As entrepreneurs we embrace the unknown rather than spending our assets and resources trying to avoid it. The true entrepreneurial spirit sees the unknown as possibility and opportunity. “It’s the stuff that dreams are made of…”

Yes, you need to know the road is rocky. You will make misjudgments. Failures, big or small, will occur. You may lose a client deal you’ve invested a lot of energy into cinching, or your company loses all of its funding and goes belly up. An old adage says simply that successful entrepreneurs are those who step up to the plate one more time than they’ve been struck out. You may find encouragement in that when you have a “failure” but it’s not a healthy, ongoing model for a successful business.

As an entrepreneur, you will be dealing with how best to allocate your limited resources. If you understand the EVC (expected value concept), and make well-researched, mathematical predictions of your odds of success, you will understand better how to allocate your resources.

The EVC, simply stated, is: Outcome Value times Odds of Success = Expected Value, i.e., businesses opportunities in which EV exceeds cost are good investments, and the greater the difference, the better the investment. If the costs exceed the EV, don’t do it.

Various gambling scenarios help to show us the truth of the EVC.

1) In a coin toss, we each bet one dollar. Whoever wins gets the two dollars. Each of our odds are 50-50. 50% of $2.00 = $1, the same as your investment. It’s a wash, no matter how many times you flip the coin.

2) At the roulette table, one bets on red or black, or even or odd. The payout is 1:1. Due to the 0 and 00 on the board in which the winnings go to the house, your odds are not actually 50-50, but 18/38, or 0.47. Your expected value is 0.47 times $2, or $0.94, while your investment is $1. Bad bet!

3) Playing the Lottery is an interesting case. The exact details of the math are extremely complicated, including factoring in the possibility of multiple winners. For example, in the first week of a typical 6 out of 49 lottery, the EV of a $1 lottery ticket is about $0.25. Assuming no winners, the jackpot increases week to week and the number of ticket buyers increases as well, but not as much as the jackpot increases. As a result, the EV increases until eventually (when the jackpot hits a little over $150 million) the EV of a ticket actually exceeds its cost.

In one famous example, Stefan Klincewicz and his associates bought up almost all of the 1,947,792 combinations available on the Irish lottery, paying less than a million Irish pounds, while the jackpot stood at £1.7 million. Although Klincewicz ended up splitting the jackpot with two other winning ticket holders, and numerous “Match 4” and “Match 5” prizes were paid out, Klincewicz still made a small profit.

Applying Expected Value in Your Business

The EVC is an essential part of both forecasting and decision-making for your business.

Spreadsheets for sales forecasting is one often-used application. For each potential deal, figure the odds of successfully closing the deal and the total value of the sale. Multiplying those two figures, you get the EV (expected value) of each deal. Add all the EV’s and you will have EV of your sales pipeline.

The difficulty is in estimating the cost of the sale – support staff, travel, conference time, cost of delivery.

Let’s look at two possibilities:

Deal #1 has a 50% chance to close a $10,000 sale. The estimated cost of the sale (including time to close the deal, deliver the product and support it) is $5,000. Your EV is also $5,000. 1.0 (.5 x $10,000 = $5000). It’s a break-even proposition.

Deal #2 has a 25 % chance to close on a $5,000 sale. The estimated cost to close it is only $1,000. Your EV (.25 x 5000 = $1250) is $1,250. Your return ratio is $1,250/$1,000, or 1.25. It’s a better proposition.

If you are a compulsive gambler, entrepreneurship may not be your best path to take. If you look at the above examples and think that the 50% odds on a $10,000 sale is better use of your time than the 25% $5,000 sale, you are ignoring the cost factor. Don’t be fooled by the thrill of a big return; always consider the costs.

Factoring in Risk

You will most frequently be more successful if you choose to invest your time and resources in those activities with the highest return ratios, but this always has to be tempered by your risk tolerance.

Deal #1 has a 50% chance to close on a $100,000 deal. If the cost to make the sale is $20,000 (includes the majority of your sales resources’ time for a couple of weeks). $50K/$20K — that’s a 2.5 return ratio.

Four smaller deals valued at $25,000 each also have a 50% chance to close, with a cost per sale of $6,250. The expected value is again $50K, but the cost is $25K — that’s a 2.0 ratio.

On paper, if you have to choose, it seems like deal #1 is the better choice. On average, over time, if you had to make this decision repeatedly, it probably would be. However, consider this: In deal #1, your odds of getting nothing — losing everything — are 50%. In the multi-deal scenario, your odds of getting nothing are only 1 in 16, or 6.25 %. Your chance of making at least one sale, and therefore at least breaking even, is 93.75 percent.

No matter how great the expected value, you must always consider whether there is an acceptable level of risk. Again we find wisdom in old sayings: “Don’t bet more than you’re willing to lose.”

