Tag Archives: risk

Risky Compared To What?

There was recently a large MTG tournament here in Denver, and since I know a lot of gamers, several people in my social circle competed, including my partner (who’s been playing since the game was invented and is quite good) and a coworker (who’s 10 years younger, and is just starting to play “seriously”). My coworker played with a “net deck” (one he’d assembled using instructions online), and my partner played a “rogue deck” (one he’d invented himself). And each thought the other was taking a big risk.

Who’s Right?

Well, the first thing to know is that tournament rankings usually look much like this:
A bell curve with net decks in the middle and rogue decks on the ends

That is, net decks are still available online because they’re good decks; they’ve been tested and tweaked by thousands of people. But they are available online, so everyone knows about and prepares for them.

The second thing to know is that my partner is one of the best players in the state, and he builds really good decks.

My coworker, with less experience and fewer resources, is unlikely to build a deck that’s better than a net deck; he’s comparing the lower tail to the big hump, and concluding (correctly) that he’s better off with a net deck.

My partner is almost certain to place highly, on the top half of the curve. And up there, the net decks are the poor options — there is simply no way to be the best when you are identical to 20% of your competition. Your only way to stand out from the pack is to be different.

K. So What?

The same dynamic is at work in any sort of competition — including business. On any metric you care to name (price, convenience, quality, safety, etc), companies and products will be distributed along a bell curve like this, with anyone who follows “industry standards” safely in the middle and the differentiation products out on the ends. If you don’t follow industry standards, you risk being below average. If you do follow industry standards, you risk never being above average.

In a game tournament there’s a clear, simple definition of “best” — the person who won the most games. But in business, it’s not that simple… and that’s a good thing. If there was only one “best”, there would be little room for competition, and no way for newbies to break into the field. But that’s not the case. There are lots of definitions of “best”, and you can certainly meet one of them.

Application

Have you done a SWOT analysis for yourself and your entrepreneurial venture yet? You should. But for the moment, I just need an internal analysis, because we need your strengths and weaknesses.

For your weaknesses — things that you’re worse than average at — you’d do better to copy the competiton, and get yourself up to average. Read blogs, check out books, call an expert, call your networking aprtners, or whatever, but move yourself towards what the rest of the industry is doing.

For your strengths — things that you’re better than average at — it’s possible that industry standards are holding you back. Take a look at everything you do in that department and ask yourself why you do it Because you’ve found it to be good? Because you think it might be good? Because everyone says you have to do it that way? And regardless of why, what results do you see from it? Do you think it’s the best you can do, or do you think a different approach might work better?

Then experiment… slowly. Industry standards, like net decks, are still around because they are good. Most exist for some reason. So you don’t want to throw everything away. You just want to try a few new things, see how they go, and try a few more.

And if you’re just starting, and don’t yet know your strengths/weaknesses? I advise you to give them some consideration — your personal strengths are the best place to start an entrepreneurial venture, and you’ll really want to know them. Take online quizzes, read StrengthsFinder 2.0, talk to your friends, talk to your coworkers, and do some journaling. But as a starting assumption, you can use the industry standard for everything, and adjust as you discover what you do well.

Resources for Further Reading
Play It Safe — and Experiment
Risk Analysis

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Dangerous or Gutsy?

Scenario:
You and some friends are on a tour in the African savanna, enjoying the scenery and the wildlife, when an angry rhinoceros charges the vehicle. There’s a rifle on the seat next to you with enough power to stop the rhino. Do you

    a) Scream and cower in terror?
    b) Grab the rifle, take aim, and shoot?

Please note that this is a scary situation. Sitting up straight, taking careful aim, and shooting steadily will require a lot of courage. It’s a gutsy thing to do.

But it’s also the safest thing to do. If you miss, you’re no worse off than if you hadn’t tried, so there’s no downside risk. If you hit, you’re a lot better off than if you hadn’t tried, so there’s a lot of potential upside. You’re clearly better off doing the gutsy thing.

And… how does this relate to business?

