Why Most Businesses Fail (A Theoretical Model)
"We should start our own business," she said, not knowing what it really entailed. Thoughts of expenses and distant profits danced in my head.
Most people don't know what it really takes to start a business. Income flatlines for who knows how long, while your debts increase and you're struggling to find ways to bring in more money. My mantra is "Reduce your expenses while increasing your income" but even cutting your expenses 10% or 20% does little to stave off the slow march towards failure.
I've created an extraordinarily simplistic business in Excel. Expenses are $1,000 per month, and income starts at $100. Income creeps slowly upward at the rate of 4% per month, with some variability thrown in just to avoid the pure hockey stick graph that looks so unrealistic. Then I subtracted the income from the expenses to find the total deficit and plotted everything on a graph. It looks something like this.
You'll notice that it takes 8 years for this imaginary business to become profitable. It takes 67 months just to cover monthly expenses (the point at which the red line starts going up instead of down), and by then you're $30,000 in debt.
As much as this graph is completely unrealistic, that vast chasm between the green line and the dotted red line should trouble anyone considering going into business for themselves. It's during this phase where expenses keep mounting and profits can't catch up with them that most businesses dissolve.
As a business owner, there are three possible ways to get past this hump.
- Reduce your expenses
- Increase your income
- Call it quits
Reducing Your Expenses: Don't Quit Your Day Job
So the first obvious thing to do is move the doted red line. I cut expenses to $800 per month, and here's what happened.
A 20% reduction in expenses, and... very little changed. You probably just scrolled up to see if there actually was a difference. It takes 6 years (rather than 8) to hit profitability, and you're only $20,000 in debt. By the end of year 7, you've earned a whopping $10,000 - definitely enough to retire on (sarcasm).
The obvious alternative is to start your business while still working a day job. Unless you're starting a bricks & mortar business and actually have to be there 12+ hours a day, you can do it on the side. (Note to self: Don't start a charming neighborhood coffee shop.) The internet is great for "on the side businesses" just as long as your hosting & advertising costs aren't too great.
But you still have to contend with the countless months of no profitability, or not enough profit to justify the effort. Thousands of eBay listings and hundreds of Google ads later and you're still not making any money... it's very discouraging. That's the problem with internet businesses. It's an efficient market and any product you provide someone else can provide just as cheap or cheaper, so it's a battle to the lowest acceptable profit margins until the effort per unit cost just isn't worth it. A trip to the post office for $2 profit on a beanie baby, or whatever is "in" this year, or $4.75 in advertising dollars and countless hours tweaking your website & ads to make a $4.76 sale is just plain frustrating.
It would be cheaper to bang your head against the wall, and probably less of a headache!
Increasing Your Income: Don't Quit Your Day Job
Whenever you discuss starting your own business, you always have the guy who says "If I don't quit my day job, I won't have the courage to do what it really takes." Let me dismiss this myth right now with a really bad metaphor.
Business is like a hallway with an infinite series of doors, or maybe that game Chutes and Ladders. You spend your time trying each and every door until one opens up and you hit a new level of profitability. Unfortunately, the new level looks just like the last one and you're stuck trying an infinite series of doors again. The more experience you get, the more keys you obtain, but five keys against an infinite series of doors isn't much help, and you end up trying the same doors over and over again. "Door 5,233 worked with key 4 last time, maybe it will work again this time." Doing that may increase your chances at success, but most likely, since you've already tried that door once, it won't work this time. Not that this fact will prevent you from trying it again and again and again like a squirrel with OCD waiting for the peanut vendor who's gone home for the winter.
In season 2 or 3 of The Apprentice, one of the contestants named Tana wasted a lot of time trying to repeat a past success. She'd started her own business during the Winter Olympics in Salt Lake City. She bought a bunch of ordinary Olympics T-Shirts wholesale, and spent her time bedazzling them. She was able to sell them at a premium because her shirts were better than the competition's.
When given a new task: Sell t-shirts designed by prominent NYC artists, she was convinced that the key to profitability was to bedazzle the artist's designs. She wasted hours trying to find a bedazzler and completely ignored marketing. After all, who doesn't like rhinestones? The other team simply emailed a list of their artists' fans and sold their shirts for 5 or 6 times what Tana's team was able to fetch from strangers off the street.
This might seem like an incredibly stupid move, but it's probably very typical behavior. We do what we think will work, and what we think will work is what worked last time.
