Sharply rising demand drives up prices and so induces incumbent firms to increase production and new firms to enter the market.  Some new market entrants will have had no prior role in the industry, and others may have been suppliers who wish to forward integrate and/or distributors who decide to go directly to OEM suppliers in order to control a larger segment of the value chain. During this rapid growth in the industry, most new players must rely on outdated industry intelligence.  Neither existing players nor new entrants can know of all the others and so they plan their own production capacity based on dated, under-informed projections of supply.

No industry can long sustain an increasing number of competing firms.  Inevitably excess capacity creates market over-supply.  Whether growth in supply exceeds the ongoing growth in demand or demand flattens out or diminishes, the result is the same: The market place becomes saturated with goods and prices fall.  Competition intensifies throughout the industry.

Financially stronger players will deploy manufacturing efficiencies and short term price competition to drive the weaker ones out of the market.  Increasing price competition will eventually drive prices down to commodity levels and only the makers of exceptionally desirable products and the lowest cost producers will survive.  Lower margins will force some players into insolvency. Larger players may acquire the protected, novel technologies of a few small competitors, but most small companies will fail;  their expensive capital equipment now worth practically nothing in an over-supplied industry.  By all these mechanisms the industry will contract.  Increasingly cutthroat competition, sustained price wars, and company failures will continue until supply falls sufficiently to meet demand and enable price stability.

What is the lesson of this predictable cycle of fast growth in emerging markets?  Do not jump in without a clear understanding of how to compete effectively.  Large companies will often watch the emerging market for opportunities to acquire small firms with proprietary technologies that make the best and cheapest product.  Small firms and especially start-ups need to think particularly hard about competitive differentiation. It makes no sense to enter even a fast growing market in direct competition with the big established players and a whole host of new small competitors.  Start-ups must take special care not to over-rely on their innovative technologies; a fast growing emerging market may spawn lots of new product ideas.  Not all of them can be winners.  Entrepreneurs may want to focus on developing a unique business model; one that takes advantage of the forces driving the market growth without needing to confront all the mainstream players. Find a niche and own it!

Nearly every professional manager knows that planning is crucial to business success.  Still, few people actually act on that knowledge.  In over 15 years of helping businesses plan their growth, it has become increasingly clear that only a small percentage of managers draft formal plans in order to create a disciplined strategic road map for success.  Instead, the motive that drives the production of most business plans is the need to raise capital, either bank loans or equity funding.  Everyone has heard some version of the old adage that “Failure to plan is a plan for failure” but few realize the actual consequences of deciding to “get by” without a carefully thought through, written business plan. The statistical evidence of that folly is overwhelming.

The Top Ten Reasons That Businesses Fail

No, this is not one of those David Lederman jokes; unfortunately it is deadly serious.  The business statistics surrounding business failure are widely published.  A Dunn and Bradstreet research report cites managerial incompetence as the cause of 96% of American business failures.  Many Internet sources have their own “Top 10″ reasons for business failure in the U.S. and although they differ somewhat in detail, the vast majority of relate directly to inadequate planning.[1] Here is the Small Business Administration’s rather typical Top 10 list:

1.  78% lack a rigorously-developed business plan keyed to the realities of their market, including sufficient research on the business before launching it.

2.  73% fail because the owner is wildly optimistic about projected sales, break-even point, and capital required.

3.  70% fail because the optimistic owner believes he/she can wing it on important issues with which he/she is ignorant, and ” can’t afford ” to hire the expertise to get it done right the first time.

4.  63% of new business owners simply don’t have the required business experience to make a success of the enterprise.

5.  82% lack cash-flow management skills. They don’t understand the importance of controlling cash flow.

6.  79% launch with a bright idea and little or no capital.

7.  77% don’t have a rationally-developed pricing model for their products or services.

8.  64% don’t have a clue as to how to aggressively promote their business, nor do they understand its importance.

9.  55% don’t understand their competition, or assume it can be safely ignored.

10.  47% rely too much on one customer/client.

Clearly, a rigorous project to write a comprehensive business would reveal most if not all of these top 10 problems in advance.  Especially if the project involved actively seeking criticism of the plan from experienced business people, investors, managers, academics and mentoring organizations such as SCORE and the Small Business Administration.

