Risk is Not Uncertainty
Author and decision making expert, Douglas W. Hubbard makes a clear distinction between risk and uncertainty.
What is uncertainty?
“Uncertainty: The lack of complete certainty, that is, the existence of more than one possibility. The “true” outcome/state/result/value is not known.” According to Hubbard’s definition, uncertainty often concerns future events that are difficult to predict. In most cases, we just simply don’t know how the events will unfold.
- Will it rain if you set your wedding date in 12th June next year?
What is Risk?
Hubbard defines risk as follows:
“Risk: A state of uncertainty where some of the possibilities involve a loss, catastrophe, or other undesirable outcome.”
In situations of risk, it is possible to assign probabilities to each outcome occurring.
- “We believe there is a 40% chance the proposed oil well will be dry with a loss of $12 million in exploratory drilling costs.”
- If you tossed a fair coin many times, it would come down heads half of the time.
The 3 Kinds of Risk Startups Face
A startup is an inherently risky business. Founders should aim to reduce uncertainty and measure risk to increase the chances of success of their startup.
According to Ash Maurya, the three most common risks related to a new venture are product risk, customer risk, and market risk.
Product risk (or invention risk) refers to whether or not the team can actually build the product they have envisioned. In this case the riskiest part of building a business is the product itself. However, if the product can be built, there is a very high probability that customers will be eager to buy it. As Steve Blank put it: “Markets with invention risk are those where it’s questionable whether the technology can ever be made to work, but if it does, customers will beat a path to the company’s door.”
A few examples:
- An effective cure for cancer.
- Developing COVID vaccine.
- SpaceX: building reusable rockets that can safely reach orbit and come back to Earth.
Customer risk asks if there are people out there who will actually want to buy the product. As Eric Ries famously said, today, for most businesses, the greatest question isn’t “Can we build it?” but “Should we build it?” At the beginning of a startup journey, we often don’t know whether there are a large number of customers who will buy the product.
A few examples
- If we build yet another social network platform, will people use it?
- We have built a special kind of running shoes for pregnant women. Will they buy it?
- We developed a new mobile app for busy teenagers preparing for exams. Will they use it?
Finally, market risk measures the viability of the overall business model and whether or not it can be profitable. It is not enough to have a great product and have customers who use it. We need to make sure that we can build a healthy business around that product.
A few examples
- Spotify is a great product, and lots of people use it. It operates based on a freemium business model. However, the company needs to ensure enough customers will upgrade to a higher-tier service and start paying for it.
The concept of product, market, and customer risk deeply resonates with a design thinking concept called the “Desirability-Viability-Feasibility Triad”. In order to be successful, an idea must be functionally feasible; we need to be able to actually build that product. The concept needs to be financially viable; we must be able to build a profitable business around the product. And last but not least it needs to be desirable for our target customers to buy it. Successful innovation to happen, all three conditions are necessary.
Distinguishing between these three risk factors can be a very helpful tool in the hands of an entrepreneur. It can help us consider the idea from many different angles and focus on the overall viability of the business. By understanding and measuring these risks, founders can make more informed decisions about their new venture and give themselves a better chance for success.
- Maurya, Ash. Running Lean: Iterate from Plan A to a Plan That Works. Germany, O’Reilly Media, Incorporated, 2012.
- Dorf, Bob, and Blank, Steve. The Startup Owner’s Manual: The Step-By-Step Guide for Building a Great Company. United Kingdom, Wiley, 2020.
- Hubbard, Douglas W.. How to Measure Anything: Finding the Value of Intangibles in Business. United Kingdom, Wiley, 2014.