When Thomas Watson, the founder of IBM, observed that success lies on the far side of failure, he was preaching a double sermon. The first lesson is the need to persevere through all setbacks. The second is equally important: learn from your mistakes.
They can yield far more value than rejoicing in success. That's why another American entrepreneur, Royal D.Little, entitled his book How to Lose $100 Million and Other Useful Information. The ability to analyse one's own errors, and correct them, is an indispensable, highly instructive part of the entrepreneurial kit.
Sometimes this means making the best of what initially seems a very bad job - like the company whose brand-new product, thought certain of success, was losing money heavily, making no impact in the market and causing extreme stress and overwork. The disaster flowed from a common error: extrapolation of the past into the future.
That can prove fateful even when the future is very recent. The company had experienced strong demand in this particular market segment in the preceding months. As the new product, designed to cream off more boomtime sales, was launched, the market went dead flat. The company had been misled by looking only at its own sales.
In its resulting predicament, thorough homework, wrongly absent before, showed that of three alternatives - battling on regardless, closure, or tweaking - only the third made economic sense. By scaling down production and attacking a different market segment, first-year losses would be kept to £50,000. Breakeven next year would be followed by £100,000 profit in the third.
So it transpired. Better still, the product surged on to dominate its segment and become a highly profitable market leader. The plans could be scaled down without loss of opportunity - simply because the original segment offered none. So beware of extrapolation - and never neglect that homework.
In another, sadder case, though, efforts to recover from unwise extrapolation became self-defeating. The start-up, a service business, had expanded to the limits of its existing offices. Market conditions looked buoyant, and a move to larger premises seemed sensible. But instead of cutting overheads, by moving to a cheaper area, the company took on much bigger and dearer offices.
Recession, hitting its business and savaging the value of London offices, delivered a double whammy. The more the firm tried to cut insupportable overheads, by subletting and cutting staff, the more its business suffered. It was chasing its own tail - the same fate that's overtaken some major companies, which have become leaner and meaner, all right, but also less able to compete.
So keep the ratio of fixed costs to turnover as low as possible. The attack on overheads is easily relaxed when business is booming, and the boom is being extrapolated into the future. If the breakeven point where income covers costs rises too high, not only will profits be inadequate, but the business will be highly vulnerable to any downturn.
On the other hand, having low-cost offices over a pub, say, with tiny staff and big ambitions has dangers of its own. As in another real-life example, it encourages the proliferation of low-profit activities. This company was undertaking far too much activity at far too tiny a return. So, even though the breakeven was low, it couldn't get past the vital mark - and failed accordingly.
So always work to high gross margins. The two latter examples provide another warning. There wasn't enough room to learn from failure and proceed to its far side, success. It's hard for a small company, especially when going well, to ask what's the worse that could happen, and what must be done if the worst (as it sometimes will) comes to the worst.
That isn't the same as prudent budgeting. Time and again, boards accept budgets which look immensely prudent compared to the previous year's wonderful rise in sales and profits. But the budgeters have merely aimed off from the extrapolated past. Just as dangerous, they're still in an upside mentality, which affects decisions as well as costs.
Nobody likes to present pessimistic forecasts. But adverse future trends won't disappear for being ignored. Nor will past failures - so exploit them. After all, they've cost plenty.
