PRINCIPLE 8

Successful Entrepreneurs Are Not Risk-Takers; They Are Calculated Risk-Takers

Here’s a question most of my students get wrong, and you likely will too. (Don’t feel bad; just about everyone answers it incorrectly.)

Ready? What is the number one characteristic of an entrepreneur? (Hint: If you read Principle 5 carefully, you know.)

The vast majority of my students—and everyone else I ask—usually say, “They’re risk-takers.” If I’m feeling generous, I’ll reward my students with partial credit for this answer, but I probably shouldn’t.

The number one characteristic of successful entrepreneurs is that they are Calculated Risk-Takers. The difference between risk-takers and calculated risk-takers is the difference between failure and success.

Risk-takers bet it all on one roll of the dice. If they fail, they fail spectacularly—and in such a way that they don’t live to fight another day. They literally go out in a blaze of attempted glory.

This is not what the best entrepreneurs do. They figure out a way to reduce risk with every step they take. They follow the Act. Learn. Build. Repeat. model that we talked about in Principle 4 and they take small steps toward their goals. Before they take those small steps, they figure out a way to minimize their modest investment even further. They ask, “How can I take this step more cheaply (and/or by using someone else’s money); how can I do it faster (so I don’t have to invest as much time), and how can I do it better than I had initially planned?”

Indeed, the process of minimizing risks begins long before you take this first step:

What are others doing wrong?

What are others doing right?

Let’s start at the beginning. Before you make any move to create a new product or service, you want to study not only the specific area where you think you’re going to concentrate, but also the industry as a whole, in order to be able to select a niche where you can excel. (You can see why this principle—which deals with minimizing risks—follows the last one, How to Spot an Opportunity.)

No, you will never know what’s truly going on in a market before you enter it. And no, you don’t want to do a lot of homework, because you don’t want your potential opportunity to pass you by while you are doing research. But before you invest your time and money, you do want to gain a thorough understanding—either by yourself or by creating a team of people who have knowledge of the industry—of what the competition is doing.

Almost always, when I say this, people instantly jump to what the competition is doing wrong and what opportunities they’re missing. And it is, indeed, an extremely important thing to do. You want to find places that they may have overlooked, or could be underserving. The list in the last chapter—where we talked about the importance of upgrading, downgrading, bundling, etc.—could help you a lot here.

What you want to do is find ways you are different.

For example, you run a small hardware store and see that Home Depot and Lowe’s are moving into your neighborhood. Instead of saying, “We’re doomed,” really study their stores. If you do, you’ll see that their very size can be used against them. Sure, they carry just about everything, but it’s extremely difficult to find any one specific item within their acres of selling space and their service—to be kind—is spotty. If you have a helpful staff and carry most things that people need to fix up and enjoy their homes, you should continue to do very well.

And don’t forget to look at what the competition is doing right: that’s another way of minimizing risk. There may be a way to build off what they have already proven to work. This is one of our great strengths at Blue Buffalo pet food company. We now have more than six hundred different product offerings. Most of the ideas stem from our CEO, Bill Bishop, who was also the marketing man behind SoBe beverages. Bill is always keeping his eye on the competition. While I’ve never stopped to count, my guess is that a large number of the ideas for our new products came from an improvement of a competitor’s product.

For example, Blue Buffalo saw that one of the smaller pet-care companies was selling a new kind of kitty litter, one made from wood chips. We started looking into the concept of using wood, and eventually that led us to begin experimenting with crushed walnut shells, which proved to be an excellent deodorizer. Our walnut-based kitty litter is a solid seller for us.

Often people resist borrowing (and then improving) ideas that someone else had first. This is just silly. If your intent is to reduce the chances of failing, why wouldn’t you want to borrow something that has already proven to be successful and improve upon it, taking advantage of your strengths? In Blue Buffalo’s case, once we improve an existing idea, we can plug the product into our distribution networks. Stores are always looking for new products. Blue Buffalo has grown in sales and shelf space by constantly adding new products our customers want to buy.

You shouldn’t care about where the idea was invented if it helps solve your customers’ needs. The idea is to always deliver new products and services as cheaply and simply as possible, with little risk, while providing value that the customer will appreciate.

MORE THAN MONEY IS AT RISK

When we talk about minimizing risks, people instantly think we are talking about reducing the risk of the money they are investing. While this is important, there are six other risks that you should also consider when you’re creating something new:

1. Time. Time is a finite resource, so you want to guard your time as much as you guard your money. Just as you have a dollar figure that would be “acceptable” to lose if the venture doesn’t work out, you want to have a time limit as well. You need to say, “I’m willing to give this idea up to six months to see if it’ll work. After that, I’m going to try something else.”

