Tom Eisenmann of Harvard Business School explains why companies fail
Tom Eisenmann’s contributions to the Harvard entrepreneurial ecosystem are hard to overstate. He’s the Howard H. Stevenson Professor of Business Administration at Harvard Business School (HBS), as well as the Faculty Co-Chair of the HBS Rock Center for Entrepreneurship, the Harvard MS/MBA Program, and the Harvard College Technology Innovation Fellows Program.
Tom has created and taught several classes on entrepreneurship, including Launching Technology Ventures, Entrepreneurial Sales & Marketing, Making Markets, and the January Term Startup Bootcamp. He has been a friend to the Xfund team from the company’s earliest days.
Earlier this year, Tom published Why Startups Fail: A New Roadmap for Entrepreneurial Success. The book is an accessible guide for founders, based on years of research, case study insights, and Tom’s own experience supporting startup leadership teams.
Here, Tom discusses entrepreneurship at HBS, misconceptions about startup failure, and how founders can “fail better.”
You’ve created 14 classes at the MBA level. What should entrepreneurship education look like in graduate school?
One of the things we teach at Harvard Business School is that entrepreneurship is a way of managing. People tend to think of it as a stage in the life of a company. You know, when companies are new, they’re entrepreneurial. Or an entrepreneur is a personality with a propensity to take risks or a streak of independence.
We define entrepreneurship as pursuing a novel opportunity, before you have all the resources you need to actually exploit the opportunity — which means you’re doing something risky, without necessarily the team, money, or partnerships you need. As a consequence, you can find entrepreneurship in big companies, government agencies, and not-for-profits, too.
A lot of what I’ve done at HBS is help design and deliver learning-by-doing experiences. We teach the concepts, but also the skills and techniques that an entrepreneur needs to explore demand for a new concept — in other words, design skills, as well as sales and marketing. The best way to learn those skills is by doing. But you can’t just throw people in. You need to put some structure around the learning experience.
How has HBS student interest in entrepreneurship changed over the years?
It definitely ebbs and flows. I’d say about a third of the MBAs at HBS are interested in entrepreneurship or tech, including building new products inside established tech companies. But overall, it’s a very high fraction; I don’t think it’s ever been this high.
People tend to think of HBS as a factory for investment banking, private equity, and consulting, and we are. But many people aren’t aware that half of HBS graduates launch a business within 15 years of graduation.
This year, you published Why Startups Fail. What inspired you to write the book?
The catalyst was a team of my former students who launched a business. I was an investor, and the venture failed — despite their following the textbook to the letter, in terms of what we teach about exploring a concept, validating an idea, minimum viable product testing, and so on. They did it all.
The venture was creating affordable, stylish, and better-fitting apparel for young professional women. You can usually get two out of three of these things, but it’s very difficult to get all three.
They raised $1 million. They wanted to raise $1.5 million, and that’s part of the failure story. They got some traction. There was indeed demand for the product, but they had a hard time manufacturing it. They were making good progress but couldn’t persuade investors that they were making enough progress. Ultimately, they had to shut down within a year.
I found that I could point to a lot of things that went wrong, but I couldn’t really pinpoint the cause. Here I was, supposedly an expert on entrepreneurship, but I couldn’t explain the most important phenomenon in my field. Depending on how you count, two-thirds, three-quarters, or 90% of startups fail. And I was a failure at explaining failure.
That set me on a path to learn everything I could about startup failure. Eventually, I built a course on the topic, which let me go deeper into a bunch of companies. The course and the book writing fed each other.
What do most people misunderstand about startup failure?
If you ask a lot of venture capital investors and angel investors what’s the leading cause of startup failure, you’ll get some cliché explanations about jockeys and horses, the jockey being the founder and the horse being the concept. Most investors will tell you that the jockey is more important than the horse. So, if a venture fails, it’s ultimately some kind of failing of the founder.
If you’ve ever taken a psychology class, you’ve probably heard about the fundamental attribution error: if I have a failure of some sort, it couldn’t possibly be my fault, because I’m me and I’m terrific. So, it must have been the investors who pushed me in the wrong direction, or my co-founder who lost interest, or the regulators who did something flaky.
But if you did something wrong, it obviously is some failure of your skill or will. We’re just wired, for ego-defensive reasons, to never allow ourselves to be blamed, but to quickly blame other people. So, the investor saying it’s the jockey’s fault fits that pattern. That’s the biggest misunderstanding.
What surprised you the most as you were conducting research for this book?
I hadn’t seen this coming, but one of the failure patterns for early stage startups is a mismatch in the needs of early adopters and later adopters. Typically, if you’re going to build a business of any scale, you need both.