People who quit their day job to start a business think that they'll be able to try dozens more doors each day, but mostly they sit around in their underwear watching soap operas and daytime talk shows and get just as little work done as they would have otherwise.
And even if you're convinced that you're not like them, that you'll be super motivated, that you'll actually enjoy banging your head against the wall and that by quitting your job you'll have infinite time, there's the constraint of money. It takes money to try different ideas, and when you're not working, that's usually in very limited supply.
Besides, your time isn't the only factor. For each idea you try you're often waiting on other people and twiddling your thumbs, and you might as well be at work getting paid to twiddle.
If you daydream about quitting your day job to work on your business that's just an indication that you don't want to work on your business. Otherwise, you'd spend all your spare time, and some non-spare time working on your business. You'd spend evenings, weekends, and more of your work hours than you should actually working on your business. If you're not doing that now, quitting won't change a thing.
Of course, you don't know if you'll ever be profitable, and even if you're convinced it will, you don't know when. Starting your own business is risky, and consists of hours, weeks, months of tedium and worry with a few moments of exhilaration in between when things seem to be working, but then things stop working and you get twice as frustrated because you thought you knew what would work and now you doubt yourself even more.
And then you have to deal with the fact that all the money going in to your unprofitable business isn't going in to savings. You're, essentially, gambling with your future. That $95,000 in debt you hit in month 97 could be $95,000 in savings if you've been financing your business out of your salary. If your business fails (and odds are it will - that's just a statistical fact), that's $95,000 down the drain.
The Honeymooners - a show about two working class families - featured a lot of get rich quick business schemes. Everything from opening up a hot dog stand near a new highway (a national chain restaurant opened up just down the road), to selling wacky gadgets on TV. They always spent their life savings on the business, and it never worked out. Learn a lesson from Ralph Kramden and don't blow your life savings on a hair brained scheme.
Business are about making money, but for an extended period of time, almost all businesses lose money.
Quitting: But Not Your Day Job
This is where most businesses end up. Unable to cross the profitability chasm, the business owner just gives up. Either because they're hemorrhaging money and need to eat, or the time spent to money earned ratio is much better at their day job. Suddenly a retirement fund looks more attractive than yet another business scheme.
If you've ever read the book e-Myth (I never have), you'll know that there's a difference between working on your business (improving your processes) and working in your business (doing the processing), and that automation is the key to success. I sort of agree with this. I got an email the other day commenting on the fact that I haven't updated this site in months. The truth is, I've been busy, and while I've been writing articles, none of them pass out of draft mode, and I've been just a little less than inspired to finish them.
But I discovered years ago that the great thing about having a website is that no matter how slowly you add items, all the old stuff is still there. No matter how slowly you build it, as long as it's getting built it's okay. I make a modest amount of money from Google ads and pimping books on Amazon, but that amount hasn't decreased much over the months. Nothing approaching something worth quitting my day job over, but enough to cover hosting costs.
I guess part of my "success" has been that I've become a bit of an expert in a few niche areas (home recording, acoustics, GTD) and I lend a unique perspective. I'm not trying what everyone else is doing (if I run across one more "Blog about the best Google/YouTube videos" I'm going to puke), I'm adding real value. Since this stuff is niche, when people Google for or want to link to articles about these subjects, often enough it's my site that pops up.
In other words I'm doing what I love, and letting the money follow. The money is pitiful, but who cares, I'm doing what I love, and the cost of maintaining this site is almost zero.
Whenever I tried some other venture, I ran into the "expenses occur every month, but profits don't quite cover them and I don't know when they will" problem I talked about so extensively before.
Just to balance out the conversation, automation isn't everything. Plenty of businesses are built on customization and making things by hand. Striking the right balance between hand made and sellable, and niche enough that nobody else will mass produce it has formed the basis of many businesses. A neighborhood restaurant can outsell a national chain by offering up better quality food, and they can charge a premium for it.
Some Tips for Would-Be Headbangers
Here's the most difficult part of the article. Trying to give you something meaningful to take away from having spent the past few minutes of your life reading this article instead of working on your business (admit it, you look forward to the distraction). Unlike Oprah, I don't have a gift basket full of goodies, so you'll have to settle for some tips. These are extra cheerful, but don't let them fool you, starting your own business is hard, hard work.
