselves usually had more than a rudimentary knowledge of the market.

What kills companies usually has less to do with insufficient money, talent, or information than with something more basic: a shortage of good judgment and understanding at the very top. Once entrepreneurs have made the decision to go into business, too many fail to routinely step back and ask -- or let others ask -- if what they're doing adds up. Indeed, they're swayed by their sentiments to act in ways that, unwittingly, put their businesses at risk. They rely on too much heart and not enough head.

Regrettably, there's no electronic device you can buy that beeps when you approach a death trap. You've got to keep monitoring your position. But knowing the shape of the traps and where they're located may keep you from getting too close.

* * *

Is this a great product, or what?
Forget about how much you love your product or service and how clever or state-of-the-art it is. When all is said and done, the most important test is whether it meets a market need. Most entrepreneurs are brash enough to think that if they like the product, so will others. But if prospective customers are more or less content with the competition, and you don't give them a compelling reason to change, you've violated a basic rule of the market. Unless you have piles of money to spend on advertising and marketing, you're going to have problems. As Jon Bayless, a partner with the venture-capital firm Sevin Rosen Funds, in Dallas, puts it, "There's a big difference between being on the leading edge and being on the bleeding edge."

* * *

With a market this big, we need only a tiny share to make millions.
To the optimist, it may look as simple as rolling off a log: for example, say the tent market is $100 million and you decide to go into it with the idea of making and selling high-end quality tents to backpackers. Presto, within a couple of years you've got a $5-million business. But a lot of entrepreneurs don't take the time to understand how a particular industry is organized, notes Fred Beste, with NEPA Venture Fund, in Bethlehem, Pa. For one thing, tent buyers aren't only the people who go backpacking. Let's speculate that at least half the market is in circus, military, and special-event tents and another 20% is in low-priced models for the backyard. "If you do the math," says Beste, "you may find that your part of the market is only about one-fourth of what you thought."

* * *

What a business! It's easy -- and cheap -- to start right away.
The start-up costs are low and the market is exploding. At the very least, you think you'll be able to match what you're earning in your current job. So what's wrong with this picture? A lot. Unless you can manage to find some point of distinction to help you rise above the flock of competitors (such as better distribution, faster turnaround time, friendlier service), you'll be clobbered. Every few months hungry new competitors will hop over the barriers to entry and try to steal your customers. Whether you like it or not, you'll find yourself doing all their market research.

* * *

These projections are conservative.
No, really.
If you don't believe in what you're trying to do -- and that you'll succeed at it -- quit right now. But even if you're convinced you'll make it, it's suicide to have only one plan. As a discipline, you need to consider what happens if your assumptions are (for whatever reason) cockeyed. The best way to begin is to ask yourself hard questions: What if instead of taking 6 months to develop your product it takes 12? What if the average customer buys only half as much as you expect? Or only a fourth? Will you have enough cash to keep going? Where will it come from? Bill Zangwill, professor at the University of Chicago's School of Business and author of Lightning Strategies for Innovation (Lexington Books, 1993), talks about the "rule of two and three": that start-ups either take twice as long or need three times as much money to get off the ground as founders predict. The same can be said about some new products. With alarming consistency, the record shows that early projections (even the "conservative" ones) are almost never met.

* * *

With my brains and your contacts, who can stop us?
It happens all the time. Two well-intentioned colleagues -- often friends -- go into business together and split the ownership smack down the middle, 50-50. Each has a separate area of expertise, but as "equals" they vow to make all the big decisions jointly. Unfortunately, those deals have a history of falling apart (often in a painful and costly manner). Sooner or later, one partner begins thinking his or her marketing savvy is worth more than the other's talent for finance or production. Given the dynamics, you can't glue the relationship back together, and all too often there's no mechanism for handling differences. If you're intent on going this route, at least have the foresight to work out a buy-sell agreement to cover what would happen in a stalemate. If you can't agree on the terms of a buyout when you're still friends, how will you be able to agree when you're at each other's throats?

