How to succeed in a startup business? Well, there is no cookie-cutter approach that works universally. Every business has a set of unique characterizing elements and has to find its optimal organizational balance. Notwithstanding the uniqueness of the success factors, which sometimes can be summarized with “luck”, there is an often overlooked commonality behind startup business failures which can be analyzed through behavioral lenses.
A well-known statistic is that 9 out of 10 startups fail – less known is what we mean by “failure”. The definition here adopted is the one given by Tom Eisenmann in “Why Startups Fail”, namely “A venture has failed if its early investors did not—or never will—get back more money than they put in.” It goes without saying that, sometimes, misfortune is the major culprit behind a company’s death – yet, given the high startup failure rates and post-mortem conversations with grieving founders, it seems like a few behavioral serial killers are still on the loose.
To analyze the perils behind an entrepreneurial venture we begin from the start. An idea bulb lit up and there you are: the next Zuckerberg. But why doing it alone? You and your friend could be the next Travis Kalanick and Garrett Camp. This is the prompt to the launching phase – it consists in the definition of the business opportunity, team building and resource collecting. Each element of the launching phase presents its own set of behavioral traps that might undermine the startup’s success.
The major behavioral bias that pervades the start-up process is overoptimism as it skews the founders’ decision making towards overconfidence about the attractiveness of the business idea and underestimation of future challenges. While optimism is the driving force of the entrepreneurial process, and is necessary for it to ever take place, overoptimism hinders the whole business design and planning. In fact, even after a successful launching phase, overoptimistic entrepreneurs might fail to notice their business flaws and fail to pivot timely.
Assuming that the founders have an appropriate degree of optimism, there are still many missteps that can occur along the launching phase. It comes like a surprise, but too often the intrepid startup entrepreneurs dodge one of the most crucial steps of any business venture: assessing the customers’ needs. This is what Eisenmann calls “false starts” and there are few possible behavioral explanations for it:
- Loss aversion – the human bias for which the pain of losing is larger than the pleasure of gaining. The ideas we are passionate about often come with a degree of emotional attachment. Facing the market might result in disillusion and consequential emotional pain.
- Availability bias – the belief that examples that come easily to one’s mind are more representative of a given case. Startup entrepreneurs commonly detect potential marketability of a solution during their professional careers or from their personal unsatisfied needs and might assume that the case is more widespread than it actually is.
- Confirmation bias – the tendency to search for, interpret, favor, and recall information in a way that confirms or supports one’s prior beliefs.
- False-consensus bias – seeing one’s own behavioral choices and judgments as relatively common and appropriate to existing circumstances. It can exacerbate the prior biases and ultimately, lead to a business investment in a project that does not satisfy a strong need in the market.
A launching phase misstep in the opposite context is the so-called “false positive” launch. The false positive start occurs when the startup has gauged the demand for the concept, but ultimately drew wrong conclusions from the market research. The false positive launch is due to:
- Confirmation bias: it makes early success rates seem more promising than they actually are, leading to an unwarranted expansion of the investment. This behavioral trap is easier to fall into because every entrepreneur has a positive outlook on their business idea, and when the first market signals seem to confirm their initial assumptions, they might overlook the core reasons for the positive response. The confirmation bias trap can be deadly also in the case of the LEAN startups, which can be summarized as the development of a minimum viable product (MVP) to propose to the market as quickly as possible with the lowest investment. It sounds promising, but it does not lead to a false positive only if the MVP was correctly designed to reflect the expanded project’s market appeal .
- Illusion of validity bias – the tendency to overestimate one’s own accuracy in making predictions based on a set of data. It can add fuel to the fire when one draws conclusions under the confirmation bias. It can also occur in later stages of the startup life, namely the scaling phase. Expanding the business geographically, its product line and/or innovation based on the initial proof-of-concept is doomed to fail if the reasons behind the initial success are not assessed correctly.
Other important steps of the launching process can be biased and lead to failure.
- Assessing the competition requires impartiality and conservatism, but sometimes one blows his own trumpet. The illusory superiority (also known as the Lake Wobegon effect or above-the-average effect) is the tendency of people to overestimate one’s own qualities and capabilities in relation to those same qualities in others and this can ultimately hurt the business venture.
- Team building is another key step of the business set-up. The most common mistake that companies make, even those who are already established on the market, is to hire a homogeneous group of people displaying similar attitudes and beliefs to those who are leading the hiring process. This favoritism for affinity is called the in-group bias and it consists in the tendency to give preferential treatment to those who belong to one’s same group. This creates a strategic disadvantage for the company as it encourages the herding behavior (also known as the bandwagon effect) and leaves less room for creative solutions proposals, necessary when facing unsatisfactory results.
- Inadequate planning is another culprit behind the fall of established companies and startups alike. The planning fallacy consists in underestimating the time or the resources necessary to complete a task. In fact, startups like Better Place are exemplary of the planning fallacy both in terms of the estimated times and financial resources needed to conclude the launch of the idea. In relation to financial resources, the planning fallacy often goes hand in hand with the normalcy bias – the underestimation of the likelihood of a disaster and of its potential adverse effects when it might affect the company. This is the reason for the lack of planning related to the boom-bust investment cycles which might affect the ability to raise sufficient funding or the lack of consideration of possible disruptive innovations from the competition. This latter was the case of the invention of Amazon’s Echo for the Jibo robot startup.
- Lastly, the behavioral coup de grace occurs when a startup is showing all signs of derails in its financial results. As the sun sets on the hopes for success, loss aversion often triggers the ostrich effect – the avoidance of negative information- which together with the survivorship bias – erroneous conclusions from concentrating on the people or things that made it past some selection process and overlooking those that did not – can lead to the escalation of commitment or sunk cost fallacy -the continuation of the behavior instead of altering its course despite the evident negative results. In fact, as the company runs out of financial resources it might persevere in spite of the reality, escalating the financial investment hoping for a reversal of the results. Perseverance is often due to the success stories of companies that survived hurdles, but in majority of the cases it produces a higher financial exposure and late pivoting efforts, leading to the final defeat of the business venture.
Once failure occurs, it brings along emotional pain and shame, which can hinder the learning from one’s failures due to the attributional bias – erroneous attribution of the result to internal versus external causes. It is important, therefore, to understand that a failure is part of the process, and a setback is not a game over.
Global startup ecosystem report, Technical report Startup Genome, 2019
Jeremy Strickland, Why Did Better Place Fail and Tesla Succeed?, Medium, 2019
The Top 20 Reasons Startups Fail, CB Insights, 2019
Tim Ellis, Jibo ‘social robot’ cancels overseas orders, as Amazon Echo redefines the category, GeekWire, 2016
Tom Eisenmann, Why Startups Fail, Publisher Currency, 2021