This video is a part of our ClassroomX educational series on the nuts and bolts of building a startup today. From defining your business model to growth, product strategy, and building your community, these 15 lessons by domain experts aim to equip young founders with crucial insights to transform their early-stage products into viable businesses.
How to defuse extreme uncertainty?
Successfully starting and scaling a business depends on the ability to make decisions quickly, even when there is uncertainty about factors influencing those next steps.
About Ido Yablonka
As a serial entrepreneur and former software engineer in the Israeli air force, Ido built and exited multiple companies to the likes of Yahoo and Palo Alto Networks. He is currently working on multiple products in cybersecurity and AI, and is an avid mentor and contributor to the Tel Aviv tech ecosystem.
Measuring expected value
The challenge for entrepreneurs is to make decisions in the face of uncertainty. "Our goal as product managers, as product decision-makers, is to deliver maximal product success, maximal value in the face of uncertainty," said Ido.
The goal of entrepreneurs and product managers, in particular, is to understand risk and make decisions based on that knowledge. Startups face several kinds of risks, he added, including market risks, business risks, product risks, and technological risks. These risks, however, are not necessarily bad. "If there is no risk, there is no opportunity for a startup," he said.
To help company founders, Ido provided a framework for business decision-making that takes into account the possible outcomes of any action. For example, a startup creating a new social network platform could be a complete failure, a moderate success, or exceptionally successful. Based on those possibilities, and their respective probabilities, Ido presents a useful mental model to help predict success.
For example, assume the probability that a new social network platform will fail is 60 percent, while the probability of moderate success is 39 percent, leaving a one-percent probability of exceptional success. Each outcome can be assigned a dollar value - the value of a failure is $0, the value of a moderate success is $500,000, and the value of an exceptional success is $1 billion.
With these probabilities and values, entrepreneurs can use a formula to calculate the expected value (EV) of a business venture by summing the probabilities multiplied by the corresponding value. In this example, that is: (0.60*$0) + (0.39*$500,000) + (0.01*$1,000,000,000), or $10,195,000, representing the "average of all potential futures".
Understanding outcome distribution
Expected value is important, but it does not tell the whole story; specifically, it doesn't tell us how spread-out our futures are. Hence, in addition to assessing the expected value of the company, another important piece of the puzzle, Ido added, is measuring variance — giving the decision-maker an understanding of the range of outcomes.
Variance is a measure of the spread of possible outcome values. In the example used above, the variance ranges from $0 for failure to $1 billion for exceptional success, implying high variance which entails more risk compared to lower variance alternatives. In general, it is best to have low variance and high expected value. "If you have two alternatives with the same variance, you want the higher EV; for two alternatives with the same EV, you want the lower variance," Ido said.
In addition to understanding variance, business leaders should understand their risk tolerance. "Be honest with yourself," Ido said. "What is my real tolerance, what are my goals?"
The goal is to eliminate exposure that is outside of a company’s risk tolerance. To assess risk, in a similar fashion to how variance was handled, Ido suggested the use of expected value and cost. "If you have alternatives with the same EV, prefer a lower cost," he said. "If you have those alternatives with the same costs, you want the highest EV."
Ido also shared some insights on choosing among multiple ideas for new products. Start by identifying the most material risks associated with an idea. Then conduct an experiment by formulating minimum viable products (MVPs), which when implemented could materially mitigate that particular risk.
For example, in the case of a new social network, there is a risk that no one will sign up. The startup could create an MVP that offers basic social networking features to get a sense of how many people will sign up. If no one signs up, that is strong evidence that the idea is not viable.
"The power of an MVP in its ability to de-risk, the most meaningful risks at the lowest possible cost," Ido said.
Entrepreneurs will always face uncertainty but Ido’s framework provides a strategy for assessing possible outcomes and their costs. "Each decision is not necessarily good or bad," he reiterated. "The only thing that is bad is making a decision and not fully understanding its implications."