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The Great Ideas Letter Forum
How to choose between different business projects... Part 2
Posted By: Dien Rice In Response To: How to choose between different business projects... (Dien Rice)
Date: Friday, 7 January 2005, at 8:58 p.m.
As well as figuring out the "expectation value" of a project, here's another step I take when I make a decision on which projects to pursue...
I look at the "downside". That is, I look at the "risks"...
Donald Trump (I think it's in his book "The Art of the Deal") says,
"Take care of the downside, and the upside will take care of itself."This is a universal theme I've noticed among both many entrepreneurs AND investors (since I invest in the stock market too). How much could you LOSE? That's your risk.
How does this come into choosing between different projects? Well, if two projects are similar, but you could potentially LOSE more in one than the other, then try to pick the project where your "downside" is least, where you could lose the least.
Why?
Well, think of entrepreneurship as a game you can "play". Each project you do is like a round of that game. Now, it is never guaranteed that you will "win" any time - you may win, you may lose.
However, to play the next "round", you will usually need some cash. If you have no cash left, it's hard to play the next round - since most entrepreneurial ideas require some money (though some can be done with very little money, as we often show in The Great Ideas Letter).
Let's say you have $2,000 you could spend on a project. And you find a project which could make you $3,000 in net profit (so you'll have $5,000 total if it succeeds) - but it could also LOSE you $2,000. (That is, you spend your $2,000, and make zero dollars back.)
The financial risk here is that you could end up bankrupt - with no money at all, if the project doesn't work out... That means it will be difficult to try another project - because your cash pool would have dried up.
Now, let's say you COULD do another project, where you could make $1,500 in profits, and the most you could lose is $500. Which project should you do?
You can calculate expectation values. If there is a 50% chance of the project succeeding, and another 50% chance of the project flopping for BOTH projects, then the expectation value is the same for each of them.
Now, let's look at the downside. With project 1, if the project doesn't succeed - you lose $2,000. And your store of cash to finance your projects disappears in one shot! You're out of the game - at least until you build up your savings again, or manage to borrow some money to finance more projects.
With project 2, if the project doesn't succeed, you've only lost $500. So your $2,000 becomes $1,500. But you still have money to do more projects! You're still "in the game"...
When I look at risks, I look at both the MONETARY risk as well as the TIME risk. I actually write a heading: "Monetary risks" - then make a list of how this project could LOSE me money. I also write a heading "Time risks" and write down all the places I could spend TIME and get nothing back for it! (You only have a limited amount of time - so you better spend it wisely.)
And there's another very important step to this, which I'll cover next... :)
- Dien
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