Have you ever wondered why nearly every business plan you come across involves more zeros than you can count? While the pressure to show j-curve or "hockey stick" growth plays its part, often a bigger reason for all these zeros is entrepreneurs' own overoptimistic expectations.
Entrepreneurship is not for the faint-of-heart. You need a fair dose of optimism to succeed as an entrepreneur. But a very thin line separates optimism from illusion. A prominent study of 2994 entrepreneurs, for example, revealed that about 81 percent rated their odds of success at seven out of 10 or higher and a remarkable 33 percent foresaw their chances of success as being 10 out of 10.
How do you square this with the reality that nearly nine out of 10 businesses fail within five years of founding and a significant number never get off the ground?
We could argue that entrepreneurs need to be optimistic precisely to be able to take on those kinds of odds. But unless you have a fat bank balance to fall back on or a love for the adrenalin rush of gambling, I advocate practicing optimism based on reality.
Let's step back and talk about how we get into this trap of thinking we've discovered "the next big thing," which could be killing our chances at success.
When making decisions involving potentially large gains or losses, we are far more likely to seek evidence that backs our favored outcomes because it makes us feel better. We get so emotionally invested in our decisions that we tend to ignore information that contradicts our beliefs. As our desire to achieve the favored outcome goes up, so does our expectation that the desired result will actually occur. Interestingly, the larger the gains we anticipate from our decisions, the higher the chances we will fall prey to overconfidence.
Behavioral economists explain that we tend to regard our current situation as unique and often ignore past negative outcomes for similar actions. Many times this happens because our predictions are based on plans that are specifically designed to show how we are going to achieve what we want to achieve. Any guesses on how many of those billion-dollar business plans actually ever make a dime?
We know from research that excessive optimism is often the most common and damaging error of judgment we make. It makes us all rush into the "hottest" industry of the day, be it dot.com, social media or Web 2.0. Of course, we can do better than Facebook and everyone else out there working on the same challenge, right?
This excessive optimism can be particularly damaging for those entrepreneurs who are looking to enter industries that are rapidly changing and new to them. A study of 2,304 entrepreneurs by researchers at INSEAD revealed that a founder's previous experience in the same industry both reduced overoptimistic bias and improved their expectations about their new business. It also showed that the benefits of having previously worked in the same industry were most apparent in high-tech.
In a similar study researchers suggested that in fast-changing industries, those entrepreneurs who were moderate in optimism were more likely to do better than those who were highly optimistic.
It is easy to see why. Since it is hard to make reasonable predictions in advance, optimistic but cautious people are more likely to make the effort necessary for more informed decisions.
On the other hand, research also shows that since optimism can help endure repeated failure, over-optimistic entrepreneurs are more likely to give it another and yet another shot, hopefully, with more reasoned expectations.
If you want to practice cautious optimism, here are some options worth considering:
1. Know your industry. When searching for new business opportunities, either look within the industries you know best or get some inside experience before pursuing unfamiliar territory further. You could do this by enlisting a co-founder (or an early employee in an executive role) who shares your passion, but also has inside knowledge of the industry you are looking to get into. This inside knowledge should help you get a more realistic perspective.
2. Ask: "What if?" If you find yourself too upbeat about your business, start asking yourself contrarian questions: "What if"? Enlist knowledgeable friends and family members to help you with hypothetical simulations.
3. Get advice. Seek experienced mentors, advisors or board members who are not hesitant in asking you tough questions. Ideally, these mentors should have a different background and experience from you. Diversity of perspectives helps ground expectations.
4. Do thorough testing. Finally, Test, test, test. Follow Steve Blank's advice religiously and validate your idea at every stage of your business idea's development. Consumer interest is the ultimate determinant of whether you will be a billionaire, a pauper or somewhere in between.
If, after all this, you still have that billion-dollar business idea, I couldn't be happier for you. Carpe diem -- Seize the day!