2. Missed Opportunities. If you’re working to start venture X, you can’t be working on venture Y at exactly the same moment—though Y may be a far better idea. In business schools, this concept is referred to as “opportunity cost”—the cost of not pursuing other things. You want to be mindful of what you’re choosing not to do. You also want to recognize another form of opportunity cost: the price to be paid for not acting right away. Someone else might implement your idea. Then there is the price to be paid for inaction; you might spend the rest of your life in a job you hate because you missed a great opportunity.

3. Professional Reputation. We all have one, although when you’re first starting out, it may be extremely slight. As I’ve said, there’s nothing wrong with failing if the idea you tried was worthy, you were sufficiently committed to it, and you learned from the experience. If you did those three things, then failure isn’t fatal. But, if you’re seen as someone who doesn’t anticipate obvious problems, or who can’t conserve resources and use them properly, that failure can seriously hurt you in the future. You may find it far harder to raise money or even to get another opportunity. Damage to your professional reputation can be a huge loss.

4. Personal Reputation. You don’t want your new venture to be an embarrassment, which could affect your self-esteem or fail to represent who you truly are. This kind of loss is similar to the loss of a professional reputation, but literally it hits much closer to home. Losing your standing with those near and dear to you, or within your religious community or civic group, can be devastating. Unintelligent or frequent avoidable failures are embarrassing and carry psychosocial consequences. Moreover, as we discussed, one of the primary sources of funding for your venture is likely to come from your family and friends. You certainly don’t want to waste their money (and good graces), especially if the money is coming from your in-laws. In addition, the time you’ll be spending on the new venture will keep you away from people you care about, so you want to choose extremely carefully, whatever you plan to do, to make the loss of spending time with them worthwhile. This brings us to the next point.

5. Relationships. Starting anything new is stressful—emotionally and financially. It’s easy for that stress to spill over into your relationships with your spouse and kids.

6. Your Health and Sanity. I wish I were exaggerating, but I’m not. If you’re not careful, the stress of starting a new business can jeopardize both.

Finally, we get to the question of money. Obviously, you never want to waste it. That’s why you do research before you begin, to make sure that there’s an opportunity. This is why you take small steps—to ensure that you don’t get too far off course—once you’re under way.

Again, you only invest the amount of money you and your other investors can afford to lose. But—and this is a huge but—you need to have a Plan B to raise more capital if the situations warrant it.

There are three commonplace scenarios that could cause you to need more money:

1. The venture is taking longer than you thought. That’s why—as mentioned before—I recommend that you budget as if you’ll have no income in the first year and assume that everything will end up costing 30% more than your highest estimate. You want to have a substantial safety net.

2. You are close. You’ve hit on the right path. All the signs are positive, but you need more cash to break through.

3. Things are going better than you could have dreamed and people are asking for additional products and larger orders than you anticipated. You never want to have to say, “I’d love to do it, but I just don’t have the working capital.”

CASE STUDY: PIZZA

The more you look at the stats, the more you are convinced you’re on to something.

Americans eat more than 350 slices of pizza per second.

Ninety-three percent of Americans eat at least one pizza pie a month.

Pizza is a $30 billion-a-year industry.

More people start pizzerias than any other restaurant.

Pizza accounts for more than 10% of all food service sales.

You’re convinced. You’re going to enter the pizza business. What can you do to minimize your risks?

ARE YOU SURE YOU WANT TO DO THAT?

One way to minimize mistakes is by not making them in the first place. A good way to try to do this is to have your employees and advisers give you honest feedback on the ideas you’d like to implement.

We all say we want this, but most of us don’t. As we said before, we want people to tell us that our latest idea, just like all of our ideas, is brilliant. Obviously, that isn’t always going to be the case.

Encourage people to speak up when they think you’re on the wrong track and reward them when they raise reasonable concerns and objections. You don’t have to take their advice, but it would be a good idea for you to think about their objections. People rarely tell the boss he is all wet without seriously thinking about it first.

FOUR TAKEAWAYS FROM THIS CHAPTER

1. Be risk averse. Perhaps the biggest misconception about entrepreneurs is that they’re risk-takers. They are not. They’re calculated risk-takers.

2. Don’t gamble with your future. Risk-takers are not successful, as a rule. The reason for that is simple: they leave too much to chance.

3. Remember: money is the fuel that keeps your organization running. Make sure you have more than enough when you begin, and then manage what you have carefully.

4. Receive honest feedback, minimize risks. If you own a business, I strongly recommend that you create an advisory board (something we are going to talk about in Principle 9) and empower all employees to tell you when you’re about to do something wrong or when they have a better idea (reward them for their candor).