What Went Wrong?
In retrospect it is not surprising that the first professors of entrepreneurship—who saw writing business plans and creating entrepreneurial ecosystems as necessary to improve the success of startups—were mistaken. The first attempts to explain complex social phenomena in almost any new field often get off on the wrong foot.
In the 1930s, for example, many economists, then members of a young discipline, explained the Great Depression using a biological metaphor. They said that the economy had matured and we would never again see rapid growth. How could they have known any better? There were no historic statistics measuring growth, employment, income, or prices. Today’s empirical economic analysis, depending on computers full of time-series data and elaborate forecasting models, was decades in the future.
When market demand came upon the academy from students wanting to learn how exciting new companies were started, instructors had little information upon which to draw to unravel those mysteries. There remain only a handful of case studies of the early years of many big businesses. Even in today’s data-driven world, the federal government has no accurate count of the number of new businesses created every year. It was not until 2006, that the Kauffman Foundation established the first ongoing survey of new firms that, over time, will enable us to develop fact-based approaches to supporting and encouraging the new firms of the future.
Even absent data in the 1980s, however, the default to a planning model to guide aspiring entrepreneurs wasn’t exactly logical, as the planning process was already being questioned. In the late 1970s, Israeli scientists Daniel Kahneman and Amos Tversky identified what they called the “planning fallacy.”6 Simply put, their research concluded that optimism is endemic to humans when they plan. Kahneman won the Nobel Prize in 2002, in part because of his insight into what is now called “behavioral economics,” which confirmed how feeble rational planning models are when subjected to the vagaries of market behavior.
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Robert Bruner’s analysis of decades of corporate mergers—those transactions that are the subject of the most sophisticated business planning imaginable—confirmed the findings of Harvard economist Albert Hirschman that roughly eighty percent of implemented plans did not meet their objectives.7 Bruner showed that eighty percent of acquisitions, usually of smaller firms by bigger ones, failed to meet their anticipated contributions to the larger firm’s earnings. This same analysis of the actual efficacy of high-quality analysis and business planning pertains in other related venues.
For example, my own analysis of a sample of university business-plan contest winners presents an even worse record. During the five years studied, fewer than one in eight of the prize-winning businesses were started and, of those, fewer than ten percent survived even three years.
Entrepreneurial ecosystems have proven no more helpful than plan writing in increasing the number of new firms. Despite over two hundred cities having established districts expressly designated as “entrepreneur friendly,” there is no conclusive evidence that local ecosystems produce any more entrepreneurs than if they had never been established or existed. A confirming indicator is that only one of the 236 local publicly supported venture funds established over the last twenty years has produced a positive return to its taxpayer investors.
Despite any evidence of its success, the prevailing two-part narrative of writing a plan continues to focus on winning the financial support of venture capitalists, and leveraging local ecosystems. But, paradoxically, faced with a system that fails eighty percent of those who try it, there appears to be no entrepreneurial impulse to make starting a firm a better, faster, or a more certain process.
Are You an Entrepreneur?
In fact, the four most important questions for entrepreneurs are not answered in entrepreneurship courses.
The first is whether you are an entrepreneur. Asking this question of a professor of entrepreneurship, a professional investor, or a successful entrepreneur is likely to trigger a fruitless discussion about whether entrepreneurs are “born” or “made,” that is, whether an entrepreneur is birthed with special talents or if she, somewhere along the way, was in an environment that nurtured the skills needed to create a successful business. Some experts throw in the unhelpful view that entrepreneurs are people who are more comfortable with risk, while others pronounce with equal certainty that entrepreneurs are more cautious and deliberate personalities.
So, how can you determine if you really are an entrepreneur? The first step is to appreciate who entrepreneurs are by understanding just what it is that they do:
An entrepreneur is someone who exploits an innovative idea—one that he develops, or copies, improves, or rents—to start a profit-seeking, scalable business that successfully satisfies demand for a new or better product.
Because the identity of an entrepreneur is defined by action, not intent or aspiration, this definition is meaningful only through experience. No one who has not started a business can really know what it is to be an entrepreneur. Studying the three elements of this definition can help you to understand if you really want to do the things that entrepreneurs do.
A new business must first have a product or service that is sufficiently novel, or that the market will perceive to be better than that which exists, so that demand will materialize. If you are an innovator–entrepreneur, you will create the idea for your new company. Most of today’s entrepreneurs, however, do not themselves generate the ideas for their businesses. Rather, they see that there is a market need and offer improved products, services, or business processes that are better than what already exists. Or, they rent or buy access to another’s innovative idea.
Second, entrepreneurs create profit-seeking companies.8 They start businesses intent on making money now and expecting that the equity value of their firms will continually increase in the future. Profit-making startups are critical to our economy; new companies are the source of most of our economic growth. As new firms start and grow, those less than five years old create about eighty percent of all new jobs. Those jobs, in turn, contribute to the economy’s ability to create more innovation and wealth in the future. Also, as you will see, innovation can beget innovation; many of our most innovative and fastest-growing companies spawn additional startups.