* * *

With this much capital, we'll figure things out.
If you're trying to build a business, you certainly don't want to have to worry all the time about where the next dollar is coming from. Explaining to landlords, the phone company, your suppliers, and other creditors why you can't pay them this month is no fun -- and saps energy from other pursuits. But whether you realize it or not, too much money can be a different kind of curse. Unless you guard against its effects, it will tempt you to approach problems in ways that don't necessarily provide value to your customer. You'll hire people you don't need. You'll lose touch with what the market wants. Bit by bit, you'll weave inefficiencies into your business that will be difficult to get rid of.

* * *

I was sick to death of bureaucracy.
That's why I started this company.
Flat organizations are swell. Evidence abounds that too much structure and needless hierarchy can harm market-driven organizations and turn self-starters into dispirited clock punchers. But to pretend that companies can go on forever without setting up channels for making decisions and resolving problems is, in a word, nave. Once you have more than a handful of employees, people will begin looking for direction. So will customers. If the buck keeps floating around with nowhere to stop, the business will suffer.

* * *

We're so small, everybody knows what I think.
This may sound corny, but in small companies "vision" counts for a lot. It can be the ingredient that differentiates two seemingly similar companies -- and enables one of them to thrive while the other one sputters. If you don't want people to work at cross-purposes, you need to go out of your way to make sure they all understand what the goals are and how you aim to achieve them. Just as top-notch salespeople have to be able to pitch their products clearly and succinctly, CEOs should be able to spell out their objectives to their employees. Some people, like John Freyhof of the Enterprise Corp. of Pittsburgh, recommend developing a crisp three-sentence version that sums things up for employees, suppliers, even bankers. "If you can't be clear about what you're trying to do," Freyhof says, "it undermines people's confidence that you really know."

* * *

Me, sell equity? No sir, I don't want to give away control.
We've heard plenty of company owners sounding off about how crazy it is to sell equity to "vulture capitalists" when they can fund their young businesses "just as well" with debt and keep 100% ownership. The assumption is that the company will grow and that paying off the loans out of cash flow will be a breeze. But in their calculations, they usually gloss over the fact that -- especially in the wake of the problems that banks have experienced in the past few years -- debt and equity are two very different things. "The bank isn't your partner, it's your lender," says Steven Roth, chairman of CR Management Associates, a Lexington, Mass., turnaround firm. When a bank gives you money -- as opposed to when an investor does -- you promise to pay it back. If you can't, you may lose your house, your car, and almost everything you own. Late one night, you realize you might have fared better with an equity partner (which, in your weakened state, may no longer be an option).

* * *

Afraid of me? People tell me what they think all day long.
Every week hundreds of people start businesses to free themselves from the restrictions of the corporate environment. But in going off on their own, they soon find themselves in their own bubble -- too isolated for their own good. Open-door policies notwithstanding, it's easy to send signals to employees that you really don't want to hear opposing views. The result is that CEOs frequently have no one they can talk to. If you feel you don't have people inside who can help you focus on the gritty problems of building a business (and face it, there are some issues that you may not want to discuss with your employees or managers), then it's critical that you find some trusted advisers somewhere else. If you're like other entrepreneurs we know, your first impulse may be to turn to your accountant or lawyer. But many CEOs find that the most valuable input they get comes not from those kinds of professionals but from other CEOs who have grappled with the same messy issues somewhere else.

* * *

It's a big family. There's my brother, my two cousins. Oh, and I almost forgot Aunt Ida.
Don't get us wrong. Family businesses have many virtues. But unless you're prepared to run a family business like a business, you're asking for trouble. (Turnaround expert Dave Ferrari of Argus Management Corp., in Natick, Mass., even has a name for it, derived from restructuring dozens of family-owned companies: "Too many people named Jones.") The most successful family businesses are those that hold members of the family to the same performance standards they'd hold any employee to. They accept that some people are well suited for the business -- and others aren't. If you're not specific about the expectations and responsibilities of family members and you can't stomach making the painful choices, be prepared. In almost every language, there's an expression for what can happen: "From shirt-sleeves back to shirt-sleeves in three generations."

