When A Harvard Professor Studies Startup Failures

I have no intention of founding a startup. But I do dwell in a city that carries an exalted status inside the global entrepreneurial ecology. Because of this, I have friends and relatives who are associated with startups in various ways: as founders, investors or employees. Just to elevate my own conversations with this nimble and sharp-witted bunch on why some companies seem to reach stratospheric heights while others collapse into the quickly-forgotten, I picked up a book and listened to a podcast that featured the expert. And who better than Tom Eisenmann, a Professor at the Harvard Business School and a Co-Chair at the HBS Rock Center for Entrepreneurship to guide me through this thorny terrain?

In an online interview, Tom narrated his own story and the events that led to his book, Why Startups Fail. The following are some key takeaways:

Tom Eisenmann: Emerging From A Tough Childhood

Tom’s father was a self-employed businessperson of sorts. He fixed television sets and also ran a tropical fish store. Since neither of Tom’s parents was educated beyond high school, their five children were first-generation college-goers. However, the kids often had to hustle to make ends meet. At the age of 10, Tom recalls working as a paperboy and handling other odd jobs, nonstop during summers. Moreover, since his father died when he was 11, Tom and his siblings took to their books with a concerted thrust on overcoming their circumstances. Eventually, three went on to pursue doctorates in various fields. Tom himself admits to seeking prestige – by joining companies like Booze Allen and McKinsey – before garnering a Ph.D. and a professorial position at Harvard.

Why A Book On Startup Failures?

As a Professor at HBS, Tom was keenly aware of the manner in which students with an entrepreneurial bent might leverage their education and networks to found start-ups. He was perhaps obsessed with whether the program was offering the best insights possible. Besides, he was both confounded when a particular start-up – Quincy Apparel – founded by two ex-students that he knew well folded up within a year. This, despite possessing a seemingly good idea, raising a million dollars, and being run by two smart and impassioned cofounders. As Tom says, “I could point to a lot of things that went wrong, but couldn’t pinpoint the root cause.” Naturally, this bothered him as an academic and guide. If he couldn’t explain why certain start-ups failed, how would he impart critical lessons from recent history?

When he then combed through the academic literature, he found that there were only a few books and papers on the topic. This was surprising since most start-ups are known to fail, generating data and story trails that can be hugely instructive to new ventures.

Spotting an opportunity to spark new research, he embarked on a quest to talk to failed founders and to investors who had originally backed them. He also read through hundreds of first-person and third-person accounts of failed entrepreneurship. He stitched all this material into twenty cases, which were added to the HBS case library. And taught a course titled “Entrepreneurial Failure.” Eventually, all these learnings led to Why Startups Fail. 

From Why Startups Fail: Inadequacies of the Minimum Viable Product

Founders are often urged to create a Minimum Viable Product (MVP) and test it with potential customers. While this approach certainly has upsides – after all producing a demonstrable version might give you insights that cannot be gathered by other means – it may also falsely bolster founder confidence since it can mask other complexities. For instance, an MVP will not necessarily determine whether customers will be repeat purchasers (or loyal subscribers) even if they espouse initial enthusiasm for your concept.

More critically, while MVP can be useful in gauging customer interest (or for projecting demand), it’s not as reliable in exposing the intricacies of the production/delivery/operations processes. As Tom puts it, it’s one thing to produce a small sample or a few pieces of something. It’s another thing entirely to get thousands of pieces made and then deliver them across diverse geographies. “It doesn’t show that you can actually execute on the Value Proposition.”

As an instance, apparel design and manufacturing is an extremely complicated process. The team must include pattern makers, fabric sourcers and quality control experts. Steps must be well-coordinated and performed in the right sequence. Even if you successfully execute a few trunk shows, that is no indication that you will run a cost-effective operation.

