Types of Risk, Types of Innovation

The pursuit of innovation is inherently risky. Innovation is about creating value by doing new things, which implies a built-in risk that the new thing won't work as well as the old thing. For me, this is a helpful connection to keep in mind when I'm evaluating or working with startups.

The question I try to answer is: What type of innovation is this company betting on?

From that answer, I can understand what type of risk they are taking.

When I understand the risks, I can:

1. Make a judgment about whether I think the risk is going to pay off, and
2. Help the team address those risks with Design Sprints or other forms of discovery and validation work.

In the world of tech startups, most of us think about product and technology risk. This makes sense, because products are very salient (we all use them every day) and because technology innovations have enabled most of the big changes to our world in the last 150 years.

But product and technology risk are simply the most visible—they are far from the only ways in which startups take risks when pursuing innovation.

Here's the list I run through when evaluating or working with a company:

Product Risk — Will our product be better than what exists? Will it be more successful in helping customers reach their goals? Will it be more useful, more usable, more fun, etc?

Technology Risk — Will it work? Will the new technology be reliable enough, fast enough, good enough? Will the technology be financially and operationally sustainable?

Team Risk — Do we have the right people? Can this team fund the company, hire well, validate the other risks, and execute?

Market Risk — Will anyone care? Will people use the product? Will we be able to reach customers? Will the market trust us? Is the market as large as we think it is? Is it growing?

👆 This one also includes marketing and go-to-market risk. You could unpack this risk a bit more and dig into the components if necessary. (That's actually true of all of these.)

Business-Model Risk — Will the business make money? Is the model financially sustainable? Can we achieve the costs (via technology and operations) and revenue (via customer acquisition) to make the model work?

👆 This one doesn't get as much attention, but as the tech industry matures, we are seeing more and more business-model risk. A whole generation of startups adopted and proved SaaS, for example, and then giants like Adobe, Microsoft, etc pivoted their businesses to this model. Startups like Airbnb and Uber have taken huge business-model risks. And some startups are basically all business-model risk. Cashdrop comes to mind, and indeed, founder Ruben Flores-Martinez has shared how economics, not technology, are at the core of his strategy.

Funding Risk — Can we finance the company until it's sustainable? Can we raise adequate and appropriate funding? Do the capital requirements match the other assumptions about the business?

👆 This is not 100% tied to innovation, but it's super important. The risk is not just that you'll run out of money—plenty of startups have been ruined because they raised too much too fast, or because they financed the company in the wrong way. These are very real risks that should be surfaced and addressed in every startup.

What did I miss? Any other big risk categories I'm not thinking about?

Finally... I believe it's possible to build a successful company (and generate venture-scale returns) by betting on one or two of these risks — you don't have to innovate in every single category.

But I think it's true that some of the biggest blockbuster startup successes have embraced most or all of these risks: Product, Technology, Market, Business Model, etc. After all, taking bigger risks generally leads to the possibility of bigger rewards. (It also leads to the possibility of failure. And most startups, in fact, fail.)

An obvious example of this "all in" approach to risk is Google's original Search and Ads business:

• Google Search began as a research project about new technology for determining the quality of a webpage. There were risks in the validity of the approach as well as the execution of that approach at scale. (Technology Risk/Innovation)
• Google bet that a simpler, cleaner, quality-driven search engine would win, even though search was considered "solved" and the "search wars" were over. (Product Risk/Innovation)
• They bet that the aggregation of attention would be extremely valuable and that an auction could be used to price that value for advertisers. (Business-Model Risk/Innovation)
• They bet that advertisers (mostly small ones at first, and then larger ones) would buy ads to send traffic to their websites, and that the overall trend of ecommerce would accelerate. (Market Risk/Innovation)
• They bet that transparency, near-realtime reporting, and precise targeting would be killer features in their advertiser products. (Product Risk/Innovation, again)

There are others that come to mind: Stripe, Apple, Netflix, Spotify...

At some point I'll write a follow-up about how to mitigate each of these risks and validate potential solutions rapidly. Until then, thanks for reading!

— JZ