Peter Thiel in his recent book From Zero to One makes a bunch of interesting, useful points about entrepreneurship.
Thiel, as you may already know, co-founded PayPal. And he has made a series of spectacular venture capital investments.
So right at the start, I want to stipulate that if you’re interested in becoming a billionaire or want to raise venture capital to fund some enterprise, absolutely, you should read Mr. Thiel’s book.
Heck, even if you’re not interested in becoming a billionaire or raising venture capital, if you’re running a small business, you probably ought to read Thiel. How often do you get to see inside the head of billionaire or venture capitalist?
But though I really appreciate Mr. Thiel’s ideas and contributions, I see a problem with Mr. Thiel’s theories: They don’t seem to me to work very well for small businesses.
Thiel’s Grading Rubric Too Harsh
My big issue with Mr. Thiel’s thinking? The grading rubric he suggests an entrepreneur use for identifying promising ventures.
Thiel, very correctly, points out the benefits of an entrepreneur or management team pursuing ventures that can massively scale and that employ things like network effects, a proprietary technology, and a strong brand to secure big competitive advantages.
But you can use, I submit, an easier grading rubric for identifying good small business entrepreneurial opportunities.
In other words, if you’re not trying to become a billionaire or trying to raise investment money from a billionaire, you can work with a more “millionaire-esque” set of criteria.
What might that easier grading rubric look like? Let me share a handful of ideas…
Start with a Decent Strategy
Okay, first? You want to be working off a identifiable “niche” or “differentiation” strategy.
But to make the obvious point, you need a good strategy for any venture you consider. You need, in other words, to have and to understand a reason that customers or clients choose you instead of your competitors.
Another important criterion relates to the profitability of the business.
This sounds so simplistic as to not warrant words, but you need to make sure that the venture is adequately profitable.
Specifically, you want to not only earn a fair wage for your time and effort. You also need to earn a return on the capital you or others (perhaps a bank, perhaps outside partners) have invested. And you also need to have some extra profit for financial cushioning so that a hiccup in the business doesn’t cause the whole venture to fold.
This calculation doesn’t have to be that complicated. Let’s say that you want to earn $50,000 as a wage for your business. Let’s suppose that you have $30,000 in annual bank loan payments. Let’s say you need a $20,000 a year cushion.
In this case, you want to focus on ventures that have a nice, high probability of quickly achieving annual profits of $100,000. That profit level pays you the wages you want, pays the bank its loan payments, and generates an extra $20,000 a year (hopefully) in cushioning you can use if something goes sideways.
One important related point… I’m just making up numbers here. Your situation will surely vary.
For example, if you want a part-time venture that is compatible with parenthood or semi-retirement, you might only require a tenth of the money I’m talking about here. $10,000 might work great for your venture.
Or for another example, if you’ll be leaving a great job and will pursue a venture that requires tons of capital, you might not be able to make things work with ten times the profit target I’ve used. In this case, $1,000,000 in profits might prove inadequate.
Low Vulnerability to 800-pound Gorillas
Another simple criterion: You want to avoid any venture where you’re vulnerable to some gigantic customer or vendor or outside agent.
You shouldn’t put yourself and your small business in the position of being vulnerable to a single big outside player.
Remember the joke: What does an 800-lb gorilla get to do? Anything he wants.
Maybe I shouldn’t get so personal here, but one of the reasons I have very low interest in pursuing the self-publishing opportunities available via Amazon.com is the 800-pound gorilla angle.
Yes, I enjoyed some great luck writing and even publishing how-to books about computers, including QuickBooks for Dummies and Quicken for Dummies.
But giant publishers reportedly have trouble dealing with Amazon. What sort of treatment might I expect? Yikes.
No Black Boxes in Supply Chain or Business Process
And here’s another, sort of similar criterion: I think you want to avoid any venture that includes a supply chain or process with a black box or, heaven forbid, with multiple black boxes. No critical step or process should be hidden from your view.
Another technology venture example nicely highlights this…
You can obviously build small businesses that rely on free, so-called organic search engine traffic from Google. And these sorts of ventures can, for a time at least, often be very profitable. (I’ve enjoyed success in this area myself.)
The problem with these search-engine-based ventures, however, is that they include black boxes like the search engine’s ranking algorithms and search engine’s penalty systems.
These black boxes mean that you won’t really know what you need to do to perpetuate success. And these black boxes mean that if something inside a black box causes a business to break, you won’t have any idea what you should do to fix the business.
High Barriers to Entry
One last, almost counter-intuitive idea: You want to focus on ventures with high barriers to entry.
In fact, you probably want barriers to entry that are so high you are only just barely able get into the business.
A high barrier to entry should reduce the competition you face because other people, too, will find it difficult to get over the barrier.
And then, a related point, a high barrier to entry can protect a market from low-skill, poorly-capitalized or poorly managed competitors who can inadvertently damage or degrade your industry or niche.
You probably don’t want to be an niche, for example, that allows low-skill competitors to come in, regularly do shoddy work, and then make customers start asking “Gosh, does everybody in this niche do shoddy work?”