Musings on Entrepreneurship and Innovation
Wednesday, July 05, 2006Why Most Companies Fail
Not long ago, I stumbled upon Paul Oremerod's book, Why Most Things Fail: Evolution, Extinction & Economics. Ormerod, the former head of the Economic Assessment Unit of The Economist magazine, paints a really interesting picture of the failure of species and business firms. He concludes that failure is pervasive, primarily a by-product of the interaction among firms, and inevitable. Although our efforts to understand and anticipate do have value - particularly in the earliest, most uncertain days of a firm's life - there appear to be real limits:
...the probability of failure, or extinction, is known to be highest when the company is first formed. It then falls away rapidly. After a short time, just two or three years, the probability of failure in any period of time is then unrelated to the age of the firm...Very basic mistakes...weed out very quickly those least adapted to survive. Soon, however, the value of more experience falls to zero. No matter how long the firm has survived, beyond the initial danger period the probability of failure in the immediate year ahead is virtually the same. Perhaps more surprisingly, there seems to be very little connection between the size of a firm, once the first few fraught years of existence are passed, and its probability of survival in any given period.
Yet another reason to suspect that stocks or other long positions (e.g., employment) in established firms may be overvalued while option positions (particularly in young firms) may be undervalued. The world seems to be an even less certain place than we think.
