January 10th, 2018
Challenges Facing Startups during Unfavorable Economic Environment
Starting a new venture during an economic crisis presents unique challenges for the entrepreneur. One of these challenges is acquiring the right amount of financing for an effective startup. For instance, a large startup would require a high proportion of external financing, which might not be available during economic crisis (Cassar 273-276). Harsh economic conditions reduce the willingness of financial institutions to lend to SMEs since such an environment increases the effect of information asymmetry on lending for the financial institutions (Cassar 263). The lack of sufficient information about the SME increases the risk of lending for the financial institutions, hence making them to demand substantial amounts of collateral to lend to the SMEs (Cassar 263 – 265). For start-up firms, the lack of information is aggravated by absence of previous performance records. Accordingly, entrepreneurs who start their entities during periods of poor economic crisis face heightened barriers in accessing credit, a factor that could impede a successful launch.
Despite the challenge in accessing financing from the financial institutions, other forms of financing may help the entrepreneur to survive even during a period of economic crisis. For instance, Schwienbancher points out that entrepreneurs faced with capital constraints can achieve success by initially focusing on achieving intermediate, small-scale goals, which subsequently attract venture capitalists to their SME’s (760). Venture capitalists are an important source of financing, with their financing being associated with an accelerated growth of start-up entities (Davila, Foster and Gupta 704 – 705). Accordingly, despite the inaccessibility of bank financing for startups during economic crisis, entrepreneurs capable of achieving a small growth with their savings are likely to attract significant sources of finances for future expansions. Such a scenario indicates that the success of the entity is not only dependent on the financing but also other aspects such as the entrepreneur’s capacity to manage scarce resources to meet short-term goals. A period of economic crisis presents an opportunity for the entrepreneur to demonstrate such capacity.
Another challenge that entrepreneurs face during economic crises is enhancing the effect of their marketing activities. Economic crises adversely affect individual and household incomes as firms embark on labor cuts to survive the crisis (Keynes chap. 18, n.p.). Such lowered income affects the individuals’ purchasing power thus influencing their purchasing decisions. For instance, changes in income significantly affect the demand for non-essential goods (Case, Fair and Sharon Oster 102). Even for essential commodities, a decline in income could affect the quantities purchased, thus adversely affecting the revenues for such entities (Case, Fair and Sharon Oster 100-101). Establishing effective marketing strategies during such periods may thus require application of substantial resources that the startups may not have. Such a scenario would favor the survival of existing firms who have the capacity to offer customers benefits such as discounts and free samples on their purchases.
Although economic crises may affect the marketing outcomes adversely, such crises may also aid entrepreneurs who have a better value proposition to establish a strong relationship with customers. Customers have been shown to have a heightened concern for the value they get during recessions, as evident from purchasing behaviors such as increase in purchase planning, price consciousness and increased patronage of cheaper brands for goods such as clothing and grocery (Hampson and McGoldrick 1 – 8). Due to such a concern, marketing strategies advanced through the mass media may fail to generate the desired effect of spurring purchases. This presents an opportunity for startups to lure customers to their relatively new brands and foster customer patronage by encouraging word-of-mouth promotion. During their early stages, startups could for instance foster customer patronage of their products by establishing and sustaining an interactive forum through the social media (Fisher 190 – 194). The social media platforms offer a cost effective method for resource-constrained entities to reach their target market and enhance the word-of-mouth promotion by the customers (Hoffman and Fodor 46 – 47).
Harsh economic conditions also present a challenge of developing the entity’s talent due to a focus on cost reduction over the duration of the economic adversity. For instance, Hofer argued out that firms facing financial distress should engage in asset reduction, cost reduction and revenue generation strategies (cited in Papaoikonomou, Segarra and Li 113). Accordingly, with restricted financial resources, and lack of access to external financing due to economic adversity, startups could find it difficult to invest in employee development thus affecting their ability to compete effectively with competitors who have established talent-management systems. Cost reductions involving employee retrenchment could however offer startups access to experienced labor at fair prices. When entities result into retrenchment as a cost-cutting measure during economic crises, startups can secure the services of such retrenched workforce at lower rates due to a lower demand in the job market. By utilizing such workforce, the startups would avoid the costs associated with training new employees thus helping them to enhance their capacity to compete with established firms.
The challenges that entities face during economic adversity highlight that opportunities could arise for startups even during such periods. The challenge for startups arises in managing their scarce resources effectively to ensure survival of through the period of the crisis. In the subsequent section, this paper discusses the strategies for startups and SMEs to survive through economic crises. Go to the conclusion here.