Next-Generation Startup Modelling (1)

Although dealing with uncertainty is at the heart of the entrepreneurial method, “Risk Management” is not a popular term in early-stage startup circles. It may be that the term sounds too old-school.

This is not to say that entrepreneurs are ignorant about risk. In fact methodologies like Agile and the Lean Startup can be viewed as risk-based growth frameworks.

As described briefly later in this article, applying risk management concepts revolutionised the world of finance. The Lean Startup movement is basically revolutionising the startup world using risk-sensitive techniques, and I believe there are is still plenty of scope for risk management to improve the startup method.

Professional risk managers distinguish between four risk management techniques, collectively referred to as the “4 T’s”: Take (or Tolerate), Treat, Transfer, and Terminate.

· Take: Intentionally pursue the course of action and fully accept the risks;

· Treat: Carry out actions designed to modify the reality and reduce the risk. Actions may be focused on organisational, human, policy, operational, or supervisory factors.

· Transfer: Pass the risk to another party. Examples include insurance and outsourcing.

· Terminate: Don’t do it.

Glyn Holton argues eloquently for the inclusion of a fifth technique that he refers to as “Investigate”, but in one’s view investigation is something that should be done as part of “Treat”, and in one’s experience many organisations handle investigation as part of “Take”. And “4T + I” doesn’t sound neat.

Financial markets, starting in the early 70’s with the popularisation of the Capital Asset Pricing Model and the emergence of the Black-Scholes option pricing model have developed sophisticated vehicles for Treat-ing and Transfer-ing risk.

Many of these are financial derivatives, the most common being futures, forwards, options, and swaps.

So much for financial risk. Most “cash-light” startup entrepreneurs are not yet at the point where capital allocation is their most pressing headache. The more fundamental question is how to minimise the risk of wasting time and energy.Life is too short to build something nobody wants”, as Ash Maurya says.

For the purposes of this article we shall refer to time/energy wastage as “friction”. Three questions are being explored:

· What can startup entrepreneurs learn from risk managers about minimising frictional losses generally?

· What can entrepreneurs learn from the financial markets about minimising friction specifically through Treatment or Transfer?

· What new products and services could result from applying this knowledge?

The emerging lexicon on the startup method (heavily influenced by the contributions of Frank Robinson, steve blank , Eric Ries, Ash Maurya, Marc Andreessen et al) identifies the first two key phases/challenges of building a successful startup as: achieving Problem-Solution Fit (“PS Fit”) and then achieving Product-Market Fit (“PM Fit”).

In these early stages, minimising the frictional component inherent in learning from potential customers while fine-tuning the product tends to be the big challenge.

According to Eric Ries: “Startups that succeed are those that manage to iterate enough times before running out of resources”. The goal is to iterate to PM Fit.

The major frictional components that will be encountered in the journey from Idea to PM Fit can be summarised thus:

PS Fit

1. Defining a low-risk way to prove the idea will work before committing fully.

2. Finding early adopters.

3. Using feedback from early adopters to get to the first useful version of the product;

PM Fit

4. Establish processes to support continuous refinement towards PM Fit ;

5. Figuring out the appropriate sales model.

In the next article we’ll explore how risk management techniques could be applied to these five challenges.