Factoring in Optimism

To be an entrepreneur is to be an optimist. It is a vital personality trait for going into business for oneself. Looking at the expected value of starting a new business and considering the statistics, almost anyone would realize that we should probably seek a full-time job! Entrepreneurs don’t, however because we consider the potential rewards worth the risk, and we believe we will beat the odds. We will succeed where so many have failed.

Sadly it is much more difficult to calculate the odds on business initiatives than for games of chance. Businesses with frequent repeated sales will gather enough data over time to have well-reasoned base models. Experience helps create expected patterns for closing ratios and lifetime value of a customer. But with a new business or truly unique deals, your estimations are based on some combination of past experience, new information, and intelligent guesswork.

“To thine own self be true” only works if you know yourself. Are you a pie-in-the-sky optimist or simply a happy believer that things turn out for the best? Factor in your personal optimism rating when estimating the possibility of success. Being an intense optimist, I’ve learned to discount all of my optimistic estimates by about 20 percent. You need someone on your team to be the voice of reason. And you need to listen to them. But when all is said and done, as an entrepreneur “the buck stops here.” We have to be prepared to be truthful with ourselves, and if an idea has no value to anyone but us, table it and find a new idea.

Finally, expected value and return ratios are but two elements of the process for making big decisions. Cash flow, strategic value, and yes, gut feeling need to be included in the mix. However, EV and return ratios should become essential elements in forecasting and planning. Use them well and consistently. They will help you beat the odds.

I had the pleasure of meeting Michael Bungay Stanier a couple of years ago and contributing to his book, Do More Great Work: Stop the Busywork. Start the Work That Matters. It’s full of inspiration, insights and advice on getting your priorities straight in your business and focusing on the best and highest use of your time. It features the likes of Seth Godin, Michael Port, Dave Ulrich and Leo Babauta, among others.

I was also interviewed by Michael, and it’s now up at Great Work Interviews. In it, Michael and I discuss:

• How it’s become more acceptable to have a “portfolio career” with your finger in many pies (or “high level ADD” as I call it)
• Why hyper-specialization, where you spend 80 hours a week doing one job, doesn’t work for everyone
• Being a hunter in a farmer’s world
• Those times you look for great work and don’t find it
• How to figure out what you’re passionate about and choose a business to start
• Networking and releasing control

You can listen online or download it.

As the economy rebounds, more and more businesses are going to start seeing profits beyond their current business model. When you’re in that position, how can you best put that cash surplus to good use?

That’s the topic of my latest article at OPEN Forum, Spending Wisely: What to Do When Profits Soar.

Image by Christian Ferrari – christian-ferrari.blogspot.com

As the economy begins to rebound, are you wondering when things will get back to normal for your business?

If you believe the prognosticators and pundits, there will be no “back to normal.” We’re looking at a “new normal” that we haven’t seen in a long time, if ever.

A recent study from the Pew Research Center says that “of the 13 recessions that the American public has endured since the Great Depression of 1929-33, none has presented a more punishing combination of length, breadth and depth than this one.” It has led to lowered expectations among the public about their children’s futures and their own retirement; a new frugality in spending and borrowing habits; and an expectation that it will take several years for the value of their home values and other investments to recover.

One thing is for sure: Nothing is for sure.

The future is uncertain, and uncertainty is the playing field of the entrepreneur. As my friend Howard Woolston says, “The status quo doesn’t remain the status quo for very long anymore. So get used to it.”

Continue reading at OPEN Forum

Image credit: skpy

Now, I know what most people think of when they hear the phrase “passive income” – they’re thinking Four-Hour Workweek, real estate investing, internet marketing – basically, lifestyle entrepreneurship. But I believe passive income is something every entrepreneur should pursue as a core financial strategy. Passive income can stabilize your cash flow, maximize your revenue, provide an exit strategy, and more.

To learn how, check out my article on OPEN Forum, Passive Income for Every Entrepreneur.

Image credit: nkzs

1. The most important question before you start is: how much will it cost to make your first sale?
2. Cash flow isn’t the most important thing — it’s the only thing.
3. Start with partners, not employees.
4. Develop continuous, passive income, even if that’s not your core business.
5. You’re not in the business of lending money.
6. Use credit for cash, not capital.
7. Do without it until you can no longer do without it.
8. Don’t try to beat the big boys at their own game.
9. Don’t sell what you can’t deliver.
10. Don’t gamble what you can’t afford to lose.
11. Establish relationships to support your growth before you need them.
12. Focus on the customer.

For more details, continue reading at OPEN Forum.

If you’d like to learn a lot more about bootstrapping, I highly recommend Seth Godin’s The Bootstrapper’s Bible, which you can download for free.