The pursuit of growth is the third defining characteristic of entrepreneurial firms. Expansion of any organization, other than government, is a sure sign of its economic value and health. Every entrepreneur wants to “scale” her company to make it bigger, better, faster, and more profitable.
This book is unlikely to be helpful to the person whose happy life’s work is to own a single hair salon, be a freelance photographer, or work as an artisan glass blower making one-of-a-kind objects. Our society is immeasurably enriched by the talents and satisfaction that such people derive from their work and the products and services that they provide to their customers, but they should not be confused with entrepreneurs. Contrast the person who starts a store to supply artists and craftspeople, with no ambition to open a second location, with Michael Dupey, who started Michael’s Arts and Crafts in 1976 and now operates 1,200 stores nationwide. Entrepreneurs, by nature, want to build and grow companies.
What Kind of Entrepreneur Are You?
The second question you must confront is what kind of entrepreneur you will choose to be. As we well know, today’s prevailing narrative is shaped largely by high-tech startups in which every entrepreneur was first seen as an innovating genius. Innovator–entrepreneurs create new businesses based on technologies that they invented.
But every other type of entrepreneur experiences more success. About fifteen percent of all startups are created by company employees who find themselves in a spin-out situation, where an existing company chooses to dispose of a line of business that it has determined is no longer within their core mission or perhaps is not worthy of the additional investment needed to achieve real success and scale. Other employees, who become frustrate
d by their employer’s lack of support for an idea, product, or service that the employee believes could improve the company’s future, strike out on their own to turn that spurned idea into a new venture. And others, sometimes called discovery entrepreneurs, typically university scientists, start great companies using the new ideas that grew out of their years of research. The five-year success rates for spin-out and discovery entrepreneurs is about forty percent.
Eighty percent of entrepreneurs are “replicative,” a term coined by Professor William Baumol to describe people who copy, and usually improve, existing and successful ideas with the intent to own a successful and growing business.9 These entrepreneurs do not build businesses motivated by the need to get their innovative idea to market in the form of a new product. Half of this group—about forty percent of all startups—are created as franchises, that is, new businesses in which an entrepreneur buys or rents the business idea from another entrepreneur whose innovative idea requires a network of other entrepreneurs to reach scale. Owners of strong franchises like Holiday Inns, Jimmy John’s, or Dunkin’ Donuts experience the lowest rates of failure of any enterprises, with more than ninety percent surviving ten years. Five-year survival rates across all franchises, both brand-new and well-established, average about thirty percent.
The remaining forty percent of startups, also replicative by nature, are unaffiliated retail businesses that sell everything from auto repairs to zippers. The merchant–entrepreneurs who start these enterprises see a market for something new, or a better way to promote and sell already existing goods.
Jack O’Neill, an early surfing enthusiast from Santa Cruz, California, began experimenting with neoprene to make a warm, waterproof jacket, so that he could surf in colder parts of the ocean. Eventually he glued together the first wetsuit, and opened a store to sell them.
John Mackey, working in a food co-op in 1980, came up with a way to market organic food beyond the demographic of counterculture aging hippies, and determined that he could build a business by targeting younger shoppers with a growing interest in how their food was sourced. Whole Foods really began as just a grocery store selling in a different way—and now, after its acquisition by Amazon, yet a new different way will begin.
The prevailing entrepreneurial narrative, formed around high-tech innovators, gives little attention to people starting “stores.” One reason is that single stores, including neighborhood restaurants, gyms, and clothing boutiques, experience failure rates second only to Silicon Valley–type innovator–entrepreneurs, with fewer than thirty percent surviving five years. But merchants, including Jeff Bezos, who created Amazon, and Bernie Marcus, whose Home Depot changed the way that hardware, tools, paint, lumber, and shrubs and trees for your yard are sold, created stores that are much more. They play an important role in making retailing work better for customers and, importantly, for product and service entrepreneurs who use those stores as channels to reach enormous markets.
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Bezos and Marcus illustrate another aspect of entrepreneurial success. Whichever kind of entrepreneur you may start out to be, including franchisees who buy fully developed business models and merchants whose first idea is just to open a single store, the chances are that you will become an innovator along the way. It is the very nature of business to solve problems in creative ways. Every entrepreneur seeks to make his product better, faster, and cheaper, to turn his store into a setting that will attract more customers, operate more efficiently, increase his profit, and build a more successful company.
How Can You Succeed?
Given the odds that four out of five startups fail in their first ten years, the most important question for anyone thinking about becoming an entrepreneur is how to avoid failure. Successful entrepreneurs seem to share three characteristics. Do they describe you?
