Different types of risk

The idea that founders take on “risk” is a misleading generalization. It is far more informative to separate the specific types of risks that founders assume, including:

– Financing risk: You can’t raise money at various stages because you haven’t hit accretive milestones or your space isn’t appealing to investors.

– Product risk: You can’t translate your concept into a working and compelling product.

– Technology risk: You can’t build a good enough or, if necessary, breakthrough technology.

– Business development risk: You can’t get deals with other companies that you depend on to build or distribute your product.

– Market risk: Customers or users won’t want your product.

– Timing risk: You are too early or too late to the market.

– Margin risk: You build something people want but that you can’t defend, and therefore competitors will squeeze your margins.

At the early stage, the main way to mitigate these risks is to recruit great people as cofounders or early employees. You shouldn’t recruit people that will give you a high likelihood of reducing these risks. You should recruit people that give you an unfair advantage. You should try to win the game before it starts.

Startups are hard, and risky. But if you lump all the risks together, you are playing the lottery. Talented entrepreneurs identify specific risks and do everything they can to overcome them.

Platform distribution risks

When your product extends a platform’s functionality, one of the main risks you face is that the platform could embed your product’s key features within the platform – what is sometimes called subsumption risk. This happened to a lot of startups in the 90s that built products for the Windows platform.

When you depend on a platform for distribution (acquiring and retaining users), you take on different risks. Specifically:

1) Oversaturation. The risk that supply of products on the platform significantly outpaces demand. This seems to have happened recently to the iOS App Store: there are over 500,000 apps and counting, and popularity tends to be highly concentrated, making it very difficult for new apps to get noticed. Oversaturation also happened to Google (organic) results in most query categories in the last 2000′s.

2) Barriers to discovery. The risk that the discovery methods on the platform aren’t meritocratic. iOS apps depend upon appearing in iTunes’ Top 25 lists, leading to a “rich get richer” bias, along with aggressive attempts to game the system. Apple has other app discovery mechanisms like its Featured Apps and Genius features, but those seem to drive far fewer downloads than the top lists. Google search has increasingly been favoring Google’s own products and also seems to heavily favor older, well-entrenched websites, making it very hard for new sites to gain significant SEO traction. Currently, social networks like Twitter and Facebook seem to have the most meritocratic discovery mechanisms, which is one reason so many startups target them for distribution.

3) Throttling. The risk that the platform will throttle distribution or monetization (for apps that rely on paid advertising, throttled monetization also means throttled distribution). Facebook started out letting apps send unfiltered notifications to users’ timelines but then introduced algorithms that heavily filtered them (thereby entrenching the position of leading app makers like Zynga). Facebook also started out letting apps charge users directly, but later changed that policy and imposed a rev-share.

If you are launching a new website or app, you should have a distribution strategy beyond just “people will love it and tell their friends about it”. Your strategy should probably involve at least one major platform. And you should think through the distribution characteristics of the platform and decide if they are a good fit for your product and how best to mitigate the risks.

Finally, it is worth noting that some of the most successful startups grew by making bets on emerging platforms that were not yet saturated and where barriers to discovery were low. Today, the most interesting new platforms are probably Android tablets and emerging social networks like Foursquare and Tumblr. Betting on new platforms means you’ll likely fail if the platform fails, but also dramatically lowers the distribution risks described above.