It’s not the size of payoff but the size of worst case that drives some entrepreneurs

In the past I wrote about the difference between the mind of an analyst and that of an entrepreneur,

It is impossible for someone who rationally estimates net present value of all options, stress tests their assumptions, meticulously conduct sensitivity analysis, determines market sizes and customer demands to start a new venture. (Dan Ariely calls this Optimism Bias, Gavin Cassar attributes this to selection bias)

Corollary: To start a venture one needs to be risk seeking and at the very least be willing to suspend their  rational mind to make the leap.

A research conducted by Saras Sarasvathy, Assoc Prof at University of Virginia points to evidence on how entrepreneurs evaluate outcomes, that it turns out it is indeed different from the methods of a rational decision maker,

Sarasvathy interviewed 45 successful entrepreneurs, all of whom had taken at least one business public (see caveat at the end of this post).  It was not the planned outcome, carefully constructed from comprehensive business plan and understanding of customer needs that drove these founders. They started with resources they had and imagined the possibilities.  Instead of estimating the size of rewards from a venture from successful outcomes or the likelihood of such outcomes, they asked, “what is the worst that can happen if they failed”.

If the failure was not all that bad they went right ahead.

In fact the failure is indeed not bad. Another research conducted by Pfeffer of Standard GSB, found that

Few of the participants in entrepreneurial activity suffer significant consequences from unsuccessful decisions, and therefore many players have less incentive than one might expect to improve their decision-making  – VCs get guaranteed principal and Entrepreneurs often, although not always, are working with other people’s money, so their financial downside, except in terms of the opportunity costs of their time, are also limited

Since entrepreneurship is already viewed and accepted by all as a high risk activity, failure is not only accepted but glorified as example of risk taking.

It’s not the size of payoff that drives them but imagining what is the worst that can happen. And it appears the worst case is not worst at all.

Caveat: Sarasvathy interviewed 45 successful entrepreneurs whose venture went public and more importantly agreed to talk to her for her study. Clearly there is survivor, selection and availability biases here. The results are also based on the conversations with those entrepreneurs which is prone to hindsight and narrative biases.

Take this for what it is worth.

We need regulations because our original business plan didn’t consider these disruptions …

A Cajun food cart in a food cart cluster in SE...

For anyone studying business model disruptions, a rich case study is unfolding across the nation, from coast to coast, one food cart at a time. Let us not make this a culinary argument and look at this purely from business perspective. If you have not been following the stories here is a summary,

Food carts are restaurant on wheels. They come in all flavors and with clever names (Curry up now). They are showing up in office parks and business districts, catering to the lunch crowd. And that is the problem for traditional  brick and mortar restaurant owners – the trucks are right at their doorsteps and eating their lunch (pun intended). The restaurant owners don’t like it!

Let us look at this in two parts to see the disruption. As I am wont to do, let us start with customers.

Customers/Customer Needs: Anyone with money to spend during lunch is a customer. Why are some willing to give up the sit down comfort and service of restaurants and try food carts? There is no one reason, there are always utilitarian and emotional reasons and it is the degree of intensity that varies for different customers.

Some were hiring the restaurant just to satisfy their hunger and they are happy to hire any other service that does the same job faster/better/cheaper. Some hire the restaurant for the experience but not likely all the time. In some cases they may be hiring the food cart just for the novelty and experience.

If you look at the comprehensive list of purchasing occasions you will find there were enough jobs for which the restaurants were hired only because there was no alternative. When food carts arrived the customers are happy to fire the inferior candidate and hire the new one.

The Incumbents: The restaurant owners had a nice run. Their product was hired by customers for lots of jobs even though it was not the right fit. Do not get me wrong, there are many other jobs for which restaurants are the right fit and rightly capture their share of the value add. But the rest of their customers incurred higher transaction cost for the value delivered. These segments were right for picking by anyone. Restaurants were however only too happy to serve the same product at the same price to all their customers and now see that advantage vanish.

Their reaction can be summed up nicely by the comments made by their rep in KQED’s Forum interview,

“Our original business plan did not take into account these food carts taking away our customers”.

Isn’t this a luxury every business would like to have?

That is the core problem. Disruptions don’t telegraph their arrival. Uncertainties are the unknowables. You can’t ask for protection because of your failure to model these uncertainties.

If disruptions these are the unknowables how can they model these?

There is really only one way – starting with customer segments and asking what jobs are the different segments hiring your product for.  If your product is not the best candidate for each one of those jobs it is currently hired for it will be disrupted. The flip side of my earlier statement, “anyone with money to spend is customer”, is , “anyone goes after that money is your competitor”. And they do that by doing the job faster, better, cheaper.

If the customers hired your product  only because of lack of alternatives are they really your customers to begin with?

Your failure to focus on customer needs cannot be fixed with newer regulations to stop the disruptors.

We all hear about customer loyalty and the need to focus on increasing loyalty. Loyalty cannot stop disruption. If you do not want to be disrupted it is you who should show loyalty – loyalty to the job your customer hired your product for, doing the job better than anyone else can.

Ten Questions To Ask About Any New Venture

Here are ten questions I ask when I talk to my entrepreneur friends, the questions follow from the framework of business strategy, customer needs and Go-to-market strategy:

  1. What jobs will your customers hire your products for?
  2. Who do they hire now, i.e., who do they have to fire first?
  3. What are their alternatives?
  4. How much will they pay for it?
  5. What budget will that come from and how big is that budget?
  6. Where do they post the job opening?
  7. Where do they look for candidates and can you go there without considerable costs?
  8. What is their hiring process?
  9. What will they find compelling about your product’s candidacy?
  10. Will the job exist two years from now?