* * *

Fortunately, our biggest customer is Sears (or GM, or DEC).
Until recently, having a big account with a major corporation was an enviable position. You didn't need to chase around for the nickels and dimes -- the dollars flowed in. But as the people who supplied desk lamps to the Sears catalog can verify, losing a big piece of business on short notice can hurt. (Nearly as painful -- and sometimes as life-threatening -- is when your customer squeezes your margins.) Realistically, you may not be able to diversify your customer base overnight, given your current products or capabilities. But if you haven't thought about what you'll do if you lose your biggest piece of business next week, now's the time.

* * *

If we boost revenues, most will fall to the bottom line.
You're making money at $1 million. So why not crank up revenues to $3 million or more? If your systems can handle the extra load and if you're able to maintain your profit margins, then the benefits can be huge. But for many companies, those turn out to be very big ifs. Imagining how a business will work from a spreadsheet and then seeing what happens when all the pieces come (or don't come) together can be a rude awakening, says venture capitalist Alan Patricof, chairman of Patricof & Co. Ventures Inc., in New York City. "Even if you think you've done all the steps before, you don't really know how everything will work in combination." Many companies find that the bigger they get, the harder it is to keep their margins where they want them. The minute they think they're losing a sale, they panic and cut the price. Unless you're careful, you'll yearn for the days when you had a nice $1-million business.

* * *

I say, If it ain't broke, don't fix it.
Entrepreneurs don't often lose sleep worrying about their successful products. But if the successes are to continue, they probably should. If the market is attractive enough, you can bet that competitors are eyeballing ways to get a piece of it -- and almost always at your expense. Rather than hang on for dear life, one way to keep competitors guessing is to embrace entrepreneurial cannibalism: spin out new models and new levels of service on a regular basis -- even if it means eating into your existing market. In today's world, many experts argue that it doesn't much matter if you've got a high-tech product or a low-tech ser-vice. "You need to be willing to eat your own young," people everywhere seem to be saying, "because if you don't do it, someone else will."

* * *

Hey, did you see us last week on CNN?
Strange things happen to some people when they're discovered by the media. They begin to forget the important things that helped earn them the recognition, and they get swept up in the curtain calls and the video replays. The mind plays other tricks: What was once admitted to be "luck" gets miraculously transformed into "foresight." We're not suggesting that you labor away in obscurity and tell the reporters and camera crews to stay away. A certain amount of public acknowledgment is great for morale and maybe for business as well. Remember, though, that ultimately you'll be judged not on yesterday's film clips but on how well you meet your customers' expectations tomorrow.

* * *

Actually, our important numbers have never looked better.
The power of the mind to rationalize unwelcome news is truly amazing. We've seen extraordinarily successful entrepreneurs who, for unexplained reasons, dismiss leading indicators of potential trouble. The data say that overhead costs are climbing fast or that the number of repeat buyers is slipping. "Oh, that's just a temporary thing," the optimist argues. And it may be. But if the numbers aren't lying, the longer you put off admitting there's a problem, the harder the fall can be.

* * *

We've reached a point where the business practically runs itself.
You've got an established business that's raking in money, has no debt, and has no minority shareholders. You can come and go as you please, and you're fortunate enough to have managers and employees who know the market and the customers at least as well as you do. With luck, it could continue like that for years. But what if your key managers were to pull the rug out from under you by quitting to launch a competitive business? We've seen it happen. You may or may not be able to fight off such a challenge. One question you might ask yourself as you assess the strength of your business is where the Achilles' heels are. Be honest. It's a lot easier to take preventive actions now (even if it means revamping your reward systems) than it is to watch the company you've built evaporate before your very eyes.

