ego risk

Why should you care about ego risk? Because risks to innovation and new ventures follow the Pareto principle: only 20% of the risks a startup talks or thinks about are ego risks, but ego risks account for 80% of the challenges they face.

I’ve talked before about the 3 types of risk in new ventures. While tech and market risk get all the fanfare, ego risk is at the heart of most problems startups encounter. If you don’t manage market risk, you will build the wrong thing. If you don’t manage tech risk, you will fail at building that thing. If you don’t manage ego risk, you will fail to build anything at all.

Here’s the kicker: Most startups don’t die because they built the wrong thing. They die because they didn’t build anything.

Ego risk encompasses the whole set of challenges of managing ourselves, our teams, and our companies. As a leader in an uncertain venture, there’s no map to follow. With no clear yardstick for gauging success (except at certain rare intervals), managing your personal psychology and the mental health of your team becomes a crucial task, not just to prevent the productivity drop-off at the half-life of enthusiasm, but to avoid falling prey to cognitive biases and misapplied mental heuristics.

We’re all vulnerable to cognitive biases: traps in our thinking that lead us astray. Here are a few to watch out for:

Survivorship Bias – We focus on the startups that made it, and ignore the ones that disappeared before we heard about them. Then we draw conclusions about the whole from that small subset. For example, the startups that we’ve heard of mostly failed because they didn’t build the right thing. We never even hear about the vastly greater number of startups that built nothing. So we erroneously conclude that most startups fail because they build the wrong thing.

Overconfidence Effect – We estimate that we’re right more often than we actually are. We are often 99% certain that our estimates are correct, only to find that 40% of the time, they are wrong. Humans are notoriously bad at predicting the future, and it wreaks havoc on business plans. Entrepreneurs may plan and act as if the future is clear and make large bets when it might be more prudent to start with a smaller bet and wait for confirmation.

Sunk Cost Fallacy – People tend to throw good money after bad when in fact, it doesn’t matter how much we’ve spent: the only thing that should matter is the payoff from the investment we’re considering making – and the opportunity cost of not doing something else with that investment. But if we invest in a plan that doesn’t work out, we are more likely to double down on trying to make it work than to ignore our losses and invest in the best current option.

Availability Heuristic – When something is easy to recall, we think it must be more likely or more common than something that is harder to recall. If the last 2 people you talked to like the color green, you will think that most people seem to like the color green. This can lead us to jump to conclusions about our product or our market, instead of objectively evaluating the reality of people’s preferences and needs.

Confirmation Bias – We see what we want to see more often than it’s actually there. Especially when there is some level of ambiguity, our brains will interpret data to be consistent with our hypothesis, rather than challenge it. This can be dangerous when it causes us to think we have confirmed a theory, and proceed to act on it, when we’ve actually gained no further validation.

Bandwagon Effect – People tend to believe what other people believe. If most of your team believes something to be true, the rest of the team may come to believe the same, regardless of evidence to the contrary. The absence of dissenting opinions can make for a dangerous environment where the whole team moves in one direction without examining whether it is in fact the right strategy.

Halo Effect – We assume that people who have one positive quality must have others as well. One result of the halo effect is that we think that attractive people are correct more often than people who are not conventionally attractive. Just because a founder is good at code doesn’t mean they understand selling – and vice versa: yet another reason to set measurable goals and test against them early and often.

Hindsight Bias – We forget how wrong we were, and underestimate the importance of those first experiments. This is why it is so important to document hypotheses and minimum success criteria.

Dependence of self-concept on success of the business – When the business is failing, it’s common for the founder to feel like they are personally a failure. The countless entrepreneurs who have talked about this usually begin by referencing many of their friends and colleagues who suffer from the same thing, but don’t talk about it. So it’s a pretty reasonable bet that this is universal. Don’t feel bad.

Stay tuned for some tactics that can help you manage ego risk.