Why Failure Is A Normal Part Of Business

Published in Investing on 5 April 2012

The binding relationship between success and failure.

"Be not ashamed of mistakes and thus make them crimes." -- Confucius

Everyone makes mistakes; this comes with being human instead of a machine. The goalkeeper who lets in a goal that Geoffrey Boycott's granny could have saved knows this only too well, as does the golfer who loses a major by missing an easy putt.

Businesses also make mistakes, such as the "improvements" to an existing product that make it worse and cause customers to go elsewhere. Failure is much more common than you might think and, in some industries, it is a normal part of doing business.

Even Apple sometimes fails

Any business that constantly relies upon new product launches is sooner or later going to experience failure because there is no such thing as a cast-iron guarantee that the public will like what you are offering.

Given some of the current media coverage, you could be forgiven for thinking that the current stock market darling, Apple (NASDAQ: AAPL.US), always gets it right. Yet in the mid-1990s Apple was on the verge of bankruptcy after a series of new products failed to capture the public's interest. While success tends to breed success, it isn't guaranteed.

Dud movies

Most Hollywood films lose money so the studios' business model relies upon the successes more than compensating for the failures. Unfortunately, sometimes the failures are so expensive that a single film can end up ruining a studio, as happened when the losses on Heaven's Gate destroyed the old United Artists.

Nowadays, the industry likes to reduce the risk by making sequels, remaking popular films and adapting bestselling novels because these all come with an in-built audience. It may not work, but it reduces the chance of a big flop. Another way in which they reduce the risk is to share it by having several studios provide the funding for a film.

But nothing can insulate the studios from the reaction of the public. A good example of this is John Carter, the latest picture from The Walt Disney Company (NYSE: DIS.US), for which a very poor opening weekend in America had led to reports that Disney was going to take a $200 million loss on the movie.

However, overseas ticket sales have since outstripped all expectations, no doubt in part because some people have become aware of the film thanks to the negative publicity, and some analysts have suggested that it could even make a profit! Big investors in the movie business probably don't sleep too well at times like these.

Plugged and abandoned

Another sector that is notorious for costly failures is oil and gas exploration. Drilling is a risky business at the best of times because the typical wildcat well fails to find commercial quantities of oil and gas.

So failure is built into the business model, and even the most successful oil explorer sooner or later has to tell its shareholders that a well has been "plugged and abandoned", three words that will usually cause its share price to fall sharply when the market opens.

The pharmaceutical industry is another sector where failure is inevitable since few of the more promising drugs in the early stages of development ever make it to the market. Shareholders in AstraZeneca (LSE: AZN) know this all too well as in recent years a string of new products have failed clinical trials or have subsequently fallen foul of regulators.

Businesses that are less prone to failure

One way to reduce the chance of failure is to look for companies that don't rely on developing new products. These tend to be companies whose products aren't easily affected by technological change and have exceptionally popular brands.

I am about as certain as I can be that Diageo (LSE: DGE) will be selling more alcohol in 50 years time, while the world will be buying more consumer goods from Unilever (LSE: ULVR). Many of these companies' brands have been on the market for over a century and it would take a huge amount of time and money to displace them from the minds, and thus the shopping baskets, of the world's consumers.

But I can't say that any information technology company, even the likes of Google (NASDAQ: GOOG.US) or Facebook, will still be in business in 2062. That's because history tells us that companies like these are just one competitor away from losing most of their market share, as happened to once dominant firms like AltaVista and MySpace

Reduce failure by building on success

Many businesses reduce the chance of failure by introducing new versions of existing products, as this lets them build upon a successful brand. Food and drink companies often do this by trying out a new flavour, such as Cherry Coke, or changing the amount sold in a pack like the smaller tins of Pringles you can find in your local supermarket.

By doing this, they hope to build upon their existing customer base as well as attracting people who are aware of their brand and thus might be persuaded to try a different version of a product that they currently don't buy.

But sometimes this fails because the change is seen by existing consumers as forcing them to reject the existing brand.

The Coca-Cola Company (NYSE: KO.US), maker of the world's most popular soft drink, found this out the hard way when it launched "New Coke" in 1985. Even though consumers preferred New Coke to Coca-Cola and Pepsi in taste tests, the adverse reaction in the marketplace meant that the company eventually withdrew it.

Happily for shareholders, the resulting publicity had caused sales of Coca-Cola to rise, which is a rare instance where failure is turned into a success!

> Get the latest on investing and the markets, direct from the desk of David Kuo. You'll also receive a special free report on '10 Steps To Making A Million' if you join The Motley Fool Collective today.

More from Tony Luckett:

> Tony owns shares in Diageo, AstraZeneca and Unilever. The Motley Fool owns shares in Google.

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