Why Startups and Scale-ups Fail Internationally -- Top Three Reasons

Robert P. Mollen, Counsel at Fried, Frank, Harris, Shriver & Jacobson (London) LLP

A couple of weeks back I wrote a blog on 12 challenges that companies face in scaling internationally. http://bit.ly/2zWG1tx

Jens Lapinski of Techstars suggested that I could more usefully approach this topic by writing about why companies fail when they expand internationally (actually, Jens was more polite than that, but ….). Fair point.

I’ve previously discussed ways to avoid international expansion disasters http://bit.ly/AvoidingIntlDisaster, but I accept that something more pointed and timely could be useful.

So here are my top three reasons that startups and scale-ups fail when they expand internationally.

By the way, startups and scale-ups are not alone in making these mistakes. Many large incumbent corporations have made the same mistakes. Incumbents also are more likely to make poor acquisitions of foreign targets (a problem that most emerging companies, scaling organically, can probably avoid).

The main difference, though, is that the incumbents, being better capitalized, are more likely to survive their international failures – startups and scale-ups may not.

1. Hiring the Wrong People and/or Failing to Integrate Them

It is really difficult to recruit cross-border – both in terms of finding the right people and then properly making them part of your organization. http://bit.ly/RecruitmentMistakes In my experience, this is the most common reason why emerging company international expansions fail. In fact, on any list, it should probably take the top 3 places. It is, of course, also a key reason why domestic scale-ups fail http://bit.ly/ScaleupChallenges, but the risks are even greater on a cross-border basis.

To briefly recap:

On the hiring side:

  -  You are not likely to be very good at evaluating the capabilities of someone from a different culture, and distinguishing puff from substance.

  -  You face a significant risk that your applicants will be people who are interested in you because they can’t get jobs with domestic companies.

  -  Headhunters paid on a commission basis may have incentives that are different from yours.

  -  Candidates who have only worked for large incumbents may not be able to transition to an environment where they lack the brand and support of a large organization.

On the integration side:

  -  These folks are not you, and they will not become you simply by your giving them an appropriately-colored tee-shirt.

  -  While it is costly to have your new hires spend a lot of time in your home office, or for one of your founders to spend a lot of time in your new international operation, having the operation drift along and fail is more costly.

More specifically:

I think a majority of the start-ups that I have helped with US establishment would acknowledge that they have hired the wrong first business development or sales lead. A significant number have hired the wrong second business development or sales lead.

Why were these folks the wrong people? I can’t really distinguish those cases where the initial recruitments caused the problem from those where the issues involved a failure to integrate.

However, the success stories I’ve seen have all involved both careful recruitment (preferably with some time to get to know the candidate before the commitment to put them in the foreign office is made) and focused integration. Indeed, a good option, if available, may be to hire foreign nationals for your domestic operations, and only send them to open the foreign office after they have proven their capabilities.

In a different vein, I once spoke with a company that had sent much of their tech development to a Eastern European team that was solely focused on doing that company’s work (on a virtual in-source basis), but the company then had to bring the work back to the UK. Was this because the team lacked the necessary technical skills, I asked? No, I was told, they just didn’t understand what was required. Did the CTO, who was based in the UK, move to the relevant city or spend a lot of time there? Well, no …. So, without appropriate integration, how could that ever be expected to work?

2. Undercapitalization

Expanding internationally is expensive. It is one thing to run a business on a shoestring with a core startup team. Hiring competitively in a foreign market is a different matter, and those costs in some markets (such as the US) are likely to be materially higher than you may be accustomed to in your home market.

It also is likely to take significantly longer than you might expect for an investment in a foreign market to become self-sustaining. Take a look at your projections, and consider whether it would make sense to assume the breakeven point takes twice or three times as long.

Also (and this is a broader point), be realistic with your projections in the first place. I frequently see five year projections from emerging companies that show a “hockey stick” in years 4 and 5. Sorry, but I don’t believe it. For example, my experience with B2B SaaS businesses suggests that, for those that are successful, the exponential growth typically starts after year 5, as the company gains credibility and momentum from a base of solid growth in the first five years. Of course there are exceptions, like Stripe, but they are exceptional – not the norm.

Additionally, as discussed further below, you are likely to make mistakes/missteps in a foreign market, and you need to build recovery from those into your time frame.

Consequently, when considering your investment needs, conservatively take into account what you will need to fund your international expansion. Also, make sure that you have a plan B in the event that your expectations for the business are not realized.

3. Misjudging the Market

Entrepreneurs frequently assume that their businesses can expand internationally without adjusting their business proposition. They spot what they think is a gap in the foreign market, not realizing that there may be reasons why competitors have not filled that space.

So humility is important. When expanding internationally, emerging companies need to be sure that they understand relevant differences between their home and host markets that may affect the suitability of their offering, and need to test their assumptions with advisors who have local knowledge. Developing a business savvy network in the host market can make all the difference.

There are many examples of incumbent companies that have gotten this wrong when expanding internationally. The most public failures are in B2C businesses: 

  -  UK grocer Tesco failed in its effort to build its Fresh and Easy mini-market business in the United States. Studies by Harvard Business School and others have given many reasons for this failure, including a failure to understand the impact of the California car culture. It seems clear in any case that Tesco rolled out the Fresh and Easy concept widely before coming to understand what was working and what was not.

  -  Pret a Manger failed when it first launched in New York, and the whole business made a loss in 2003 because of the US expansion. It closed most of its stores. When it relaunched in New York, it adjusted both its food and coffee. In the words of the former commercial director, "We learnt that you can't just plonk a UK retail success into a different environment."

  -  Best Buy’s US big box store format did not work in many foreign markets, where, among other things, customers preferred smaller stores or a different product mix. Walmart, Target, Home Depot, Carrefour, Starbucks and a large number of other retailers have also burned their fingers in foreign markets by failing to understand local consumer preferences and expectations.

  -  eBay’s ecommerce site lost out to Chinese competition when it first launched there, reportedly in part because it didn’t offer instant messaging between the customer and the seller in a culture that highly values that communication. Groupon is another example of a company whose business model did not work in China. Indeed, a large number of US tech companies have failed in China, for a variety of reasons.

Emerging companies lack the resources of a Tesco or Walmart to recover from international mistakes. That makes it all the more important that they manage the risk of their international expansions by not over-committing resources until they have had a chance to test their assumptions. Entrepreneurs are often concerned that they will lose “first mover advantage”; however, there are many examples where, in fact, it is the second, third or later entrant in the market that has taken the prize.

Conclusion

This blog has the same tag line as my last one. Expanding abroad is risky. Don’t just jump in and assume it will all work out. You can’t eliminate the risks, but you can reduce them through appropriate management.

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This discussion is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions or comments, feel free to contact [email protected].

You will find a listing of Bob’s weekly startup blogs on US and international expansion and early stage financing here: http://bit.ly/StartupGuidesIndex