The most successful business owners have an innate understanding of risk and how to manage it. This article evaluates four different businesses in the context of risk to draw lessons about effective risk management.
Risk concerns the overall impact and probability of a specific outcome. For instance, a 20% probability of a $100,000 loss has an expected value of ($20,000) while a 10% probability of a $1,000,000 gain has an expected value of $100,000. The smart business owner constantly assesses risk in his or her business dealings in order to minimize the potential downside and maximize the potential upside.
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Put another way: It is wise to invest in businesses and business deals that have a high probability of upside and minimal downside. While this seems obvious when stated explicitly, many businesses operate on quite the opposite principle. That is why so many entrepreneurs invest their life savings into a business only to see their dreams dashed.
Following are four different businesses and their risk profiles:
One: Online publisher. This business develops online distance education programs for fitness professionals. To manage risk and avoid large investments in product development, it begins with a simple ebook written by an investment. It tests the ebook with a low-cost website.
If the ebook sells well, the company invests in an expanded program with a hard-copy book, DVDs, and seminars. It also tests different marketing strategies on a small scale and rolls out the strategies that perform well. In short, this business is able to generate excellent profits through a strategy of low-cost testing and rollout. At the same time, it focuses its products in a niche market (fitness) in order to offer new products to its loyal customers,