We tend to associate “gutsy” stuff with “dangerous” stuff. And sometimes that’s true: going over Niagara Falls in a barrel requires guts and is dangerous. But sometimes, as in the rhinoceros example above, the “gutsy” decision is also the least dangerous decision.

And that happens in business sometimes, too. Buying enough factory capacity that you can actually meet demand, shipping a product you know isn’t quite as good as you’d like, or starting a blog in your free time… all of these take courage, but are, objectively, the best, smartest, safest decision.

Recognizing which ideas are dangerous, and which are gutsy-but-good, is one of the most important skills you can develop.

Resources for Further Reading
Intelligent Risk Taking
Risk Analysis

Play it Safe — and Experiment

In Learning From Your Competition, I discussed what things you can learn from your competitors, including what price, which promotions, and which combinations of products are most likely to be effective for your business. But if your business just copies what other businesses do, why should any customer go to you? This is especially true on the internet, where “Just like Facebook, only different” has repeatedly proven a recipe for failure.

What your competition does is safe

Nonetheless, copying the competition is a good place to start your entrepreneurial ventures, because you know there’s a market for what they’re selling. If you offer a product that’s basically the same as your competitors’ most popular product, at a price that’s the average of all their prices, using the same promotional methods as they do, you’re pretty much guaranteed to sell some of it.

It’s a low-risk choice, but it’s also a low-reward choice: since your offering is essentially identical to everyone else’s, you’re relying on the vagaries of fate to randomly steer some of the customers in your direction.

Once you’re safe, then experiment

With your solid base of safe, low-risk products, you have a relatively stable platform from which to explore. Now start experimenting.

Experiment with new products, or product combinations. Would your customers like these new items? Would they like the deluxe edition? Instead of buying products individually, would they like a subscription?

Experiment with prices (the people who select the MSRP are just guessing, too). If you put this on sale for 10%, does it increase the number of sales by more than 10%? If you increase prices on this one by 5%, how many people still buy it? What does it go for on eBay? Does it make sense to have different prices at different times of the day? Different times of the year? In different locations?

Experiment with delivery. Does it make sense to open another location? To offer home delivery? To create e-products that can be sold everywhere? Will customers pay extra for quicker delivery or more efficient locations?

Experiment with promotions. Is advertising the best method? What about networking meetings, or a booth at local events, or seminars at your local library? Are your customers on Facebook? Would they like to receive information via text message or email?

Keep what works, get rid of the rest

Eventually you’ll have a fantastic marketing mix — product, price, distribution, and promotion — that is great for your customers, and gives them a reason to bring their money to you.

Resources for Further Reading
Seth Godin on Competition
Risk Analysis

Pessimism vs. Realism

Excessive pessimism is as blind to reality as excessive optimism

My MBA class this term, instead of dragging us all into a classroom and forcing us to listen to lectures, is based around an online marketplace simulation — something like if the creators of Sim City decided to create Sim Startup. We’re at the point in the game where our company needs venture capital, so we’re selling shares of our company in order to raise money. And the question is, how much is a share of our company worth?

Well, that answer depends on a lot of things. How much money do we have now? How many other assets do we have now? How much money will we have in 90 days? How many sales will we make? How much will we spend? All kinds of things that we may or may not know the answer to.

Business Requires Guesses

So you make a guess. In Risk Analysis, I discussed making a low, a high, and a medium guess.

The Pessimist assumes that the low guess is accurate.

The Pangloss assumes that the high guess is accurate.

The Realist assumes that the middle guess is most likely to be accurate, but is prepared for any of the three.

Pessimism is not Realism

Pessimists like to justify themselves (and obliquely attack you) by calling themselves “realists”. But in fact, pessimists are just as blind to reality as optimists are — sometimes more so.

Sometimes bad things happen. Pessimists understand that.
Sometimes good things happen. Pessimists forget, ignore, or disbelieve that part. And by doing so, they miss out on a lot of opportunities.

Both bad and good are part of reality. So a realist must take both into account. A realist must be prepared to bail if things go badly, and must be prepared to run with success if things go well.

