You might think that the most successful entrepreneurs on this planet got where they are today by taking huge risks. Some of them got lucky, others didn’t. While luck indeed does play a crucial role in achieving success, there is another component I recently discovered. It seems counterintuitive at first but actually makes a lot of sense. I am talking about de-risking your options.
More Risk = More Reward
What is true for investments, where higher risk is usually compensated with higher return and therefore more risk offers more reward, is also true for the business and startup world. But as with any investment, you can think about how you can de-risk your choices while still keeping the upside as high as possible. That’s what I want to talk about in this short article.
Richard Branson marvelously practiced the strategy of derisking when launching Virgin Airlines. He saw a business potential but wasn’t sure if it’s going to work. Instead of just blindly investing and hoping for the best, Branson was looking for ways to cap his downside. So he was able to negotiate a deal with Boeing to return the airplanes he bought in the early days at no cost if the business plan didn’t work out. Here’s what Branson said about this on the Tim Ferriss podcast: “Look, I promise that I’ll only go into the airline business on one condition and that is if I can persuade Boeing to let me hand the plane back at the end of the first year to protect the downside. So I knew the worst that could happen would be to lose six months of the profits of Virgin Records if it didn’t work out. Boeing agreed to it.”
Think about the worst scenario of your new business idea or business decision you are currently facing and understand what the worst possible outcome is. Then think about ways to mitigate this worst result by negotiating special deals, setting yourself a specific timeline e.g. trying something out for 6 months and kill it if it doesn’t work. You focus on the downside rather than the upside and try to cap the maximum risk you could get there. At the same time, you most likely still have a significant upside, even if it’s just a testing period or a pilot project that you launch. That’s exactly the scenario you want to be in.
A real life example from a startup
Now it’s time to focus on a real life example from a startup I was able to consult over the past months. When the corona crisis hit, many small businesses were caught off guard and either had to suspend or even close their business activities. One company I was working with during that time was active in the fitness industry. Their product was a physical fitness installation that was being sold to gyms. Unfortunately, due to the corona lock down, the gyms were closed and not open for any business and people had to stay at home.
Now you think, people stay at home, so we should develop a version for the home market so people can train at home. This is not what the product was designed for but it is an obviously logical way of thinking about the chances and limitations in the current corona crisis. The only issue: This means quite some heavy upfront investing to adapt the product and software to a completely new market in a super short period of time and without having any proof if the new, adapted product will work. So the investment and time commitment that is required to pull this off as fast as possible is significantly high. The potential upside on the other hand, by not knowing how many people will buy this and having low revenues per customer is pretty limited. This is basically the last situation you want to be in.
A good way of handling this situation is thinking about how you can derisk the downside, the huge upfront investment of time and money while still keeping a relevant upside potential. One way to go would be to launch a landing page, explaining the home product there, before it is even built, driving traffic to the site (e.g. through your own email list or some social media ads) and giving people a chance to preorder the product. If you hit a certain number that justifies and compensates for the upfront investment, you give it a go. If you don’t, you reimburse every single person that preordered from you and apologize for not being able to go ahead with the planned product launch. That way, you can test the upside potential while limiting your downside risk.
As you see, successful companies and entrepreneurship are not so much about taking huge risks, but thinking about how you can mitigate and cap your downside while still having a significant upside. The application of this strategy of risk mitigation allows you to stay alive longer and take more bets than just a single big one. That way you are more likely to find success along the way, and out of different experiments and tests you run an upside you can capture and a successful business you can build around this opportunity. So the next time you face a tough business decision, ask yourself how you can mitigate the risk while still keeping a relevant upside potential in the equation. Happy derisking 🙂