How to Avoid Business Failure

Paul Carroll, co-author of Billion-Dollar Lessons, talks about the fallacy that strategy doesn't matter, the importance of naysayers, and the need to gauge competitive threats carefully

Most of the mistakes driving the current crop of corporate failures probably could have been avoided, says Paul Carroll, co-author of Billion-Dollar Lessons. The book analyzes 750 significant business collapses over the past quarter-century and identifies why they failed. Many of the book's principles can be extrapolated to the small business owner, Carroll recently told Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.

Why study failure?

I realized one day that every business book I was reading was looking at business successes and trying to teach people how to be like those guys. And it seemed to me that if you just try to learn from successes, you're missing a big part of the picture. To really understand the game, you have to talk to the winners and the losers.

How did you choose which failures to study and write about?

We looked for the biggest failures among large companies in North America, and we had a team of 20 researchers investigate them over 18 months. We applied screens to get down to the 750 that we analyzed.

What was the biggest question you had about these flops?

We wanted to know if failure could have been foreseen. We guessed that one in five would be obvious, but in fact, it was closer to one in two. We found that 46% of the failures could have been foreseen.

What was the No. 1 cause of failure?

It was misguided strategy, which is interesting, because there's this idea—a fallacy, really—that business strategy doesn't matter, it's all about execution. That was completely wrong. You can't just figure things out as you go along. Strategy failures were far more common than sloppy execution, poor leadership, or bad luck.

What kinds of strategy mistakes were most common?

Going outside of your core business model to expand into a new area. Typically, companies that stayed close to their knitting didn't have big problems. But Avon (AVP) decided in the 1980s that it wasn't really in the business of selling cosmetics, that it was a culture of caring. They decided to start selling medical equipment and operating retirement homes, which turned out to be not such a good idea. We looked at a cement company in England that was one of the biggest players in the cement business, but they decided they were really in the business of helping homeowners. They started selling lawnmowers and went bankrupt.

How does a small company that wants to grow avoid over-extending with that disastrous kind of merger or acquisition?

Don't expand beyond what you know. If you're McDonald's (MCD), "Do you want fries with that?" typically works for you. But if you're selling hamburgers and you decide to put greeting cards in the store, that's a stretch. If you're thinking of buying something, don't get carried away by the prospect of how great it is. Task someone with the job of raising the objections: What if the economy goes south? What if sales figures aren't as good as they look? What if a key person leaves? What if we have a culture clash? You need to have somebody who is there just to raise every possible objection.

Why does every company need a naysayer in the ranks?

Because there's a tendency to get moving on something and then constantly confirm that you're right to do it. If you like the idea, of course you want it to be right. But it's important to have some debate and even some role-playing about all the possible things that could go wrong. Companies that do well tend to have a culture of encouraging disagreement.

It seems like that full-time devil's advocate wouldn't be a very beloved person around the office.

No, but what you might do is rotate the role, so one person isn't always the bad guy. The key to making this work is that the instruction has to come from the senior person saying, "Challenge me." And that person can't then give out signals that say they really don't want to be challenged.

What are some of the other key failure lessons?

Technology. It turns out that most people don't understand it all that well. We saw instances where companies bought into a business model based on today's technology and didn't realize it would become obsolete very quickly. So FedEx (FDX), for instance, got into the business of sending faxes for clients, and the company got hammered a year later when everyone got fax machines in their offices.

Jumping in without thorough research can be disastrous, but what about the opposite? How dangerous is inaction?

Often in business, there's a tendency to stay the course and underestimate a competitive threat. This is particularly bad for the small retailer who maybe hears about a Starbucks (SBUX) locating nearby and decides there won't be any negative impact on his business.

In 1981, Kodak (EK) did a huge study on digital photography and decided it would be a serious threat in about 10 years. They never came back to that study, and eventually they completely missed getting in on that market, while their competitors handled the transition to new technology much better.

So the trick is to go ahead and make predictions about how much this competitive threat might hurt you and then keep track. But you have to be honest and don't fudge the numbers. If you're honest, you can keep on top of the situation, and you'll have a trail of evidence to evaluate how much your company is being hurt and what you can do about it.

Are there any places right now where small business owners might take advantage of large corporate failures?

Assets are cheap, and there are some deals out there right now—but again, it's important to be cautious. On the macro level, a lot of mall developers messed up and overbuilt, so this might be a good time to get a deal and get a better space in a mall.

What advice would you give to an entrepreneur today?

People talk themselves into doing things they later realize were stupid. Listen to those nagging doubts, if you have them. Sometimes CEOs live kind of lonely lives. They feel like they can't talk too much, and they feel they have to commit, or else they'll look indecisive. It never hurts to look at history. Try to find analogies locally or in your industry of companies that thrived in previous hard times and those that failed, so you get both sides.