Startup Reality Distortion #4: Flickr, MySpace and Others Did It, So You Can Too

April 28, 2006

One of the pieces of advice I’ve given my youngest brother lately (who is still very early in his career) goes something like this:  “Someone will win the lottery tomorrow, just not you.  So get to work…”  The rationale behind this big-brother advice is that it’s a mistake to look at some of the extreme examples of successes and use this as a basis for one’s own strategy.  These extreme cases are by far the minority and for every success (like MySpace and Flickr) there are hundreds, if not thousands of companies that simply don’t amount to much at all.  
So, my advice to you, software entrepreneur, is that some company with no revenues and no discernible business model will be bought for tens of millions of dollars this year – just not yours.  Although there’s a chance that I could be wrong, the odds are in my favor that I’ll be right (and being right 99.9% of the time is good enough for me).
The issue here is one of simple statistics.  Too many naïve entrepreneurs look blindly at the possibility (i.e. I could make $50 million by selling to Google!), without looking at the probability of that event occurring.  This is commonly known as the “expected value” (EV) of a given situation.  The EV calculation in its simplest form, looks something like this:
EV = Value Of Potential Outcome * Probability of that Outcome
So, if you have a .1% (i.e. 1 in 1,000) chance at making $50 million your EV is $50,000 (which, coincidentally, is about how much money you might invest in creating that nifty little Web 2.0, Ajax-powered business that does something or the other).  The problem lies in the fact that your probability of that $50 million exit is much, much lower than 0.1% (probably by a few of orders of magnitude), like 1 in a million (which has a nice ring to it, even though I can’t prove it).  And you may or may not own 100% of the company at the time it ever reaches that kind of size anyways.  So, with 1 in a million odds, your EV is now $50.  
Of course, I’m not telling you something you don’t know.  You’re smart enough to have figured out that the overall probability of success (on average) is indeed low.  But, chances are, you don’t think of yourself as average – far from it (and likely, rightfully so).  See my other article on the “Lake Wobegon Effect”.
You say to your self:  Self, is not my shiny new software as cool as Flickr?  Does it not use AJAX with as much fervor as just about anything else?  Does not my logo have cool Web 2.0 colors and use a font with rounded edges?  Are not the 100,000 users I’ve signed up each as valuable as those teenagers that MySpace amassed?  Am I not at least a little more intelligent, dedicated, hungry and entrepreneurial than all those other software entrepreneurs out there doing similar things?  Surely, my chances are much better than average…  And, its possible that you’re right.  That you are above average.  Maybe even well above average. 
But, there are two problems with this reasoning:
  1. Even if you are 10x or 20x “better” than average, that likely still doesn’t make the probability of success high enough for the EV to be meaningful.
  2. There is more that contributes to the likelihood of your success than just your personal intelligence, hunger, business skills, etc.  (there’s tricky thing called “the market”)

In some of the research I am doing for my MIT graduate thesis, I came across a PhD research project on entrepreneurial risk taking at Wharton, of which the findings can be broadly summarized as follows:
  1. Entrepreneurial risk profiles seem to be indistinguishable from “regular” wage earners (i.e. entrepreneurs are not the big risk takers we think they are).
  2. There are actually two types of uncertainty in entrepreneurial ventures:  market uncertainty and ability uncertainty.
  3. Entrepreneurs display risk aversion when it comes to market uncertainty but exhibit over confidence or “risk seeking” tendencies with regards to ability uncertainty.

Basically, what this means is that when you buy the “no business model” lottery ticket, you’re doing so not because you’re not afraid of market risk (you are), but you are likely thinking that your above average capability will somehow compensate for that risk.  But, the odds are (literally) against you.  Unless you’re the type that would spend $50,000+ and/or 12+ months of your life on a lottery ticket, this just doesn’t make sense.  
Of course, there are other reasons to work on projects instead of businesses, which I’ve discussed before – and that’s totally fine.  But, just don’t mislead yourself. 
Moral of the story:  Somebody’s going to hit the jackpot.  Just not you.  Get to work building a real business.

Written by Dharmesh Shah


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