An Object Lesson

Early in this term, our company decided not to spend money to increase our factory capacity. It was felt that we should have extra money on hand, in case bad stuff happened.

When we went to market that quarter, our brand was enormously popular. We had 75% market share — everyone wanted our products. But we were only able to provide a few of them: of the 265 who wanted our brand, 182 of them walked away empty-handed. Our company was so prepared for the bad stuff that we weren’t prepared for the good stuff. We lost hundreds of thousands of dollars in sales, and made our potential customers very angry.

Pessimism is not always the best approach.

Risk Analysis

When you’re writing a business plan, one of the things your investors would like to know is how much risk you’re taking. It’s possible that you might also want to know.

A brief diversion into game theory

As I type this, I’m sitting at a tournament of Magic: The Gathering, semi-eavesdropping on a conversation between two of the lowest-ranking players in the tournament.

“That takes you to 10 life. Then next turn I can draw a Chalice and you won’t be able to play your cards, and I’ll win.”

It’s a good strategy as far as it goes. Chalice of the Void is a good card, and it does cause a lot of problems for his opponent’s deck. But he’s relying on an awful lot of luck. What if next turn he doesn’t draw a Chalice? What if his opponent has a way to get around the Chalice and still play cards? What if his opponent wins this turn, and he never gets a chance to draw a card? If any one of those things goes wrong, he’s in trouble.

A Pithy Mantra for Strategy

In The Vor Game (a wonderful series if you’re into philosophical sci-fi), Miles Vorkosigan is given advice on planning a military campaign:
“The key of strategy, little Vor, is not to choose a path to victory, but to choose so that all paths lead to a victory. Ideally.”

That is, it’s good to have a plan based on what you think is most likely to happen. But it’s better to have a plan for anything that might happen… and best to have a such a plan that leads to success in all cases.

OK, so I should…?

Make a plan

While you put together your plans, write down the things you know for sure. This is mostly confined to things that you’re going to do (you can be pretty confident that you’re going to run an ad in the newspaper or that you’re going to pay your workers $7/hour), but may include information you have from others on what they’re going to do.

Take a guess…

Then, for each thing you have to guess, make your best guess based on the data you have. This could include the number of customers you’ll get (based on the number of people who will see your ad or the number of people who drive by this location), the weather where your products are made (based on NOAA’s forecasts), or whatever. Calculate how you’d do if those numbers were correct. Will you be making money? Will you be making enough money?

…and cut it in half…

Now take all of those numbers, and cut them in half. Assume you’ll get half as many customers, or that they’ll pay only half as much as you thought, or that you’ll only get half as much product as you expected. How would you do if those numbers were correct? Will you still be making money? If not, how much do you lose? What can you change in your plan to accommodate and mitigate those problems?

…and double it

Now take your original best-guess numbers and double them. Assume you’ll get twice as many customers as you thought, or that you’ll get twice as much product as you expected. How would you do if those numbers were correct? Would you be able to meet demand? Would you have enough employees? Would you have space to hold the extra inventory? If not, what can you change in your plan to accommodate and mitigate those problems?

And synthesize it all together

You don’t want to act as if your half-as-much or your twice-as-much numbers are accurate when your best guess puts it right in-between. It’s silly to cut expenses for a customer drop you haven’t seen: all you do is guarantee that your customers will in fact drop. And it’s silly to buy storage space for inventory you don’t have; it may never come.

But if you know what you would have to do, you can keep yourself more flexible. You can buy your advertising in 3-month chunks instead of paying for the full year upfront (in case you need to cut expenses). You can keep an extra $1000 on hand to pay for a storage unit if necessary. And the things that remain the same in all three plans you can implement with confidence.

Risk Analysis, not Risk Elimination

Depending on your business, your industry, and your situation, your half-as-many numbers may look pretty bad. Your twice-as-many numbers may also. This method doesn’t guarantee that you’ll have no risk. It only tells you how much risk you’re taking on, letting you know upfront what you might be getting yourself into. You have to decide for yourself if you’re ok with those consequences.

Resources for Further Reading
My Business Plan Isn’t Feasible
Tactics vs Strategy