* * *

Did I mention I'm thinking about buying a minor-league baseball team?
People leave jobs all the time, but it doesn't occur to a lot of entrepreneurs that there's a time for them to move on. Understandably, too, because their companies are so closely intertwined with their identity. However, for the sake of the business -- and for your own sanity -- it's often better to hire a CEO (or perhaps even to sell out) than to stick around too long. Different people reach this point at different times in the life of the business -- and in their own lives. Some find they can't -- or don't want to -- develop the new skills needed to manage the business as it gets bigger or as the market changes. They become lethargic and depressed. Others get bored and sometimes go off in crazy new directions. Either way, you need to be able to identify the symptoms and decide what to do about them before you start poisoning the company.


Tom Carns, whose $5-million company, PDQ Printing (featured in "Quick Study," April 1992, [Article link]), in Las Vegas, has been reorganizing under Chapter 11.

"I was the president of my national trade association. In December 1991 my picture was on the cover of the industry magazine. People from around the United States would pay $3,500 to spend a few days with me in the print shop. I was doing one-day seminars -- I'd leave Las Vegas at 7 a.m. on a Thursday morning to do my seminar, and I wouldn't be back in the office until Monday morning, when I'd often have consulting clients waiting for me. I was so blooming busy that I lost control -- one of my managers embezzled several thousand dollars.

"The business just wasn't that exciting anymore. So I looked for something that was.

"After we filed for bankruptcy, I spent a lot of time really beating up on myself. I went through a period when I was really down. Was I just a flash in the pan? Was I stupid? Did I have what it took to bring the business back?

"Last January I went up to a ski resort in Utah. I didn't leave my room for five days. I completely dissected the business. Then I put together an overall plan. One of the things I've come to recognize is the limits of delegation: You can delegate tasks, and you can delegate responsibilities. But the one thing you can't delegate is leadership. If I hadn't divorced myself so much from the business, the trouble wouldn't have happened."

Leif Blodee, cofounder of Keener-Blodee, a Holland, Mich., furniture manufacturer (featured in "Hot Seats," June 1988), which went out of business in 1991.

"Before my partner and I started the company, I had a small design firm, where I was designing furniture for other manufacturers. I showed one of them a line of chairs and was told it couldn't be done the way I'd suggested. I said, 'Oh yes, it can.' So I went into business with a guy I'd known for a long time, though we had not been in business together. We raised about $600,000 from investors and banks and began to increase the size of the old facility from 5,000 square feet to 12,500 square feet.

"My partner had a large-company mentality -- he had run a division for a large company. He spent a lot of time applying for licenses to do business in states where we never sold a piece of furniture. We hired reps all over. We had 12 people in a brand-new plant, all busy making samples for the reps. What we needed were orders.

"We expected to reach several million dollars in sales a year, but we never sold more than $200,000 in a year. When it became clear that the bank wouldn't let us keep going, we quit. But I don't quit very easily. The bank sold a lot of the equipment for pennies on the dollar; in fact, I ended up buying some of it. We should never have expanded until we had orders in our pocket. We expanded too fast. It was too easy to get the money."

Ann Machado, founder and CEO of Creative Staffing, a $12-million Miami-based temporary-employment business that was on last year's Inc. 500 list; she shut down a similar business in October 1991 after it persistently lost money.

"We began making money in our original business in the second month of operations, in 1985. People would come to me and say, 'You should franchise this.' I didn't want to do that, but finally, at the end of 1989, I thought it was time to put our system to the test. The way we did it was to start a new company, up in Orlando.

"I had the right person to run it, someone who'd worked with me for years. We'd done extensive market research. Then, just before we were set to open, an industry friend said, 'Don't open.' The market had been flooded -- there were something like 117 temporary agencies in a town that could support maybe half that many. But by then I was too committed. I said, 'I don't participate in recessions.'

"I'd been in Miami 22 years. Orlando was a different market. Sometimes it took us six months to get an appointment, and it would usually lead nowhere. People in Orlando thought nothing of canceling an appointment on the spot.

"We never reached break-even. I'd write a check for $10,000 every month. I changed managers after aa year -- I changed practicall everything. Finally, after losing $150,000, I pulled the plug. But really, I had no business starting it in the first place."




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