One of the hardest challenges entrepreneurs face is making decisions in the face of highly uncertain and risky situations. Often, these decisions can make or break a product or even an entire business. Lucky founders get it right and make it big once. Successful, serial entrepreneurs know how make calculated bets and are smart about learning from their mistakes.
One of the tools used by great business minds is a simple two-by-two matrix which compares decisions and outcomes. This four box tool helps them learn from both successes and failures and make better choices in the future. Using this matrix prevents them from falling into the trap of thinking that all good outcomes are the product of good decisions and bad outcomes the product of bad decisions.
To illustrate, let's use the example of a simple wager on a single roll of one die. Assuming a six-sided die, the chance of any one number is one-in-six or about 16.6%. Let's look at the outcomes.
Good decision, good outcome
Say someone gave you the following bet: you have to pay $10 to play, and you get $20 if you roll a 1, 2, 3, 4, or 5, but you get nothing if you roll a 6. That leaves you a 5-in-6 chance of winning $10 and a 1-in-6 chance of losing $10. The total expected value is $6.67. It's a bet worth taking.
You roll a 3. Congratulations! You've won $10. You've made a good decision and had a good outcome. The decision was not very hard and the outcome fairly expected.
Bad decision, bad outcome
Now, let's take that same scenario and change the numbers. Say it costs $10 to play and you get $20 if you roll a 1 and lose if you roll anything else. The expected value is $-6.67. It's not a good bet, but you decide to play anyway.
You roll a 3 again and lose. It was neither a good decision nor a good outcome, and it was also not surprising.
Here is where is gets tricky...
Good decision, bad outcome
Let's go back to the first scenario: $10 to play, you win $20 if you roll a 1, 2, 3, 4, or 5. However this time, you roll a 6. You lose.
Was it a bad decision? No, it was the right decision; the odds were in your favor. You just had a bad outcome. If that same exact situation came up again, you should take the bet and roll again. And you would probably win.
Bad decision, good outcome
Now, let's look at the second scenario: you take the bet at $10 to play and you win $20 if you roll a 1, but you lose if you roll anything else. Not a good bet, but you decide to play anyway.
You roll a 1. Winner! But was that a good decision? I would say no because the odds were against you. However, you had a good outcome. And therein lies the rub. The positive outcome would seem to suggest you made the right decision. Not so, you were lucky not smart.
Many times in business we end up with bad outcomes on good decisions and good outcomes on bad decisions. However if we fail to realize these types of situations, we risk taking away the wrong conclusions and making similar mistakes in the future. Skilled entrepreneurs learn how to reflect on decisions and outcomes and learn from those situations to decide if they made skilled decisions or just got lucky (or unlucky).
One of the best tools for developing this skill is a decision journal where you lay out your decisions, the options, your assessment of risk and probability, and then record the outcomes and reflect on your results. This allows you to see your bias, develop new skills for assessment, and clarify your goals for future decisions.
While real business decisions are much more complex than rolling dice, they often boil down to the estimated probability of two or more outcomes. Looking at possible options and likelihood of possible outcomes allows you to develop better strategies and make better decisions in the future.