- Join a community of like-minded people, preferably with a good mix of aspiring business owners and people who are successful in your field. If you're working on your own, or even if you're working with a partner, you end up thinking in circles. Writing out your ideas forces them out of your head and into a linear format where you'll see the incongruities, and seeing how other people tackle the same problems as you is inspiring. Sure nobody will give away their secret success formula (I hear it's just salad dressing anyway), but they will pat you on the back, and give you a few words of encouragement. Don't restrict yourself to virtual communities. One should never underestimate the benefits of human contact, and if your business is bricks & mortar, it never hurts to know a lot of potential customers. PS - your community is also a good potential customer base. It's much easier to figure out what people want when you're surrounded by and one of those people.
- Do what you love. Yeah, I know, this is about as cliched and pithy as it can get, but you have to remember that any business idea you come up with has been thought of by at least a thousand more people than you think, each of them just as smart as you are. If you don't love it, you'll simply give up. Loving what you do also means that you're less likely to engage in stereotypical thinking, leading to more creative solutions, and whatever path you head down, it's more likely that there will be people hungry for information about the road ahead, so your advance reports will become valuable, and you can then sell your services back to the community you've been reporting to. There's also mounting evidence that there's tremendous advantage to being first. Copycats will make money, but on an order of magnitude less than the original. Don't be a copycat.
- Become an expert in your field (if you're not already). You don't have to know everything, but you do have to have enough of an overview to know where everything fits so that when you come across something new, you know what to do with it, and in a few months time you'll come up with a new use for it. People will also put their trust in someone who sounds authoritative and can provide real insight much more readily than someone who just sounds like an arrogant blowhard. A little humility here also goes a long way towards people believing you're sincere. Own up to your own mistakes, heck broadcast your mistakes and write an article about why nobody should follow in your footsteps.
- Start a blog. I've already told you to get everything written down, do what you love and to become an expert. Writing a blog is a natural next step. It will also help establish you as an authority in whatever field it is you're pursuing.
- Don't allow yourself to get desperate. Studies about how people make decisions when under pressure show that you lose flexibility when there's a deadline looming. You try the first thing that comes to mind, and unless you're an expert, it's frequently the wrong thing (and even when you're an expert it's frequently the wrong thing). (Klein, 1998) So quitting your job is just an incredibly stupid idea because that deadline (being broke) will affect your thinking for the worse, no matter how far into the future it is. Even the stubborn belief that if this business works you can quit your job will affect your thinking.
- Learn how to handle your finances in your private and business life. Remarkably, unlike a starting business where cutting your expenses 20% just changes how long it will take to fail, when you're profitable (i.e. you have a day job), cutting your expenses 20% has a significant impact on your ability to save, and the more you have saved, the more flexibility & freedom you have to pursue avenues you will enjoy. Dominguez & Robin wrote a book called Your Money or Your Life, which completely changed my attitude towards money. Reducing expenses and building a savings is just as important as increasing your income. A penny saved is two pennies earned - one in the bank, and one less penny from your monthly expenses you'll have to cover when you retire. We'll all be living off of our nest egg eventually, and hopefully our nest egg will be big enough to support our lifestyle. Your goal should be to increase your nest egg, and reduce the expenses of your lifestyle. It sounds simplistic, but this book to really showed me how and why it was possible.
- Test yourself against reality. Robert J. Ringer, in his excellent book Winning Through Intimidation ("through" being a double entendre meaning both "using" and "in spite of"), summarizes most self help business books as "Work really hard and hope for the best." You absolutely must know the impact of your actions, and if at all possible, before you take them. This can take many forms from tracking the success rates of various advertising methods to starting a user forum to get feedback about what people really want. You have to keep your eyes open, watch the competition, and do whatever you can to increase your actual odds of success.
- Try a lot of different things. Flexibility, doing what you love, testing yourself against reality. Diversification is sometimes what saves your butt in the end. Business lore is rife with tales of people who started doing X, but ended up being successful because of Y. 30% of the money this blog makes comes from the articles I wrote about music & recording, but I'd never know that if I hadn't written those articles. If you're too narrowly focused for too long, you'll miss potential money making avenues. Robert G. Allen, the "No money down" guru (or charlatan, take your pick), wrote a book called Multiple Streams of Income. In it, he says that having just one source of income is a mistake. If it dries up, you're screwed. Not all your sources will be as profitable as others, but by having them you're not just hedging your bets, you're increasing the odds that you'll strike gold.