Don’t Bother Me with Facts

Few operating businesses write plans despite all the accumulated evidence that a written business plan – built on sound market and competitive research and including operational and financial plans – is crucial to business success.  Temple Porter once remarked to me that people only take business planning seriously when business pain forces them to do so.  Foresight simply does not motivate the vast majority of managers.

Mostly at the early stages of business development when businesses need capital and MUST write a business plan to attract investment, or when they require additional financing in later stages, will they grudgingly write one.  Generally, even in those situations entrepreneurs and managers sell their businesses short by producing a document designed more to “sell” outside investors on their idea than to actually plan for their own future success.  They seem to forget that the founders and owners are the people most invested in the business.  Outside investors stand to lose only some discretionary capital: Owners and founders risk years of work, dreams, foregone opportunities, the cost of loans they personally guaranteed, perhaps their business credibility and certainly their jobs.

Every management team can recite a laundry list of plausible sounding reasons not to write a business plan for use a road map for growth.  “Time, resources and money” they will explain, “are better spent on running the business.”  Another familiar favorite is “We have a business plan but it’s not written down.” Yet no one can keep all the details of a real business plan in their head all at once.  So yes, even though 78% of businesses fail due to a “lack a rigorously-developed business plan keyed to the realities of their market” they all have plenty of reasons.  Only the other 22% have decent odds of survival, to say nothing of achieving prosperity.

Business Planning Best Practices

Every business needs to review its business plan annually.  That does not mean that they must right a new one every year, of course; in most cases that would overstate the need.  If a business has a written plan less than three years old, the executive team should review and discuss each strategy in light of the changing market place, available resources and external trends such as those in technology, regulation or demographics.  Management must place special emphasis on updating their competitive analysis and marketing strategies at least every year.  Still, operational plans and financial strategies warrant annual re-evaluation too.  Rather than write a full new plan, management can write an update and add it to the plan.  Update should include new factual findings, the reasons for making changes and specific new strategies and tactics.  When reviewed and approved by appropriate stakeholders, managers should communicate the plan, its central strategies and especially reasons for changes to the company’s employees.  When everyone knows and understands the overall plan, it is much easier to make individual day to day decisions and obtain “buy-in” and the sense of teamwork and shared mission that goes with it.

If your company or start-up venture does not have a business plan, write one immediately.  Spend the time to do it right and completely, with a full analysis of your business model, product or service, target market, value proposition, industry, competitors and financial plan.  If you decide to fly blind instead, in all likelihood you will eventually crash.  Look really hard at those statistics above.

By the time entrepreneurs go looking for venture capital funding, they have already invested a great deal. They have spent years developing and refining the business concept, researching technologies, markets, customers, products, competitors and alternative business models. Inevitably, they have invested some of their own money and maybe asked family and friends to take some risks too. Moreover, they have spent months drafting, vetting and editing a business plan that proves – right there in black and write – that this business is a winner with enormous financial upside. When they finally gets an audience with a VC, they are in no mood to hear a “no thanks.”

On the other side of the table, the VC knows exactly how the entrepreneur feels; he has been here many times. Any investor with an ounce of empathy would find it had to say no thanks to someone who has worked so hard to hear a “yes.” As if empathy were not enough, there are plenty of other reasons for VCs to avoid saying “no;” some good, some bad, some true and some false.

Now most VCs are honest, fairminded business people who behave ethically.  Still, VCs often fail to voice their sound business reasons for saying ”no thanks.” For example, if the entrepreneur has failed to make a convincing case that the target market size is attractive, that the product or service is compelling enough to sustain competitive differentiation, that the business model will work or that the management team has relevant experience, then a “no thanks” makes sense. Still, it feels bad to say “no” and VCs know that entrepreneurs don’t like it. Many presenters become defensive, some will think the VC is stupid and/or out of touch. The entrepreneur might even tell her friends and networking colleagues that this particular VC is a jerk.

If a VC does say “no thanks” and the entrepreneur reacts calmly and rationally, she is still rather unlikely to simply take one “no” as a final answer: The VC may well be in for a long discussion of the merits of the business plan, whether they want to listen or not. Yet VCs are professional investors disciplined to think ahead, to keep their options open and to avoid alienating rare resources such as smart entrepreneurs, so they often perceive that their interest lies in simply saying little or nothing; at least not saying “no” directly.

