Monday, October 28, 2013

Profit Driver #1: RISK

“To get profit without risk, experience without danger, and reward without work, is as impossible as it is to live without being born.”
― A.P. Gouthe

This first profit driver is a no-brainer for everybody and common wisdom is full of references about risk as an important way of accruing future gains in business.

In particular, start-ups are, by their nature, extremely risky undertakings. If you ever doubt this, try getting a bank loan based on a start-up business plan. Ok, I'm glad we've cleared that up :)

In a start-up, uncertainty is the only well-known attribute: you don't know exactly who is your customer, you don't know what is the actual need of that customer, you don't know how will you satisfy that need, you don't know if your product will ever work, you don't know if your team will hold during the runway phase, you don't know how long your runway really is.

Let's take the possible risk responses according to the T-A-R-A framework:
- Transfer - can you really transfer the start-up risk? Not really. I'm not aware of any insurance policy for this, other than the normal practice of ringfencing the start-up from other profitable endeavours you might have (if possible, protect your personal assets in the same way).
- Avoid - sure, you can simply cop out and forget we ever talked.
- Reduce - you can share the risk by going through seed rounds and accept contributions (cash and advice) from other VC's or investors. Since you know this will dilute your equity, you know then that reducing risk means also reducing possible future benefits.
- Accept - and that's the only interesting scenario that I want to bring up in this blog entry.

Once you've chosen to accept the risk of entrepreneurship, you might as well just manage it!

Strictly from that point of view, the lean start-up methodology is just that: a very smart risk management methodology for start-ups.

Let's just look at the main chapters of Ash Maurya's excellent book, Running Lean:
1. Document your plan A
2. Identify the riskiest parts of your business model
3. Systematically test your business model

If you want to build a low-burn start-up (and who wouldn't?), you have to read Ash's book. This is one book that compels you to take notes as you read it :)

The lean start-up methodology is grounded in the scientific method: you formulate falsifiable hypotheses (i.e. formulate them in a way they can be explicitly negated as a result of experiments), continuously test them (if possible, in caeteris paribus conditions), learn about customer responses from those experiments and seamlessly incorporate them in your next product iteration.

The more you can rinse and repeat this learning cycle, the less risk and waste will be incorporated in your start-ups early life. The lean start-up methodology teaches you to systematically navigate through the start-up's unknowns, discover them and translate them into your unique advantages in the newly discovered marketplace. Your assets.

On Assets (as Profit Driver #2), next week.