Why 9 Out of 10 New Firms Fail, And Why it Won’t Be Different in the CBI Industry

This article was submitted by Phil Fumas

The CBI industry has experienced stellar growth in past years. While a few years ago there was only a handful of firms in the industry, Investment Migration Insider puts the number today at over 400. Low barriers to entry, interesting margins, and a growing number of high net worth individuals have attracted many to the business, and new companies are formed frequently.

History and research tell us, however, that most new companies fail.  This is especially true during a hype phase, as we are experiencing in the CBI industry: Any outsider observing the space will recognize a “gold-rush” mentality. Similar trends could be seen in the DotCom bubble of the late 90s and the current state of frenzy in the crypto-currency realm.

This is the cold hard truth every entrepreneur or investor needs to be aware of. Some statistics put the number at nine failures out of every ten startups, i.e. at 90% – or even more. The reasons for failure are many, but there are certain recurring themes:

·        firms run out of money (cash flow is more important than profitability)

·        the team doesn’t have the right capabilities

·        they have no clear vision or strategy

·        regulation catches up with the business

While getting off the ground is hard, it seems even harder to properly fly. Verne Harnish, author of the well-known book “Scaling Up” states that only 6% of companies are ever able to hit 1 million USD in annual revenue. Why don’t companies manage to scale up? According to Harnish, the key factor is complexity: as you add employees, the complexity in organizations tends to grow exponentially, necessitating the need for more rules, procedures, etc. Overcoming complexity requires solid leadership, a strategy, and empowerment.

The question remains; will it be any different in the CBI industry? And the answer should probably be: why should it be any different?

The regulatory writing on the wall

Perhaps most relevant to the CBI industry is the threat of industry regulation, and lack of strategy and vision for most businesses in the sector. Alongside topics such as the Panama papers, tax evasion, and refugee flows, the CBI industry attracts attention and consequently regulation.

As the CBI industry becomes increasingly regulated, it is clear that only those adhering to the highest standards will have any success going forward. Since so many CBI programs require the blessing of governments, and in some cases, the blessing of other governments (i.e. the USA in the case of the Caribbean), it is clear that the barriers to entry are increasing.

Solid government relations require upfront and sustained investment most smaller firms simply cannot pre-finance. At the same time, expertise is hard to copy and gives incumbents an advantage. Similar to technological advantages of larger IT companies, smaller firms in the CBI space do not have the track record required to gain the trust of governments.

Additionally, many clients come to established players in the industry through referrals from prior clients. This “word of mouth” effect is particularly pronounced in circles where confidentiality, privacy, and trust are highly prized. Not being able to out-spend the competition with more effective marketing is thus an additional barrier to entry for new firms. Even if they were,  it may not work anyway as brand loyalty is often particularly important in such circles.

Surviving ≠ thriving

Even if they do make a dent and survive in the CBI industry, scaling-up will be even harder to do for new companies. Running a global operation at consistently high standards is no easy task for any organization, but when dealing with sensitive client data, different time zones and demanding clients, the task becomes even harder to manage.

At the same time, the threat of cyber attacks grows with increasing success, necessitating more investment in solid IT policies and infrastructure. Even today, we still see some firms loading their entire client and contact lists onto unsecured online mailing services to do direct mailing campaigns – practices like these do not inspire confidence in clients or serious intermediaries.

Finally, there is a certain network effect apparent in the most successful CBI companies (the network effect is why services like Uber become better over time, as they attract more drivers, which attracts more passengers, which attracts more drivers, etc.). Older companies in the CBI industry have assisted more clients, thereby generating more word of mouth.

Governments, on the other hand, want to partner with service providers that can deliver the most clients, and who have teams to actually implement what is being promised. Thus, the more clients a service provider can bring to a government, alongside expertise and capacity, the more likely they are to win the contract with a government. Likewise, the more government programs a company can offer, the better their chance of attracting more clients, and so on…

This all goes to show that being a start-up in this industry is no easy feat and no different from other industries. The CBI industry is ripe for consolidation, with many smaller firms being regulated out of existence or partnering with larger firms. No doubt, we will see interesting times ahead.