First, appearances notwithstanding—and often notwithstanding the revised hindsight recollections of successful entrepreneurs themselves—most entrepreneurs prepare for a long time before actually starting a company. While many entrepreneurs look back on their decisions to start a company in prose that suggests a thunderclap or a Biblical revelation, most had an intuition that they might become entrepreneurs well before they actually acted. Many budding entrepreneurs are like corporate CEOs who, twenty years before they achieve the corner office, recall almost unconsciously preparing themselves for the C-suite. Long before their ambitions were apparent, in some cases even to themselves, they attentively watched the corporate decision making process, projecting themselves hypothetically into their bosses’ shoes and asking themselves what they would do in the circumstances.
Richard Branson tells of becoming an entrepreneur by a happy “mistake,” calling his first record company “Virgin” because, he said, he knew nothing about business. In fact, Branson had worked in the record business in his high school days. Along the way, by observing how the industry worked, he formed views about better ways to make records, pay artists, and market music. In short, long before starting his company, Branson had developed a comprehensive critique of the industry that he was about to revolutionize. He had a very clear idea of how he would take a very different approach to running a record company.
A second characteristic of success involves a certain kind of mental flexibility, being able to change direction as circumstances require while keeping a clear line of sight to the goal of building a successful company. Michael Levin saw opportunity even when his investors would not change their vision of where success was to be found for his startup. The rigidity of a business plan is antithetical to a good entrepreneur’s inclination to respond to opportunity and to shifting facts and circumstances.
A new business, no matter how carefully planned, always proves to be a platform for unexpected innovation. When Henry Ford was frustrated that he could not make his cars affordable when building them one at a time, as he had done in his first two companies—both of which failed—he borrowed the idea of the assembly line from the meatpacking industry. Ford flourished while hundreds of competitors, committed to conventional production methods, failed.
Aspiring to build a big company is the third characteristic of successful entrepreneurs. Daniel Burnham, the city planner responsible for Chicago’s beautiful waterfront, which he designed more than a century ago, famously said, “Make no little plans; they have no magic to stir men’s blood.”
Every entrepreneur faces a decision that is fundamentally economic. Can you maximize your income and your ability to accumulate wealth by starting a business? Because the failure rate of new businesses is so high, even in enterprises with the best rates of success, every potential entrepreneur must consider that a decision to start a business may mean that he or she will experience lower overall lifetime earnings and may end up building fewer personal assets than those who elect to remain employees for their working lives. This is a hard and risk-laden reality to confront.
With this in mind, every aspiring entrepreneur should think twice about starting a new business if the business he dreams of cannot grow to scale or if she is not really committed to managing and growing a company.
The bigger a business gets, the more likely that it will survive and then thrive. Risk decreases as businesses become larger because larger enterprises accumulate resources, using them to support continuing innovation as well as beat or buy new competitors.
Size also allows for more efficiency, which, in business, always leads to expanding profit. Sam Walton, for example, transformed the lives of millions of people when he started Walmart. He was inspired to start a store as a means to get better goods to poor people, particularly those in rural areas, whom he believed were paying too much for inferior products. Walton’s great innovation was managing his company’s supply chain, a term that he helped to champion, by controlling products from the manufacturer’s factory to his shelves. He had to grow to massive size to capture the efficiencies needed for Walmart to provide better clothes, televisions, and groceries at lower prices—a p
ricing revolution that, we now know, has resulted in Walmart’s competitors offering lower prices across a range of consumer items, and overall savings to American shoppers, whether they shop at Walmart or not, of at least $630 per household per year.10
Will You Have an Entrepreneurial Moment?
In the pages ahead you will meet many entrepreneurs. None of them live in Silicon Valley. A few have a touch of genius. Most, however, are regular people with educations and job experiences much like your own. Only one started a company while under thirty, when entrepreneurial failures are most common. Five wrote plans; one described a business that worked: he wrote it only when his product had already been tested and ready, and when he needed money.
Each of these individuals has, or had, unique reasons for deciding to take a step that most would have seen as fraught with risk, but a path that each knew could change the course of their lives. These entrepreneurial moments happened when the budding entrepreneurs assessed that the potential returns of devoting their lives to starting a company seemed greater than the perceived dangers involved. Not one of these entrepreneurs foresaw creating the companies they launched as their career goals. Rather, it seemed to be a natural next step.
The real magic in the stories ahead has to do with why anyone would want to become an entrepreneur. It is why you are reading this book. If you are successful, you might become rich and maybe even famous. More important, however, you may be happier. Nearly a century ago, Abraham Maslow, a psychologist who studied happiness, concluded that, when someone is able to invent new solutions to human needs and to see their solutions valued in the marketplace, they achieve a kind of happiness that he called “self-actualization.” Successful entrepreneurs come to believe that the best use of their experience, skills, and education is the building of new businesses. They seem to see their talents used in ways that are more authentic, resonating with a higher purpose in life.
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