Big Business Vs Entrepreneurs: Small business Failure Rates
Just how hard is it establish a new business, and compete with businesses that dominate an industry? Let’s look at American style football. The NFL, the National Football League, is America’s dominant sports franchise, first established in 1920. In 2006, the NFL had total revenue of over $6 billion, leading all other sports leagues in the world, although Major League Baseball was fast approaching the same level of revenue. In addition to having its own TV Network (the NFL Network), it’s games area also shown in prime time on all four major networks. The Championship Game, or Super Bowl, is watched by over 100 million people in the US and around the world. Let’s take a look at some of the challenger’s to the NFL’s dominance.
Far and away the most successful, and the only challenger to eventually be integrated into the NFL, was the American Football League (AFL), established in 1960. Keep in mind that in 1960 the NFL was not the dominant, extremely sophisticated organization it is today, so early challengers had more hope for success. The AFL operated independently until 1969, at which point its 10 teams became the American Football Conference division of the NFL. The AFL was a threat to the NFL right from the start, signing half of the NFL’s first round draft choices in 1960. The merger was announced in 1966, but not finalized until 1970. Competition between the two leagues began with a championship game in 1967, although the term “Super Bowl” was not used until the third championship game in 1969. The NFL teams easily won the first two championships, but the third was a huge upset victory by the AFL New York Jets over the NFL’s Baltimore Colts, made particularly noteworthy by Jet’s quarterback, and notorious playboy, Joe Namath famously “guaranteeing” victory before the game, played at the Orange Bowl in Miami, Florida.
Remember the World Football League? Probably not. Founded by Gary Davidson in 1974, with the ambition to bring American style football to the world, the WFL only made it to 1975. They managed to sign some big name former NFL players, including Miami star running backs Larry Csonka and Jim Kiick, as well as receiver Paul Warfield, for the then astounding sum of $3.5 million for the trio. Other well known players who signed on included quarterbacks Ken Stabler, Daryl Lamonica, and Craig Morton, as well as running back Calvin Hill. The league did not lack for stars, and, at first, things looked bright, with attendance in the first few weeks a very respectable 43,000 on average, but it turned out that most of those tickets had been given away or sold for very low prices. The league quickly started running out of cash, with reports of players having to be fed by local citizens in Portland, and the team in Charlotte having its uniforms impounded for not paying a laundry bill. The day after the 1974 “World Bowl”, the champions’ uniforms were confiscated by sheriffs deputies. Nonetheless, a new season began in 1975, but only two of the previous year’s teams returned with the same owners in the same city. The league folded mid-way into the 1975 season.
Then there was the USFL (United States Football League). It lasted three years, from 1983 to 1985, and was the greatest challenge in recent times to the dominance of the NFL. The USFL was created by David Dixon, who, although an antiques dealer by trade, had been instrumental in bringing the NFL franchise New Orleans Saints to his hometown. He studied the idea carefully, over a period of 15 years, commissioned a study, and watched the results of the WFL. Dixon had a realistic outlook, which included preparing owners to endure years of losses, which is typical for most new businesses. He signed deals for TV coverage with ABC and with ESPN, and the president of ESPN, Chet Simmons, even signed on as the league’s first commissioner. Despite the credibility and extensive planning, once the league started play in 1983 there was immediately a great deal of franchise instability, with some franchises moving, and others flirting with insolvency.
Like most of the NFL challengers, instability among the franchises was a major problem with the USFL, due in part to the fact that, like most sports leagues, the USFL was not really a single business, but a collection of businesses; each team owner in the new league was responsible for making sure his team was solvent. Among many other issues, getting leases to play in stadiums, often in competition with existing NFL teams, was often a problem. Teams moved, owners went bankrupt, or got into disputes with each other. Nonetheless, the USFL introduced a number of innovations that have since been adopted by the NFL. The USFL introduced the two point conversion, instant replays to challenge officials’ rulings, and the salary cap. Like the WFL, they also signed a number of big name NFL stars, including Herschel Walker, Craig James, Doug Flutie, Mike Rozier, Reggie White, Jim Kelly, and Steve Young. In this way, they made a mistake that continues to this day; the idea that brand names can make a league or franchise. (The Washington Redskins of the NFL, under owner Dan Snyder, are a casebook example of this mistake signing both players and coaches based on past glory rather than future promise. Those attempting to popularize soccer in the United States with past-their-peak stars like Pele and David Beckham are other examples).
