14 January 2020

Part of the folklore about successful entrepreneurs is that they succeeded because they first failed. "Fail fast", entrepreneurs are often told, and you'll learn valuable lessons that will help you in your next venture. But this is a myth, writes Professor Francis Greene.
Startup Office with staff on computers

While second-chance stories are comforting, my research shows that entrepreneurs don't learn from their mistakes. In fact, it's the opposite: fail once and you're most likely to fail again. Believing in the myth only sets entrepreneurs up for more failure—and leads to disappointment and frustration.

There are many reasons why this is so, but the most important is basic psychology: learning is a complex process that usually doesn't proceed as simply and obviously as we hope. We struggle to take away lessons about what went wrong and then apply those insights to new situations. Or we exemplify our experiences and leave out key details that would help us get a complete picture of why things went wrong.

Hard Lessons

I reached these conclusions after working with thousands of entrepreneurs and startups over the years in academia and government. What I've found is that there is precious little evidence that failure helps people learn to be successful. Mostly, what passes for evidence are the cherry-picked stories of famous failed entrepreneurs who became successes later on. We conveniently forget the far larger number of entrepreneurs who failed and didn't get to tell their tale. In the US, only about 50% of startups make it to their fifth birthday. Even fewer make it into adolescence or adulthood, according to the Bureau of Labor Statistics.

To be sure, there are some quantitative studies that show serial entrepreneurs have greater success than first-timers. But the overwhelming majority of the studies don't show that failed entrepreneurs specifically are more successful. In my opinion, the studies that do touch on failure usually come with limitations or caveats.

To test the topic on a large scale, I looked at nearly 8,400 German startups to see if the new companies launched by failed entrepreneurs did any better than first-timers.

They didn't. In fact, they had poorer outcomes the second time around.

Failed entrepreneurs were more likely to go bankrupt or dissolve their businesses than first-time entrepreneurs. In fact, even if an entrepreneur had run a business successfully before, they were just as likely to see their new business fail as a first-time entrepreneur.

Other researchers have reached similar conclusions. A Harvard Business School study of venture-capital-backed firms in the US, published in the April 2010 Journal of Financial Economics, found that previously failed entrepreneurs were no more likely to succeed than first-time entrepreneurs.

A study of German entrepreneurs by a researcher at KfW Bankengruppe found that entrepreneurs who started a company after a failure performed poorly compared with other founders. "Their probability of survival in general as well as their risk of failure in particular is worse than that of other startups", according to the researcher. They added that on average, "there is no indication that business failure triggers a reflection process in which entrepreneurs look back on mistakes they have made and adapt their future behaviour accordingly".

Practice and Confusion

Why does this happen? Why don't entrepreneurs learn from failure?

For one thing, learning is difficult in startup contexts. Usually, when we think of learning, we think about gaining expertise through regular practice. In his Outliers book, for instance, Malcolm Gladwell calculates that it takes about 10,000 hours of practice to be a chess grandmaster.

But part of the reason practice pays off is because a chessboard is regular. It always has 64 squares and starts off with 32 pieces. You face one competitor. Likewise, in football, a consistent number of players on offence face a consistent number of defenders and try to advance by clear, regular rules.

These regularities don't occur in startup situations. Markets evolve, customers are fickle, and opposition numbers vary. You must learn what it takes to become the equivalent of a chess grandmaster by playing with constantly evolving rules and opponents—making it much more difficult to interpret prior actions and experiences successfully.

Take the process of trying to understand customer preferences. Talking to potential customers might reveal their current needs—but customers themselves don't understand what they actually need, or they may not be able to articulate that need accurately. They may even tell you things that send you off in the wrong direction. (As Steve Jobs famously said of the limitations of designing by focus groups, "A lot of times, people don't know what they want until you show it to them").

So an entrepreneur talks to customers and puts out a product that doesn't find an audience, which then flops. But the failed entrepreneur thinks he or she can try again by analysing what didn't work the last time. There is just one problem. Even if the entrepreneur can get a handle on the flaw—unlikely, given the flawed information that led to the flaw in the first place—that understanding doesn't say anything about a customer's current needs, which have likely changed since the last time around, based on numerous factors. Any lessons learned the first time around likely won't apply.

For the same reason, the very business itself is starting at a big disadvantage. A second attempt at a startup won't face the same context as the first. There will likely be different market conditions, prices, and relationships with suppliers. Whatever you think you've taken away from your failure about planning, structuring, and running a business may not mean much, making failure even more likely than if you were starting from scratch with an open mind.

Another issue: most business closures don't close quickly. They limp along until the entrepreneur has no choice but to close up shop. But that makes it tough to know what really caused the failure.

Let's say a small business loses a key customer. It replaces the customer, but the initial loss left it too weak to deal with a number of subsequent problems, such as tighter credit. Still, the business survives for a couple of years until the red ink gets to be too deep, and the owner gives up.

Because the loss of the customer happened such a long time ago, it doesn't seem like the cause of the failure—so the entrepreneur doesn't identify it, and doesn't learn from what went wrong there. The entrepreneur is more likely to blame something that happened closer to the actual shutdown and look for takeaways there.

Psychlogical Barriers

Finally, there are a series of hurdles to learning that have to do with the way we think.

Starting a business involves the orchestration of complex and interconnected activities like marketing, logistics, financial planning, sales, and operations. But we all have a tendency to simplify the stories we tell ourselves. It is easier to say, for instance, that a couple of bad sales quarters wrecked a company than a series of cascading problems throughout the enterprise.

This tendency to simplify is often combined with another common human frailty—blaming past failures on external events, rather than attributing these outcomes to our own actions.

For instance, entrepreneurs commonly blame the bank for causing them to fail because it will not give them credit or extend it when they run into cash-flow difficulties. But they tend not to look at the root cause of these difficulties and their own role in leading to them, such as their failure to anticipate high overheads. It's hard to learn from your failure if you don't want to look at the failure honestly.

Or if a retailer is forced to close, the entrepreneur might blame the mall that moved into town, the local council that refused to block the big franchiser, or the customers that flocked to the new operator. All of that clearly played a role. But entrepreneurs never examine if the underlying factor was their failure to come up with new ways to keep customers engaged as times changed.

Tough Lessons

Is there any way around this situation? One piece of advice from my research is that previously failed entrepreneurs thinking about starting up again should pause and reflect. Hold a "premortem" that tries to work out why the venture might fail. It forces entrepreneurs to figure out their available options.

What's also clear from my research is that if failed entrepreneurs want to "look back to go forward", they need to ask themselves if they have relevant industry experience. Study after study shows that entrepreneurs with know-how and know-who perform much better than entrepreneurs with little or no background in a field.

This is also a good litmus test for investors. If the entrepreneur has next to no industry experience, their advice should be to encourage the entrepreneur to come back later, when they have built up their expertise, to add advisers or team members that have this experience—or to advise the entrepreneur to pivot their idea to an industry that is a better fit.

Telling people all this may not seem as comforting and encouraging as "fail first, succeed later". But the sad reality is if an entrepreneur fails, they very likely haven't learned what they need to succeed the next time around—and they are often better off not trying again.

Francis Greene

Francis Greene is Chair in Entrepreneurship at the University of Edinburgh Business School.

This article first appeared in The Wall Street Journal.