Friday, December 9, 2022

Deciding What Kind of Business to Start? Here's a Simple Approach Every Entrepreneur Can Follow

Deciding what kind of business to start begins with defining success, and then considering the role of variance.


Photo: Getty Images

While there are countless ways to decide what kind of business to start, for the sake of argument let's imagine there are two basic approaches:

Low variance. Decide to do what other people have successfully done, and with hard work and perseverance you should reach the 80th percentile of success in that pursuit, if only because most people don't work nearly as hard, or as smart, as they like to think.

An example of the low variance path -- lower risk, but lower return -- is a person with solid carpentry skills who decides to go into the deck building business. Lots of customers need decks. Then again, plenty of construction small business owners build decks. Choose that route, and with time and effort you might not get rich... but the odds are good you can make a decent living.

High variance. Think of this as the outlier path. Choose to do what few people have successfully done, and you might -- just might -- become extraordinarily successful. (And rich, if that's your goal.)

Mark Zuckerberg is a good example of the high variance path. Instead of taking a low variance approach and, say, starting a web design business, he launched a new and unproven venture. The odds of success in that high variance approach were naturally extremely low, but in his case the upside turned out to be astronomically high.

Sounds great.

At least for the Zuckster.

Starting a Business With High Variance

The Facebook founder isn't just a high variance outlier. He's also a good example of survivor bias, focusing on people or things that "survived" while overlooking those that did not.

Take Ryan Gosling. He dropped out of high school when he was 17 and moved to L.A. to pursue acting. It worked spectacularly well for him, but what about the thousands of kids who drop out and move to southern California in hopes of making it? Do they all become movie stars?

Of course not.

But you never hear about them.

The same is true for Steve Jobs. Jobs dropped out of Reed College so he could "drop in" on classes that interested him. It worked for the Apple co-founder. (Maybe not so well for this forgotten Apple co-founder who arguably left $75 billion on the table.) But what about the countless people who don't finish college? Do they all become billionaires?

Of course not.

But you never hear about them.

That's why Michael Shermer, the author and publisher of Skeptic magazine, says advice on high variance success distorts perceptions by ignoring all the businesses and college dropouts who failed. And why university of Waterloo professor Larry Smith says, referring to Jobs:

And what about 'John Henry' and the 420,000 other people who tried ventures and failed? It's a classic case of survivor bias.

We make judgments about what we should do based on the people who survived, totally ignoring all the guidance from the people who failed.

The problem with survivor bias is that it doesn't really indicate whether a particular strategy, or technique, or plan will work -- and specially whether it will work for you.

Take the high variance approach by basing your plans -- or your expectations of success -- on a blueprint that worked for an outlier, and the potential outcome may be extraordinarily high. But so will your level of risk.

That's neither a bad nor good thing.

But it is definitely a factor you should consider.

Starting a Business With Low Variance

The flip side is choosing a route with low variance. As Nassim Taleb writes in Fooled by Randomness, "Wild success is attributable to variance. Mild success can be explained by skills and labor."

Keep in mind "mild success" can still be considerable. Say your interest lies in healthcare. The high variance approach would be to launch a startup based on a new wearable device: The odds are low it will capture the market, but if it does... yeah.

The low variance approach could be to go to med school. With time, study, and hard work, you could become a skilled physician. While the upside isn't unlimited, it's still pretty great, especially if you someday scratch your latent entrepreneurial itch and launch your own practice.

To evaluate the odds of success, Taleb advises considering "alternative histories." If you could relive a set of events 1,000 times, what would the range of outcomes be? In a high variance approach -- becoming Steve Jobs, Ryan Gosling, Joe Kudla, or Kirk Hammett -- the odds are (maybe) 1 in 1,000.

In a low variance approach -- say, starting a deck-building business -- the odds are likely considerably better than even. Assuming your level of effort and perseverance remain constant, you'll probably have about the same level of success, and make the same amount of money, 700 or 800 times out of 1,000.

Randomness -- or luck -- won't play much of a role.

And that's an important point, because luck always plays a role in extraordinary success. While if you out-work, out-think, out-skill, and outlast other people you are much more likely to be successful, research shows you also need to get lucky.

Right place, right time. Or right person, right time. Or right idea, right market, or right audience. As Mark Cuban says, "To make billions, you'll have to get lucky."

Bottom line? The lower the variance, the smaller the role luck is likely to play in your success.

Starting a Business Means First Defining "Success"

As you consider which business to start -- or which career path to take -- first decide what "success" means to you. If you want to make a decent living doing something you love, consider a low variance approach; choose a path where effort and skill tends to pay off directly.

If you want to get rich, you'll need to choose a path where effort and skill matter, but so does luck. While survivor bias -- and hindsight bias -- appears to explain success, no path, no plan, and no strategy is ever certain. Success in that case will only seem inevitable in hindsight. "Wild" success will always be at least somewhat random.

But keep in mind that where success is concerned, "mild" is relative. Start a deck building business with one or two employees, and your upside is largely constrained by the hours you work. Build that business by adding services, crews, and locations, and your "mild" success can become considerable.

Which leads to an even more important point. When you're deciding what kind of business to start, variance matters.

But the most important factor is whether you will get to do work you enjoy: Work that leaves you feeling fulfilled, and satisfied, and happy, and that allows you to control, as best possible, your own destiny.

The beauty of starting a business is that you are free to choose what kind business. Make sure you design and build your business not just on a potential outcome, but also on the process of achieving that outcome.

Then, no matter whether the outcome is mild or wild, you'll still be successful.

Because you will be doing what you love to do.

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