The USFL followed a familiar route to failure. Owners, including Donald Trump, anxious to win, and perhaps, in this case, excited by short term passion than long term profit, evaded the salary cap, and spent more than could be justified, draining coffers. Thus more capital was needed, and rather than follow the well thought out business plan, the owners started selling franchises in areas, like San Antonia, that could clearly not be successful. Like the WFL, the league might secretly have been hoping to merge its teams with the established NFL, and, like the WFL, failing that, they filed an antitrust suit against the NFL. While the jury agreed that the NFL had, for practical purposes, a monopoly, they also found that the NFL did nothing to prevent the USFL from getting television coverage, and that most of the USFL’s problems were due to its own mismanagement. It awarded the USFL only one dollar in nominal damages, which was tripled under antitrust law to three dollars. The USFL finally received a check for $3.76 in damages in 1990, the additional 76¢ representing interest earned while litigation had continued. (As the technically winning party, the USFL was also reimbursed for millions it had spent on attorney fees.) With $160 million in debt, the league folded shortly after losing the case. In addition to the innovations adopted by the NFL, many USFL players went on to successful careers in the NFL; a USFL kicker, Sean Landeta, was still playing in the NFL in 2006, more than twenty years after the USFL’s last game.
The Arena Football league was next. Played indoors, and on a smaller field, Arena football was founded in 1987 by Jim Foster, who had worked both for the USFL and NFL. The Arena League is the only NFL challenger still operating, but on a small scale; its average attendance is just over 12,000 per game, as compared to over 67,000 per game in the NFL. Until the late 1990s, about the only exposure for the AFL on TV was on late night, tape delayed ESPN broadcasts. As with all start up leagues, they have been plagued by franchise instability, for example, the New York CityHawks moved from New York to Hartford to become the New England Sea Wolves after two seasons, then after another two seasons were sold and became the Toronto Phantoms, who lasted another two seasons until folding. The AFL is probably best known as the home of Kurt Warner, who played for the Iowa Barnstormers before moving on to the NFL and leading the Los Angeles Rams to victory in Super Bowl 34. There are currently 17 AFL teams: Like the XFL, the teams now begin their season after the Super Bowl, hoping to provide continuity for fans after the NFL season ends, rather than competing head-on with the NFL.
The XFL was founded by Vince McMahon, owner of the hugely successful WWF, World Wrestling Foundation, known more for its theatre than its sport, but very profitable. The XFL lasted only one season, 2001, despite a promising start. Like the USFL, the XFL had a major network, NBC, as its partner, guaranteeing the all-important television coverage. A major difference with previous challengers was that the XFL was structured as a single business, with the league owning all the teams, rather than the league serving as a cooperative body for competing franchise owners. Springing from his wrestling background, McMahon developed a cruder and even rougher version of the NFL, with trash talking public address announcers and cheerleaders dressed even more provocatively than those of the NFL. While the NFL has made major efforts to broaden its base and cater to female fans, the XFL was still very much designed as a man’s game. The teams had names like the Las Vegas Outlaws, the New Jersey Hit Men, Orlando Rage, and Chicago Enforcers. Political correctness was a not a prime concern. Perhaps most emblematically, instead of a pre-game coin toss, XFL officials put the ball on the ground and let a player from each team scramble for it to determine who received the kickoff. From a business standpoint, the league was designed to fill a void in the football schedule, with the season starting after the Super Bowl, and competing with winter sports like basketball rather than with the NFL.
The first XFL games had high viewership on TV, probably due to the novelty factor, but thereafter ratings dropped off sharply. The league was also burdened by the fact that due to McMahon’s background as a promoter of staged wrestling matches, and the fact that he owned all the teams, there was a question as to whether games might be fixed or manipulated in some way to make them more exciting. By the standards of pro sports, salaries were very low, and fixed by position, with quarterbacks earning $5,000 a week and most other players earning $4,000 a week. Former professional wrestler Jesse Ventura served as a broadcaster for some of the games, in addition to his day job as governor of the state of Minnesota. By the end of the season ratings had dropped so low that The NBC telecast of the Chicago/NY-NJ game on March 31 received a 1.5 rating, at that time the lowest ever for any major network primetime television broadcast in the United States. The league folded after the end of the first season, on May 10, 2001. A number of XFL players went on to play in the NFL and Canadian Football league, and the NFL “borrowed” a number of XFL innovations, just as they had done in the case of the USFL. These included the use of the sky-cam, miking up players, and interviews with coaches during games.
We’ve covered the more serious contenders to the NFL’s dominance; they have all generally had very substantial, if not adequate, capital, good TV coverage arrangements, and players that were good enough to, in many cases, succeed in the NFL. There have been many other attempts that have not made it nearly as far. How about, for instance, the WPFL (Women’s Pro Football League), which competes with the NWFA (National Women’s Football Association). Or the American Professional Football League, founded in 2003. Or the Intense Football League, founded in 2004, the American Indoor Football Association (2005), United Indoor Football Association (2005), Continental Indoor Football League, (2007), World Indoor Football League (2007), All American Football League (2008), United Football League (2008). The list goes on.
There is a viable league in Canada, which does not really compete with the NFL. The Canadian Football League, or CFL, is relatively small, having only 8 teams, as compared to the NFL’s 32. Nonetheless, it is Canada’s most popular sporting league after the National Hockey League. There is NFL Europe, but that is, obviously, part of the NFL and serves as the NFL’s attempt to spread American style football around the world. Of course, there are many successful “football” leagues throughout the world, but almost all of those outside the US are playing what Americans call soccer. Of the many domestic challengers to the NFL, it appears that not a single one has ever been profitable, with the possible exception of the American Football League before it was incorporated into the NFL. No challenger has managed to succeed as an independent league of any consequence. Many of the challengers rule changes and other innovations have been copied by the NFL, and many players have gone from the NFL to other leagues, and vice versa. But, from a business point of view, despite the fact that Americans clearly love football, and the NFL has provided a template for success that has been copied by others, the business of challenging the NFL has been a complete failure.