You obviously need the early adopters, because if you don’t get them, you never get off the ground. It’s often the case — often, but not always — that early adopters have different needs than mainstream customers. For example, the first customers for Dropbox were software engineers who have incredibly sophisticated needs for file management. They’re working in multiple devices, collaborating with lots of people, and using gigantic files.
But Dropbox founder Drew Houston wanted to design an application that would be so easy to use, his mother could use it to store her recipes. He had the discipline to design for his mom, not for the early adopters. The early adopters still got a product that was good enough that, even though it was missing some things they wanted, they still embraced it.
A lot of entrepreneurs dive head-first at the early adopter. It’s natural; you love them, you need them, you want to make them happy. But if you build what they want and invest aggressively, assuming everybody is going to look like them, you can end up in a bad place.
That’s called a false positive pattern, and I hadn’t seen it coming at all.
The other surprise involved domain expertise. I’ve worked with a lot of MBAs who don’t have expertise in the industry into which they’re launching, but it goes just fine. That wasn’t the case with the women’s apparel venture team. Apparel is one of those domains where there are thousands of arcane details that if you haven’t mastered, you can get yourself into a lot of trouble.
For example, when you’re manufacturing apparel, sourcing fabric can be a challenge. Even when two fabrics are in theory the same, they may have different elasticities, depending on when they were made. Then, all the other points in the process — the pattern cutter, the quality control people, and so on — have to fit together. The founders I worked with had no understanding of the process, and it took them time to master it. But you don’t have much time as an entrepreneur.
If you launch Instagram, you don’t need to have worked at Kodak and learned about photography. But if you launch an apparel business, it helps to work for one before. The same is true in food and beverage.
So, the fact that domain expertise was super important in some businesses, and truly unimportant in others, was a surprise.
In the final part of your book, you talk about how founders can “fail better.” What does that mean?
There are three ways founders fail badly.
One is timing the decision to walk away. Many failed founders say they wish they had shut the business down sooner. There are many reasons why you run the thing too long. You have to try to sell the company, pivot to a new business model, or try to raise money from new or existing investors. It takes time.
There are also ego-defensive reasons why founders run the business too long. Great entrepreneurs are persistent, so they think that if they throw in the towel, they must not be a great entrepreneur. Plus, sometimes there’s nobody to talk to. You can’t really be candid. If you’re trying to raise more money from your investors, you have to whitewash a little bit what’s going on, so you can’t get their best advice on how to proceed.
Your employees are counting on you. Somebody’s family is about to have a baby, and they get their benefits from you. If you shut down, they’ll be out on the street. And there are always stories of eleventh-hour miracles, and people hope for that against hope.
So, there are many reasons why founders run the business too long, but there are some good tests for figuring out when it’s time to shut down. Usually, everybody is better served if you do it sooner rather than later.
The second way founders fail badly is by damaging relationships in the process of shutting down. If you run your bank balance down to zero, in an effort to try to find a miracle, you can end up with a lot of people who don’t get paid what they’re owed: employees, tax authorities in the worst case, vendors, lawyers, and others.
Some shutdowns end by selling off parts of the company to other companies, and you can get into tugs-of-war with investors over how to manage those transactions. So, tarnishing relationships is pitfall number two.
The third way founders fail badly is by not learning from the experience. Again, because we’re human, we’re wired to blame others, rather than ourselves, and there’s so much emotion associated with a failure. An entrepreneur’s identity is intertwined with their venture. If the venture dies, a big part of them has died.
It’s the five stages of grief. They go right through the Kubler Ross thing — denial, anger, bargaining, and all of it. The emotions are so strong that many founders aren’t able to make sense of what happened. They’re not thinking clearly, and they alternate between anger and serious depression.
In addition, the personal financial ramifications can be devastating. A lot of entrepreneurs will have run their bank balance way past zero. And they’ve been working so hard, they may have trashed their personal relationships. They may be looking for a shoulder to cry on, but after they’ve disappeared for the last six months, family and friends don’t always have a sympathetic ear.
It’s a really rough process. Healing from it can involve alternating between distractions and rumination. If it’s all rumination, you’re going to drive yourself crazy or get depressed. If it’s all distraction, you will never learn anything. Finding the right balance and eventually letting the emotions settle down so you can learn and take some responsibility is critical.
Too many founders end up at extremes in terms of how much responsibility they take for what happened. Many take no responsibility at all, and they learn nothing. It’s quite possible they will get back on the horse and ride over the same cliff again.
At the other extreme, you have founders who take too much responsibility. They’ll say, “I never should have been a founder. I’ll never do this again. I was ill-suited for the role.” This may be true. But more often than not, the failure was a complicated mix of the founder’s fault and other people’s faults, the universe conspiring against them, bad luck, and so forth. If these founders never try again, society is deprived of something important, great, or helpful that they might someday build.
In sum: learning, preserving relationships, and getting the timing right are all very hard, but central to failing well.