For VCs, there is always the nagging possibility that this idea might turn out to be the next Google, Genzyme or Facebook. If they say “no thanks” now, they may fear that the entrepreneur will shut them out of later investment rounds. Even if the VC is convinced that this venture is a loser, he may worry that the entrepreneur may not come back when she does have a great idea. It may be selfish to avoid saying “no” directly and not telling the candid truth about why not, but then entrepreneurs are unlikely to ever find out that the reason the VC gave them for not investing was only an excuse. 

VCs may avoid saying “no” in some quite ambiguous ways that are tough for an entrepreneur to see through. For example, they may tell the entrepreneur that the firm has too many portfolio companies that need attention just now; “Try me again in six months.” That could be true or it could be just the right “maybe” to get the entrepreneur out of the office without making them angry or inviting a debate. “I just could not sell the idea to my partners” is another hard answer to figure out. “This looks interesting, but it’s not in our space” might be true as well (but makes one wonder why the VC had you in for a presentation in the first place). A little advance homework should shed light on what kinds of deals a particular VC firm prefers and largely avoid this reason.

One egocentric, insensitive and potentially dangerous way that some VCs may avoid saying “no” is to send the entrepreneur on an impossible mission. “Get your sales up to $2 million before the next partners meeting and I’d say you have a shot” is one example. Another might be, “If you get Warren Buffet or Bill Gates to invest, we’ll come along” or “sign up a few high profile reference accounts like Boeing, Microsoft and Intel and we will reconsider.” These are extreme examples, of course, but you get the idea. By setting a high bar and/or a short timeframe, the VC can not only avoid saying “no” but also leave the entrepreneur believing that it was their own fault that they missed out on funding.  A thoughtless VC may may set a lower bar, or repeatedly send the entrepreneur off to put together just a little more information.  That behavior is sure to start a meaningless quest.

That is not to say that every suggestion that a VC might be more interested if the start-up achieved a certain milestone or had more information is either false or unreasonable. Yet sending start-ups on an endless quest leaves open the selfish possibility that if someone else funds them, the VC could still get in on the next round. Of course, if the entrepreneur does meet the challenge, the VC can always set up another impossible quest, or revert to “My partners are not crazy about it” or some other excuse. Again, most VCs strive to be fair and completely straightforward, but some do not.

So what’s the harm when VCs don’t say “no,” even when they mean “no?” Entrepreneurs are optimists by nature and they need to be. So the lack of a “no” sounds like “maybe” to them, or least an affirmation that there is nothing fundamentally wrong with their plan. Yet in fact, the mere lack of a “no” from a VC says nothing of the kind and it can create serious problems, especially for inexperienced entrepreneurs. Their idea may be a stinker, and plainly so to a professional investor: More commonly it may just be too risky to fund, or not have the potential for the $100 million to $500 million in fifth year revenues that attracts venture money. VCs reject many plans because the management team lacks relevant experience, but any one of a dozen other good reasons may apply.

So a discussion with a VC that ends in only a “not now” may actually teach an entrepreneur nothing of value, perhaps even mislead and encourage them to continue to seek funds and obfuscate that the management needs to make substantial changes in the business model, strategy and/or management. An entrepreneur may well leave the VC’s office, not only without a clue, but essentially lulled into believing that it was only his timing that was off or some other reason that seemed false but benign to the VC.

To avoid a long wasteful quest, entrepreneurs need to hold VCs to a higher standard. They must state clearly at the outset of their conversation that they welcome constructive criticism, that they want the whole truth, no matter how difficult, that they do not need coddling and won’t take a “no” personally and that they will not insist on a long debate. It may help to remind the VC that entrepreneurs hear “no” all the time. Point out that the VC’s experience and insights could really be helpful, but only if his assessment is frank and straightforward. No one wants to hear “no thanks” but the reasons underlying a decision not to invest are inherently valuable. Hearing only happy talk that avoids the actual issues can inadvertently fuel a fruitless quest that wastes the resources of entrepreneurs and investors alike.