As you can see from the example above, it is far harder to succeed as the founder of a small, new company, than to take over an existing organization. Statistically, within four years, most new businesses will have ceased to exist, with most fail within the first two years. We believe those statistics actually dramatically understates the failure rate, as the great majority of small business startups are never tracked for statistical recording purposes. The commissioners of the NFL have, no doubt, been smart, hardworking men, but, generally, the challengers to their dominance have also been smart, hardworking men. The great majority of new companies fail within a relatively short time, and this failure rate has little to do with the quality of the people creating those start-ups; it is simply the nature of new things that most will fail: many businesses are not adequately capitalized. Consumer preferences are notoriously hard to predict; the constantly shifting tides of macroeconomics and politics impact every new business. But more than anything, people are creatures of habit, and those used to watching NFL games, and following certain teams, will continue to do so, absent huge incentives to act otherwise. While large companies do implode or go bankrupt, it is the exception rather than the rule, as they have a base of customers, employees, investors and others who have a vested interest in seeing the company survive, and this forms a stabilizing influence.
Many corporate managers are inept, yet they often personally make huge fortunes even if the company they manage loses money and decreases in value. During 2007, it became almost routine for a large financial institution to reveal that it had lost billions by investing in subprime mortgages. The stock of Countrywide Financial, the United State’s largest mortgage lender, lost at one point in 2007over 80% of its value; yet the company’s CEO, Angelo Mozillo, made well over $100 million selling his shares of stock in the company. After losing $2.3 billion in the third quarter of 2007, Merrill Lynch, the largest brokerage firm at the time, fired it’s CEO, Stanley O’Neal, who walked away with $160 million in stock, stock options, and other benefits, not including the $35 million bonus he had been paid just nine months earlier. The CEO of the world’s biggest bank, Citigroup, was fired about the same time, and also received an outrageously high bonus as a reward for failure.
Someone who starts a small company and fails typically loses their own investment, and perhaps capital invested by others, but a start up entrepreneur is hardly ever rewarded for failure. While huge payments to the leaders of large corporations are the rule, any sort of profit for small, new ventures is the exception. There was a time, during the late 90s Internet boom, when you might routinely read about someone making a fortune from a new company that had yet to show any profits, and was wiped out when that bubble burst in 2000. But profits from start up businesses created as part of manias like the early Internet boom are only a tiny part of the greater universe of new companies.
The difficulty of creating something new applies not only to business organizations; it applies to almost everything, including nation states. One reason that Americans have so much respect for the nation’s “Founding Fathers” is the implicit realization that to start anything, from scratch, especially something that is quite different from what has gone before, is so much more difficult that taking control of an existing operation. By all accounts, the odds were stacked hugely against the founders of the United States, and, like any start up, they should have been expected to fail – and many did expect them to fail. Early on, the very existence of the country was in doubt. But at some point, America passed from new start up to young but established country, and from that point on, even gross mismanagement did not put the existence of the country in doubt. Only when half of the nation seceded during the Civil War did the existence of the country come into doubt again, and, luckily, at that point the US once again happened on an exceptional leader in Abraham Lincoln. If one compares men like George Washington, Thomas Jefferson, Alexander Hamilton, and Abraham Lincoln to more recent US leaders of either party, you can get a pretty good gauge for the difference in character required to start something new versus managing an entity established by others.
One reason why sports have been so successful is because in this respect they are much more like an established business than a start up. Sports is about tradition, and just as Microsoft, IBM, and GE have a CEO, good or bad, and every state has a governor, year in year out, every year there will be a quarterback of the New York Giants and the Dallas Cowboys, every year there will be a group of pitchers for the Yankees, and assorted stars, coaches, and owners of all the thousands of different sports franchises across the country. Sometimes the pitchers, quarterbacks, and coaches will be very good; sometimes not. But the Yankees franchise is over 100 years old, and is not in danger of going away. The Chicago Cubs were founded in 1870, and during their very long history, have won the World Series only twice, in 1907 and 1908. Despite being so bad that they are referred to as the “lovable losers”, there is no danger of the club ceasing to exist, and its players still command huge salaries. Navy’s football team lost to Notre Dame 43 times in a row before finally getting a victory in 2007; no entrepreneur will be allowed so many failures before being forced to throw in the towel.
This is one of the reasons why success in small business is so much harder than success in sports, and why, from a sporting point of view, small business should be viewed with so much respect. While the Cowboys will always have a coach and a quarterback, and while GE, established in 1890, will always have an extravagantly paid CEO, no one really cares whether your new business succeeds or fails and, odds are, it will fail.