August 10, 2016
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Why do startups fail? Plenty of reasons. Even the best laid plans can go wrong unexpectedly.
But are these disasters really unforeseeable? I’d argue that no, they’re not impossible to avoid. But you have to know what to look our for. Here are the top five reasons why startups fail.
One of the biggest reasons why companies kick the bucket is that they discover their market is either very small or nonexistent. Some of the symptoms of market failure are:
Boundless optimism about customer acquisition is another huge reason why businesses fail. Interesting sites, products or content don’t automatically translate to big sales. If your cost to acquire customers exceeds the profits you make over the lifetime of each customer, your business is destined for failure.
Of course, that statement is obvious when you spell it out. Despite that, entrepreneurs in every industry overlook this simple fact when launching their businesses.
Business Model Basics
A successful business model has two components—scalability and monetization. When we talk about monetization, we’re looking for ways to monetize customers at a much higher level than it originally cost us to acquire those customers.
The cost to acquire one customer is the sum of your entire marketing and sales expenses spent over a period of time, divided by the total number of customers you acquired during that time. If you spent $100,000 on marketing in 2014 and acquired 100,000 new customers, your cost to acquire was one dollar—and we should talk privately, because that’s impressive.
Your customers’ lifetime value is the total amount of money each person pumps into your company, minus things like delivery expenses, maintenance, etc. that comes with each relationship. The higher your lifetime value is and the lower your cost to acquire is, the better shape your business should be in.
The other aspect to think about is how quickly you can recoup that cost to acquire each new customer. Recovering that cost should be done within a year for each person (in most industries) if you really want your business to be efficient.
Poor management is sadly a very common issue plaguing startups, and can lead to the problems spelled out in Points 2, 4 and 5 because:
The CEO’s job is to manage what cash remains and to know whether that money is capable of taking his or her company to their next milestone and financial success.
Startup valuation doesn’t change linearly, and just because you got your Series A round 12 months ago doesn’t mean your business is automatically worth more money.
Management’s job is to secure enough cash to steadily advance the company’s goals. If crucial milestones go unmet, money vanishes and the ability to raise more cash does too.
Spending should be highly conservative in the startup’s early stages because your offering is still under development. You don’t need, for example, a full marketing team when your software is months away from beta testing because your product doesn’t even meet the market’s need yet. Hiring sales reps and marketers at this point is just a drain of cash, although it’s a common one. This is something we have personally seen in our experience marketing for startups.
But at a certain point, there comes a time to be more liberal with the gas pedal and really start accelerating your business. When your business model has proven itself (with data showing conclusive proof that your cost to acquire customers can be maintained as your scale your business, and that those customers can be monetized at least three times as much as their initial cost), it’s time to accelerate as fast as your cash flow permits.
It’s a dramatic switch from hoarding every nickel to investing aggressively in the company’s future, and knowing exactly when to flip the switch is difficult, especially for first-time CEOs.
The last big reason startups fail is because their product, once finished, simply didn’t meet their market’s need. Product failures are caused by failures in execution or strategy, sometimes both.
In many cases, a startup’s first product won’t meet the market’s needs. In a best-case scenario, that product will only require a few rounds of revisions to get it right. In a worst-case scenario, that product will be so out of touch with market expectations that it will have to be completely scrapped or overhauled.
In the second case, it’s clear that the startup team didn’t do their due diligence when researching their ideas and market.
Startups and other businesses fail for a huge number of reasons, but the ones listed above are the most common. Often new entrepreneurs get so excited about their ideas that they overlook even the most basic research and business practices in order to become the next big thing.
There’s simply no substitute for market research, sound management and choosing a business model that’s both efficient and scalable.