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

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

 


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.
 
 

Posted by Dharmesh Shah on Fri, Apr 28, 2006

COMMENTS

Why not help him evaluate his revenue model instead of dissuading his passion?

Your lottery analogy implies that you believe his ability is not at all bound to his success, so it's either flawed or you're just trying to hurt his feelings.

It's clear that risk lowers safety levels, but everybody's level is different and it's a very non-transferrable threshold.

I've been there.

posted on Friday, April 28, 2006 at 8:33 AM by Ryan Elisei


Not trying to dissuade entrepreneurs or reduce their passion at all -- quite the contrary.

Am suggesting that if attempting to build a real business, one should stay away from the "lottery ticket" style ventures and be more focused on the fundamentals.

posted on Friday, April 28, 2006 at 9:24 AM by


The safest solution is to work for an already profitable company, or build one just like it. The term, “real business” is also based on a threshold which varies individually.

The EV equation is indeed simple. If you want to maximize probability you must minimize profitability, thus Paul Graham’s essay, “Inequality and Risk”.

I just don't buy the "risk is bad" outlook on life. It's awfully pessimistic and reinforces potentially obsolete paradigms. I love your blog though.

posted on Friday, April 28, 2006 at 10:42 AM by Ryan Elisei


Dude, provide an auto-discovery RSS feed. Its easy email me and I'll tell you how.

posted on Friday, April 28, 2006 at 1:04 PM by jim collins


The situation is even worse than you suggest, as your expected value calculation implies complete risk-neutrality and no loss aversion. Betting $50,000 for a 1/1000 shot at $50million isn't something most people would do unless they were quite rich and enjoyed gambling.

There's also the time-value of money and opportuinty costs to consider.

posted on Friday, April 28, 2006 at 1:37 PM by toby


You seem to imply (at least it comes across to me) that MySpace etc are not "real business". The NYT artile mentions that MySpace generates about $200M in ads rev (not as much as yahoo with similar pageviews, but still).

I think the lesson is that it is not about how cool your website looks but how you can attract uses. In case of MySpace, they discovered music/band is the key driver. They started MySpace Secret Concert and was a big hit.

posted on Friday, April 28, 2006 at 1:43 PM by Zheng


Except expected value is the sum over all such outcomes.

posted on Friday, April 28, 2006 at 1:53 PM by Ted Dziuba


I think you've made some very good points. In most cases, people's sites/businesses will not amount to much and will probably fizzle out. Although, just because you may never get that life-changing offer from Google or Yahoo, that's not say that you can't make a living from it. I do appreciate your realistic perspective on the subject.

posted on Friday, April 28, 2006 at 11:04 PM by Matt


I can appreciate your realistic perspective toward the notion of selling a web app to google or yahoo. However, there is a fundamental difference in the way you (the author) look at the situation.

From the sounds of this article you are probably not an entrepreneur, rather something such as an engineer. You reduce it to simply chance, and compare it to a lottery ticket (which is 100% chance). A young entrepreneur's biggest hurdle in starting a business is overcoming limitating beliefes set by those who cannot 'think big'.

A persons business is like a mirror into their self, their strengths and weaknesses, their will and their vision. That's why for entrepreneurs often have large and healthy egos, since that is what launches them and the business to success.

While yes, there are many businesses that are not going to amount to anything, it is the process of creating businesses and having them fail which ultimately evolves the entrepreneur and leads him to achieving success.

I agree to not 'put all your eggs into one basket' and to have a backup plan if your business is not successful. However, the notion that a person should throw away a dream simply because of past 'statistics' is not condusive to creating and building a business.

"I would rather aim for the stars and fall in the mud then aim for the mud...and make it" - famous quote (can't remember who). Thanks for the article.

posted on Friday, April 28, 2006 at 11:06 PM by Rey Marques


Looks like I have once again failed to correctly articulate my point.

I have nothing against entrepreneurism (I am one myself and working on my third company now).

My primary point is that the path of many contemporary startups that forego revenues and profits and instead focus on some eventual acquisition are not the best way to build businesses.

Guess what I'm trying to say is that the market rewards actual value creation and this takes a fair amount of work.

Need to practice properly articulating my point. :)

posted on Friday, April 28, 2006 at 11:14 PM by


I think you articulated your point just fine. It is good advice: don't count on hitting the jackpot, instead build a business to last. It was crystal clear to me and it makes sense. Some people just aren't used to this kind of reason and logic coming from an entrepreneur.

posted on Saturday, April 29, 2006 at 12:04 AM by Robbie Allen


Yes I definitly agree, the market rewards actual value, not percieved value. Very good point, however, I just think the underlying way you communicated it seemed a little harsh. Perhaps there would be a way to communicate this point with a different spin. Congrats on starting your 3rd company.

posted on Saturday, April 29, 2006 at 12:18 AM by Rey Marques


Are you sure you're good at math? You wrote: "Even if you are 10x or 20x “better” than average, that likely still doesn’t make..."

Do you realize how much better stats like 10x and 20x really are? If you came out with a car that got 10x better gas mileage, would anyone notice? Hey, man, my new Honda gets 350 miles per gallon, about 3500 miles on a tank of gas!

So can I get funding on my invention of a 350 mile per gallon car? I think so.

posted on Saturday, April 29, 2006 at 10:15 AM by FA 22


I am by no means a math expert, but lets not confuse *you* being 10X better/smarter, etc. with the outcome (your product or business) being 10X better.

Just because an individual is orders of magnitude "better (on whatever dimension) does not mean this translates to similar effects in the things they create (like their businesses).

I'm actually thankful for this, as I'm not nearly as smart as other people, but my outcomes turn out to sometimes be modest successes.

posted on Saturday, April 29, 2006 at 10:21 AM by


Can you please give a link to the mentioned PhD thesis (or it's author and thesis name). It sounds really interesting and is close to my research area. Thank you in advance.

posted on Saturday, April 29, 2006 at 11:12 AM by Vladimir


Vladimir:

Here is a link to the paper cited:

http://www.sba.gov/advo/research/wkpbw249.pdf

posted on Saturday, April 29, 2006 at 11:21 AM by


I'd like to respond by saying the question of the widespread fervor to create spin-offs start-ups is a great thing, on a social/darmwinian level, even if most of them fail. So that while your points are well-taken in terms of the low odds for an individual entrepeneur or hacker, the process of many contributions to to the application pool is a sign of health of the system.

The bubble 2.0 phenomenon is also interesting in terms of what it says about the state of the "tech economy" as a labor force. That is, how is it that so many folks can afford to even consider 'making a go" at the big times (in the form of the vaunted google/yahoo buyout). Why isn't all of this energy going into degree accumulation and climbing corporate ladders? Is it simply that jobs are scarce, or is there a sea-change in terms of the way the tech worker sees herself -- as a more empowered worker-- ?

- Chris

posted on Saturday, May 20, 2006 at 7:15 PM by Chris Amato


I agree to most points, but I tend to disagree to the argument as a whole.

Start-ups where you know what you're doing and love it are more likely to succeed than a idea picked up just cos you thought it was great. This should tilt the odds a bit.

Secondly, not many people are looking to be bought out for $50mn by biggies. A small scale working startup making you a $100k a year is a very healthy goal too. That should tilt the odds further.

Thirdly, it is would ideally be best to start out with more than one start-up. Four simultaneous start-ups means probablility of success goes up, four times.

Fourthly, as someone mentioned in the comments, unless your life depends on it, it's an experience. YOu will never not gain anything from it.

Cheers. :)

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