How did you decide how much to charge for your product or service? Did you base it on the competition? Some margin above your cost? Or did you throw a few numbers in a hat and pick one? A crystal ball, perhaps?

I’ve seen many companies that didn’t seem to give their pricing much more thought than that. Outside of a few industries, such as retail and energy, in which pricing is heavily studied and practices are well-established, pricing is often an afterthought, based on only one main factor plus some gut feeling, rather than the many factors that should be considered. The price of your product is more than just a number you plug in to your forecasting spreadsheet. It’s an essential part of your marketing strategy.

Continue reading at OPEN Forum

Retweeets and comments (there, please) much appreciated, as always.

Just the Facts

I started as the Entrepreneurs Guide at About.com in November 2002, shortly after I left my last full-time employer and started back on my own. About.com has served me well over the past 6½ years, and I have served them well. Perhaps most importantly, I have helped hundreds of thousands of entrepreneurs find, follow and fulfill their dreams of business ownership. I have also consistently grown the readership and produced some of the most popular articles on the web on a variety of small business topics, including:

• Choosing a Business to Start (#1 on Google for “choosing a business to start”)
• Create a Great Business Name (#1 for “creating a business name” and “picking a business name”)
• Pricing Strategy (#5 for “pricing strategy”)
• Make Money Online (Without Spending a Dime) (#1 for both “make money online” and “making money online”)
• Passive Income: How to Earn More and Work Less (#2 for “passive income”)
• The Real Problem with Network Marketing and Multi-Level Marketing (#2 for “network marketing”)

Some of my other personal favorites include:

• Swinging for the Fences: Risk, Reward, and Entrepreneurship
• Building Your Reputation When You Don’t Have Clients Yet
• Cash (Flow) Really Is King
• Time Is Money
• Juggling Multiple Streams of Income
• The Innovator’s Dilemma
• Business mentoring series:
  • Why Every Entrepreneur Needs a Mentor
  • Choosing a Business Mentor
  • Working with a Business Mentor

So what am I going to be doing with all that “free” time? I’ll be spending it on my own entrepreneurial pursuits and other projects I’m passionate about, plus hopefully a little more sleep and time with family.

I’ll continue to write here, as well as at The Virtual Handshake, Linked Intelligence, Work.com, GTD Times and a variety of other outlets as the opportunity arises. If you are trying to reach me and only have my About.com email, you can contact me here. You can also find me on Twitter at @ScottAllen.

Personal Reflection

It’s odd. On the one hand, I wish I could say it wasn’t my choice to leave About.com. It would be nice to be able to blame them. It’s always easier to put the responsibility on someone else, isn’t it?

See, I was “fired” from About.com. But the fact of the matter is, even though I was fired, it was my choice to leave. It was my choice not to do the things they wanted me to do in order to continue as an About.com Guide. It had nothing to do with the quality of my work – in fact, they plan to keep most of my articles up on the site indefinitely. I just didn’t consistently meet the quotas they set for content production, site maintenance, etc.

Why???

They weren’t unreasonable, and I’m not really that disorganized. And I’m not so busy with other more important things that I was simply incapable of meeting the requirements.

So why would I sabotage myself?

It’s taken me a week to “mourn” the loss and get in touch with the answer to that question. Here’s what I’ve come up with…

I’ve come to a point in my life at which I simply don’t want to work in environments that don’t fit well with my own work habits. And I’ve come to realize that I really detest deadlines, I can’t stand quotas and I don’t like being measured against arbitrary metrics rather than real results. In fact, give me a quota, and it seems my instinct is to just barely meet it. But give me something I’m passionate about and I will far exceed expectations.

Now here’s the funny thing…I asked for this.

Back in December and January, I was starting to come to terms with these insights about myself. I began to visualize the kinds of projects I’d like to be involved in that I would be passionate about and that would fit my work habits. And one appeared. And then another, and now a couple of more are on the radar.

Meanwhile, About.com was stressing me out every week.

A wise person once told me that in order to receive something new in your life, you have to make room for it. While my conscious mind wasn’t willing to release the About.com gig to make room for these other things that are a better fit for me, my subconscious was. My subconscious knew that it wasn’t a fit for my vision of my future. I have no regrets, and it served its purpose, but frankly, I’m amazed I lasted as long as I did!

So my few lessons learned out of this experience that I hope may enrich your life in some way are:

1. Find work that you’re not only passionate about, but that suits your work style. Failure to do so will be a source of constant stress. Life’s too short not to love what you do.
2. When things aren’t working, listen to your subconscious. It knows what you need and will sabotage you for your own good if it must. Listen to it and you can consciously make those transitions on your own terms.
3. Be careful what you ask for – you might get it!

Image: Davor Pukljak via stock.xchng