It is a commonly held belief that entrepreneurs are good at taking risk — that as a group they live life on the edge and are willing to risk everything to win in the marketplace.
But research shows that those who start businesses are not always willing to take big risks. What they are good at is exhibiting a tolerance for ambiguity — dealing with the unknown (Bhide, "The Origin and Evolution of New Businesses").
How, then, is risk "managed" in the early stage business? In the book, "New Business Ventures and the Entrepreneur," the authors suggest that entrepreneurs should take conscious and deliberate actions in seven areas in order to control their risks:
Define and understand the business model. This topic was recently addressed in the article, "Let Business Model Guide Decisions," published in the Deseret Morning News on Aug. 6.
Start small. Concentrate on what you do best. If possible, find a vertical market segment that can be exploited and then outsource the components of the business that are not core.
Conduct conscious experiments. Build a prototype rather than the full product. Software technology companies will often develop a "mock-up" of the product, showing screen design and functionality without fully coding the product. Customers are told that they are looking at an early version of the design and are asked for feedback.
Make fixed costs variable costs. On the sales and marketing side of the business, hire sales reps rather than incurring the costs and expenses of hiring and training a sales force. Outsourcing manufacturing can save the costs of capital equipment, buildings and inventory. Once the business model is validated, many of these resources can be brought into the firm.
Manage the nature and timing of commitments. Avoid making big up-front commitments that will force the company to invest large sums of capital while proving the business model. For example, build a prototype of the product and attempt to close a contract, then stage your cost increases into the business that has been booked.
Stage financing. The cost of debt capital can be high for a new business, and the opportunity cost of selling too much equity too early may be the most expensive capital that the business will ever acquire. Organize the growth of the business into stages and acquire only the amount of capital needed to prove out that stage. Typical growth stages for most companies are: proof of concept, completion of product development and initial marketing, start of full scale manufacturing and sales and capital for expansion.
Stay flexible. Most businesses will migrate their plans within a few months of launch. Success comes as you listen, adapt and tweak the product to what the market wants.
I have watched a local start-up company since early spring as it has carefully managed risk while making significant strides toward full-scale commercialization of its product. The founders have designed a hand-held device for the surveying and measurement marketplace. The management team has utilized their capital wisely and has completed the proof of concept, product development and initial marketing phases. An alliance with Hewlett-Packard has now been forged, and a press release from both firms will be forthcoming this month.
The entrepreneurs began by developing a concise and well-written plan that defined their business model. By staying small and conducting marketing and product experiments during the first few months, they were able to keep the founders' capital commitment low. Manufacturing will be outsourced to keep fixed costs down during the early stages of growth. The company is on track for a professional financing round at the right stage: full-scale manufacturing and sales.
Adherence to many of the above principles has benefited this company and will be helpful to other entrepreneurs as they manage risks in an ambiguous market environment.
Gary D. Williams is affiliated with the BYU Center for Entrepreneurship. He can be reached via e-mail at cfe@byu.edu.