John wants to start a business.
John has been to restaurants. John likes restaurants. John has always thought it would be excellent to own his own restaurant.
Like most people, John thinks restaurants are a proper business. Not like the risky tech businesses that kids are into these days.
Everybody eats, right?
Wrong call, John. Restaurants are spectacularly bad businesses. There are two main reasons for this.
- High competition.
- Limited upside.
Competition is not great. But it's still possible to build a decent lifestyle business on a fiercely competitive market.
Limited upside is worse.
Limited upside means you sign up for the pain while limiting the amount of good stuff you can get back. Not smart.
This is what it looks like.
The upside is limited in case of a restaurant. You can only serve X number of customers per day and make X amount of revenue. Let’s say $10,000 per day.
Now let's take another example — a startup. In most cases, the upside is virtually unlimited. If you choose the right market and combine luck and awesome execution, there’s almost no limit to the gains you can make.
The negative scenario in both cases is similar — you part ways with your savings, many years of your life and a girlfriend.
A successful startup will change your life. A successful restaurant? — I 'm not so sure.
You should always aim for opportunities that have a limited downside (how much you can lose) and an unlimited upside (how much you can gain).
Why do people choose a capped upside?
Why people are more likely to choose options with a limited upside is the higher overall probability of success of this single option.
The probability of an average restaurant ever making money is let's say 25%. For an average startup, it's more like 10%, and that's generous.
Even though the expected payoff of a startup is higher, on the surface, it looks like restaurants are a safer bet. People naturally want to avoid failure, so they go for the safer option short term.
But careers don't consist of single options. If you look at your career as a whole, it will be better to take many options with unlimited upside and count on one of them ultimately being successful.
One big fat payout is what we should be aiming for.
The total amount of value you can create this way wildly exceeds the capped return and safer single option route.
The negative side is that you will have to go through more failure along the way before achieving a successful outcome. Emotionally challenging, but a better overall strategy for maximizing value.
Never go bust
This strategy only works if you can avoid going bust along the way. What going bust means is that you lose your ability to make more bets, take more options — losing all of your money, reputation, etc. It does not necessarily mean going bankrupt. This will almost inevitably happen at some point in your career.
Going bust is more likely with a restaurant than with a startup because of the personal financial guarantees you have to give to get started. That's why restaurants mostly have an uncapped downside.
In the startup world, the options are distributed by venture capitalists and angel investors, who choose the companies they want to fund (they will be there to share the pie if it turns out all right). In startups, founders usually take limited personal financial risks compared to starting a restaurant.
There is one rule — never go bust, you need to keep playing.
Unlimited upside does not have to necessarily mean a venture scale business with tons of funding, thousands of employees, and 16-hour days for years on end. You have to be a crazy individual to want to live a life like that.
The same principle can be applied to a lifestyle business. Build small(er) businesses with high upside and low downside.
A personal blog can be a good “option” to take.
The maximum downside is the time you spend writing. The upside is that millions of people will read your blog and you will be able to turn it into a sizable personal income that will support your lifestyle.
Starting a niche e-commerce site, publishing books on Amazon, becoming a YouTuber. All of those options have a limited downside and virtually unlimited upside. Not venture-scale businesses, but the potential upside would be life-changing for most of us.
You can apply the same logic to everyday business decisions.
Let's say your goal is to increase sales. You can spend a week doing direct outreach to customers or a week writing some relevant blog posts. The downside in both cases is spending a week of time. The upside is different.
If your blog post succeeds, it can bring in customers for years to come. If it wildly succeeds, it can take your business to the next level. But the most likely outcome is that nothing great happens short term, and it will not have an impact on this quarter's results.
A week of direct outreach is undoubtedly more predictable. You can be quite sure you’ll create some results when you put in the time. But the upside is limited and directly connected with the hours you put in.
Both of those options make sense at certain times. Which route you should pick depends on the situation.
Keep your eyes out for options that have a limited downside and unlimited payoff. Take them as frequently as possible and be patient will the payback. It will take many failures, but over time it's inevitable that one of them is going to pay off. It's important that you don't go bust and keep playing.