(Second in a 3 part installment)
A Google alert steered me to an article called “Beating the Odds When You Launch a New Venture” that had just come out in the May issue of Harvard Business Review, authored by Clark G. Gilbert and Matthew J. Eyring. It was one of the best pieces Iʼve ever read about entrepreneurs, their attitudes, and management of risk. They said that entrepreneurs arenʼt cowboys—theyʼre methodical managers of risk.
I thought their concepts applied equally to small and big business. I contacted one of the authors, Clark Gilbert, to discuss his ideas and decided I wanted to share his thoughts with my small business friends. The result is my interview (below) with Clark.
My comments follow his answers and are primarily addressed to small business owners.
Clark Gilbert (firstname.lastname@example.org) is the president and CEO of Deseret Digital Media and was formerly a professor at Harvard Business School.
5. BR: Can you explain your thesis that “Risk and Value are inversely proportional?”
CG: Think of a chart where every time you take a unit of risk off the table, you increase a unit of value. Thatʼs how risk works in a new venture. A venture that has multiple rounds of investment demonstrates this effectively. Every key risk the entrepreneur takes out of the venture increases the value of the venture in the next round of funding. The challenge for entrepreneurs in corporations or non-profits is that they do not have this interim scorecard. But it is there in principle and managers who embrace this will be more successful with their ventures.
BR: Everything you say is also true for small businesses. For them, every risk taken off the table increases their chance for survival and profits. Small companies do not have the cushion to absorb a risk gone wrong that larger corporations have. Risk reduction or avoidance should have a larger priority.
6. BR: Can you briefly explain the three types of risk you refer to that have to be dealt with?
CG: Let me focus on the first two. Deal killer risk is the type of risk that if left unresolved will kill the venture. Some entrepreneurs make the mistake of waiting until pretty far into the life of a venture before removing this type of risk. In the article we talk about the example of a satellite radio company pouring millions into a satellite system only to discover the receiver was prohibitively expensive. Path Dependent risk is risk that once resolved might change the subsequent direction of a venture. For example, working on product pricing might fundamentally change your manufacturing strategy. Resolving the one will shape the other.
The problem is, many managers proceed as if all risk is equal. Hereʼs the problem with that approach. Suppose you donʼt look at a deal killer risk until youʼve spent millions on a new venture. Or you spend millions on one risk that becomes irrelevant upon future information. That is why we talk so much about sequencing risk in a way that recognizes that all risk is not equal.
BR: The third type of risk, according to Mr. Gilbert, are ones that can be resolved without spending a lot of time and money. They are not as crucial as the Deal Killer and Path Dependent Risks, but if not addressed could lead to a serious problem. Not every risk in this category can be addressed prior to your venture formation or youʼll never get started. . .nor can every one be discovered until you are in business. However, your success chances are improved if you deal with them. You should try to prioritize them.
7. BR: How does an Entrepreneur with limited cash go about the process of identifying the different risks his venture will face?
CG: The fact that you have limited cash should make you more focused on identifying risks. You can start by asking questions like, which risks, if unresolved, could threaten the entire venture itself? Which risks will impact others? Which risks are the easiest and cheapest to resolve?
BR: I would also challenge all assumptions in planning the business, like your projected sales and how fast they will occur, expenses that you may not have anticipated, particularly those in acquiring customers, and your basic reasons why customers will buy your product or service. If any of your assumptions are seriously flawed, an unforeseen risk is awaiting that you may not have the resources to resolve. I would look for free outside help in addressing these issues.
8. BR: In your experience, how much change of direction does an average start-up company employ in their first year of operation and in subsequent years?
CG: There are a number of academic studies in this area. Most will show you that most new ventures have to change multiple times before getting on the right path. At Deseret Digital Media we have a huge poster that says: “We adapt”.
BR: My experience and studies show that almost all business plans dramatically change as the business progresses. Many of the opportunities you envisioned do not materialize and many new unexpected ones appear. Write your business plan in pencil.
9. BR: Expand on your thesis of investing in stages to maximize success.
CG: The key is finding points along the way to pull back and readjust. Staging capital often forces readjustment (so does running out of money). Imposing milestones, where key uncertainties will be resolved or managed, forces learning early in a venture. When resources are scarce this is forced. When resources are not scarce, the entrepreneur must impose discipline. A staged approach can help this.
BR: In my experiences, testing was always paramount in introducing a new product or starting a company. . .no doubt motivated by lack of cash. Never start out nationally or globally. Test your product in a small geographic area for customer acceptance and to tweak your offer and/or product. If itʼs a product, make a prototype and show to prospective buyers. If all say no, rethink whether to proceed or re-engineer the product or offer. Test on the Internet, direct mailings, ads, etc., in small inexpensive doses. Staging allows you to set measurable goals that need to be met before proceeding to the next step and its resource commitment.
Part 3 Continued Next Week…