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“It’s risky not to take enough risk.”
— Magnus Carlsen, World Chess Champion
In my business, I see a lot of business failures.
Often, it is easy to say, “What were they thinking?” But the truth is, I rarely see the flip side of the risks that business owners take: the successes. Those people don’t call me.
The essence of risk — in a business context or otherwise — is that
we don’t know today, with certainty, the effect our decisions will have tomorrow,
let alone next week or next year. We try and see if it works.
One of my former clients was a “flash boy” broker/dealer that I liquidated. They purchased expensive, high-speed order flow from retail stockbrokers and had algorithms to trade and make lots of small profits from the information in the flow. The company raised $30MM from a handful of individuals and $60MM from a prominent private equity fund.
But after just two years, the money was gone.
According to the Chairman, who is a pioneer in the industry, my client had the right people and the right IT infrastructure — all very expensive. Unfortunately, the algorithms just didn’t work; he personally lost a couple of million dollars. In the end, the only way to test the investment was to try it.
When is it Risky to
Not
Take Enough Risk?
Many years ago, I was hired by a rent a car company to consolidate seven accounting centers into one regional office. I thought I would first thoroughly assess the situation, then develop strategies and plans, and then implement the plans. This approach minimized the chances that my consolidation plan would fail.
But the first week on the job, I learned that my arrival had been announced 18 months in advance.
The accounting offices were collapsing. There was no staff and no time for a thorough assessment! I had no choice but to begin consolidating immediately with what was, at best, a risky “directional” plan. Fortunately, it worked. Nine months later, all accounting and finance was in one regional office and the books were closed on time with accurate financial statements.
Another time, I liquidated a high-end party rental company. They had a lock on the billionaire market in town.
But they still went out of business, because they never took the risk of raising prices.
Their service was superior to the competition, but they charged less. After lowering prices in a bit of a price war with a new entrant (that ultimately failed), my client feared losing customers with higher prices. They didn’t have margins to cover the higher costs of superior service. Adios.
Chess grandmaster
Maurice Ashley recently said, “Sometimes you play too close to the vest. And what happens in a competitive environment is that the margins are so small, it’s so close, the abilities of top players, that if you try to play it safe, if you try to be incrementalist about it, those guys will stop that in a second.”
Business is competitive and you will lose out by only making incremental decisions.
Tips on Taking Risk
Decision quality matters. A lot.
That’s how you ensure more wins than losses. In the “flash boy” example, the investors made a good decision, even though, ultimately, it did not work out. Seven years later, the private equity firm is doing well, as is the former Chairman. Batting averages matter. When time allows, use the
five-step method I have discussed previously.
Monitor and course correct along the way.
Tracking is the final step in the five-step process; what happens will always be somewhat different than planned. When I consolidated the accounting offices, I constantly monitored progress, both formally with my staff and informally by visiting field operations.
Make sure to
listen to the noise, too. Meet your customers, employees, suppliers, and competitors. Don’t let corporate bureaucracy tell you everything is “on track” when it might not be.
Physically wandering around your organization
is a great way to get unfiltered, employee information.
Get the direction right.
Some problems are too complex to solve upfront. Such was my challenge consolidating the accounting centers. So, I began by first consolidating the southern accounting centers into Nashville and the rest into Boston. I added staff as needed in Boston and Nashville as the consolidation continued. Then I rolled Nashville into Boston.
Find ways to minimize execution risk.
During the accounting center consolidation, I made lots of very small, very quick, low-risk decisions. In larger organizations, proactively and formally dictate how much risk people are permitted to take.
Formal limits of authority
is one way to do that, particularly as a means of controlling the financial consequences of decisions.
Limits of authority is a written authorization, to individuals within an organization, which
allows them to commit the company to do certain things.
This may include entering into a sales contract, extending credit, making purchase commitments, making payments, and so forth. This authorization is formal, documented, comprehensive, and understood throughout the company. The key is to focus on the authority to commit.
Where possible, understand the nature of the risk/reward distribution.
In the investing world, this is simple to do, because there are only two fundamental types of investments: equities and fixed income. Equities have an expected return with a lot of equally weighted variance in actual outcomes above and below the expected return (similar to a normal distribution in the statistical world). Fixed income depends on a series of fixed payments. There is no upside beyond the expected return, however, the odds of no return or a very small return are slim.
“Safe” business decisions tend to be like fixed income: a small gain if successful, a small loss if not.
Riskier decisions have a wider range of outcomes, particularly negative ones. But, unlike equities with a “normal” wide and evenly distributed possibility of outcomes around expectation, risky decisions can be
skewed
more towards upside or downside. So, think about the possible range of outcomes before moving forward.
One way or another, businesses must take risks to survive, let alone succeed.
Don’t hesitate to take risk, just do so wisely.
That’s called judgement.
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