- Take Action. Being able to diversify presupposes that you're actually on the move already. You can't cover a lot of bases if you haven't been at bat yet. Start small, set your goals and do something. (Yeah, another pithy one, I know, but it seemed like a natural fit here.)
- Raise the barrier to entry. Another good reason so many businesses die is that they fail to differentiate. People continue to engage in stereotypical thinking and just do the easiest, most obvious thing. Since they came up with it on their own (and they may even love it), they think they're the only ones doing it. But if you can create something that fewer people can or will copy, then you can charge just a little more for it. This isn't just about differentiating yourself from the competition, it's about creating something that they can't copy. The escalation path is usually pretty clear - it's the thing that few people are doing and that you resist doing. (This when bedazzling your Olympics t-shirts can net you more money.)
- Don't spend it unless you're sure you can recoup it. This is a real rookie mistake. "If I can get 100 widgets for $1 each, 1,000 for $0.90 is even better!" You need to be sure you can recoup your expenses before you spend the money. Frequently, this means doing things by hand instead of spending the money on the cool automation tool, or using an existing tool instead of buying the shiny new thing. Economies of scale are for companies that operate on that scale. Take less of a profit margin per-sale now to ensure you aren't stuck with an inventory that won't move and a mounting debt.
- Never stop learning. If you haven't figured it out, I read (or at least used to), a lot of books. Learning from other people's mistakes, gain a different perspective. The more you know, the more flexible you'll be, the better the decisions you'll make, the firmer your grasp of reality, the more you increase the odds in your favor.
It's common lore that 9 out of 10 new businesses fail each year. I suspect the number is much higher than that since most new businesses never reach the point where people claim them on their taxes or open up business bank accounts. The odds are probably closer to a thousand to one. There's good reason for this - starting a new business is much harder, more time consuming and expensive than most people think. We pin our hopes and dreams on our ability to beat the odds, and we mistakenly believe that starting our own business will be easier or more enjoyable than working for someone else. For 999 out of 1,000 people, this simply isn't true.
I certainly haven't been shopping for any new shoes
And I certainly haven't been spreading myself around
I still only travel by foot and by foot it's a slow climb
But I'm good at being uncomfortable so I can't stop changing all the time
I noticed that my opponent is always on the go
And won't go slow so as not to focus and I notice
He'll hitch a ride with any guide as long as they go fast from whence he came
But he's no good at being uncomfortable so he can't stop staying exactly the same
If there was a better way to go then it would find me
I can't help it the road just rolls out behind me
Be kind to me or treat me mean
I make the most of it I'm an extraordinary machine
- Fiona Apple, Extraordinary Machine.
Alternate versions of the above graph.
It's worth noting that due to the variability of the change in revenue from month to month (from -20% to +30%), I was able to randomly generate a lot of different graphs. Some of my fake businesses were successful faster than others (higher average increase in income). On a long enough scale, all my sample businesses look like the last chart in this section - in my model the increase in revenue is guaranteed over the long haul while expenses stay stagnant. It's not entirely realistic, but it's worth nothing that I could cut the graph off anywhere to make it look like a runway success, or a dismal failure.
- The Cost of Bootstrapping Your App: The Figures Behind DropSend (part one)
About how starting a dotcom (Dropsend) cost the owner $45,000. Note the recurring £900 ($1564)hosting bill.
- Here's What It Really Takes To Start Your Own Wine Store, Bakery, Restaurant...
- Bitter Brew: My Coffehouse Nightmare
- Start with Nothing Brilliant article about "Greg Gianforte, founder of $30-million RightNow Technologies Inc., (who) learned that bootstrapping is not simply about pinching pennies and cutting costs. Smart bootstrapping is about turning your lack of resources into a competitive advantage."
Who's linking to this article
- Businesspundit "Cash managment is not a problem for startups. It's a problem in expansion of a successful business."
- The Business of Software "I'm not sure exactly how to express my dislike of such negativities in a short post here, but it is so far removed from my experiences and those I read on this forum."
- Global Market Development (The Carnival of Entrepreneurship 6) "Since we're looking at the dark side - Mark T. A. W. of MarkTAW.com proves why not quitting your day job helps you to succeed when starting your own business..."
- Crazy on Tap "he is somehow attacking the religious text of a certain type of entrepreneur."
- Hacker News "His article is pretty dark and I can not fully share the theoretical models."
page first created on Saturday, March 04, 2006, graphs revised with feedback from bon vivant on June 8, 2009
© Mark Wieczorek