Consider Alternate Sources of Funding (Instead of Venture Capital)

One of the fallouts of studying at a prestigious school – like HBS, Stanford’s GSB or IIT/IIM in India – is that you are likely to evince a fair degree of venture capital interest. In turn, students from such schools are also likely to chase VCs. As Tom puts it, “This goes to the root of elite business schools, we lionize venture capital.”

But, as a founder, you must be aware of the pitfalls of VC funding. Venture Capitalists are likely to urge startups to “Grow, grow, grow” or rapidly scale since they are betting on a minuscule number (like 3 out of 60 companies) delivering a return of 10 or 20 times. With about 30% of their portfolio companies, they hope to make a bit of money but expect the rest to fail. Since such a model only works with high growth at a rapid rate, founders often flounder at the altar of speed.

Referring again to Quincy Apparel, the founders planned to offer affordable, stylish and better-fitting workwear for women. Their trunk shows – the MVP – received very warm and positive feedback. Though they planned to raise $ 1.5 Million, they ended up raising $ 1 Million from Venture Capitalists and decided to launch with a shorter runway. Their sales also grew well. In Month Five, they racked up $ 40,000  in revenue, and in Month Six, $ 60,000. They also had a repeat purchase rate of 39%, indicating a strong loyalty among buyers. But their return rate (of clothes that did not fit well enough) at 35% was much higher than their budgeted 20%. As a result, they burnt through their cash reserves and eventually ran out of capital.

One of the insights, suggests Tom, is that if they had procured the money from some other source – for instance, by offering equity to a garment manufacturer, they might have been able to leverage the funder’s industry expertise (and even infrastructure) and be offered the leeway to pivot and learn from their errors. Essentially, searching for more “patient” sources of money – whether that be from angel investors, or potential old-economy partners like factories – can be helpful to some startups.

Avoid False Starts Based on Misleading Customer Responses

The Lean Startup model advocates customer discovery before you start building anything. It involves a lot of rigorous customer interviews. But sometimes, such interviews, according to Tom, can also be misleading. Some customers might get infected by your own enthusiasm for your solution, and might end up saying exactly what you want to hear. We also can’t discount other types of response biases, that have led to false projections.

Moreover, he has noticed that if founders create a prototype and present it to customers, the latter often feel sorry that the team has already spent effort in creating a sample; they are then likely to display an appreciation, instead of voicing a more honest indifference or aversion. Instead, if you present two alternatives to customers, and ask them which one they prefer, they are more likely to reveal concerns.

Tom suggests that you have to be always conscious of whether your idea meets a strong unmet need, if your solution is differentiated enough from competitor solutions, and is complex or difficult enough to prevent easy imitation. Such basics should not be swept aside amidst strong but disingenuous customer hurrahs.

Establish a Founders’ Agreement or Understanding

Setting up the right equation between cofounders is also a significant must. The two Quincy Apparel co-founders were best friends before they started out. They also made a pact not to let the business affect their relationship. But later, when things got tough, one founder had the Board oust the other. Their personal relationship understandably suffered and they weren’t on talking terms for two years, though eventually, they patched up. Tom says, “It’s crucial to have the hard conversations between founders,” which can include dividing the functions in a manner that does not impede decision-making agilities.

Build Conviction Into Your Sales Pitch

As an angel investor, Tom typically looks for people who can sell their concepts well. Because, they are likely to have to do that repeatedly – to investors, to hires, to customers et al. But selling does not just have to do with just talking. As Tom himself learned in his McKinsey days, a critical component of sales is listening. So Tom would also look for the founder’s ability to absorb inputs and process them critically without being hardnosed about her or his message.

When asked if a Harvard Business School education really offers founders any added advantage, Tom shrugged off the opportunity to don his salesperson’s hat. Like an honest academic, he said: “I wish I knew.” Perhaps a more feasible path to success for most would be to read this very insightful book.

References

Tom Eisenmann,Why Startups Fail: A New Roadmap for Entrepreneurial Success,Currency (Penguin Random House), New York, 2021