Why too little risk is horribly dangerous
These are risky times. Governments are falling, going bankrupt, or deadlocked. Companies are struggling to find the right balance between caution and optimism.
No one knows what will happen next, and it is crazy to operate your business as though you do.
Don't you wish there was a way to reduce risk and still preserve the possibility of big wins?
There is – it’s called the real options approach. Using it, entrepreneurs and executives (and everyone else) can lessen the risks they face, even in uncertain times.
Make bets after you see what happens, not before
According to the book, Real Options, “an option is the opportunity to make a decision after you see how events unfold.”
Think about it. Imagine if you could place a bet on a football game after you see which team is ahead at halftime. That might be slightly more profitable than betting before the game, wouldn’t it?
The authors explain, “On the decision date, if events have turned out well, you’ll make one decision, but if they have turned out poorly, you’ll make another. This means the payoff to an option is nonlinear — it changes with your decision.”
Always keep your options open
Real options theory suggests that the more volatile the times, the more essential it is to keep your options open. Thus, taking less risk (preserving fewer options) is actually more dangerous than investing to preserve a number of options.
Here are two examples of steps you can take to reduce risk and increase your odds of success:
1.) Make a list of all investment decisions that are contingent on future events. For example, if orders rise by more than 20%, you will have to open a new factory.
2.) Highlight decisions where uncertainty is large enough that you wish to delay an irreversible investment decision, while preserving the option to pursue this course of action. Instead of committing to build a new building, you could commit to have an architect draw up plans, which will take four months. If at the end of that period you still feel comfortable going ahead with the project, you can use the plans to gain approvals, which will take another five months. But along the way, you are delaying an irreversible decision to approve the entire project.
Image credit: Flickr member Paxson Woelber.
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Professionally, you create value when you align your thinking and actions with how a company earns its revenue, manages its costs, and utilizes its assets.
11 年Plan. Do. Believe.
A Renaissance Man, as described by his employees
11 年This process applies to piloting an aircraft, which includes continual development and refinement of skills, and practice to become more proficient. Many years ago, prior to an IFR (Instrument Flight Rules) departure from MIA (Miami International Aiprt) in a Cessna 172, ATC (Air Traffic Control) gave me a SID (Standard Instrument Departure) as part of the clearance. My IFR instructors only taught what was necessary to pass the FAA IFR exam. It was my own responsibility to continue the learning process. Rather than "freak out" and decline the SID, I accepted the clearance and told ATC I would get back to them if I had any questions. While located on the ramp sitting in the cockpit I located the SID in my approach plate reference, carefully studied it, and realized the SID saved considerable effort when writing down the clearance and getting a preview of the vectoring of what I might expect during the departure process. I now readily accept use SIDs and STARs (Standard Terminal Arrival Route). I have also discovered ATC will give the the verbal details for an unidentified SID or STAR which only applies to a turbojet. By reference to the instructions, I can easily get an overview of what to expect during the departure or approach. When I realized I needed XM weather (weather reporting product sold by XM Radio) in the cockpit as a bare necessity to help me navigate on Angel Flight missions (https://aircharitynetwork.org/) during inclement weather, I added a basic AnywhereMap system (https://www.anywheremap.com) with XM. This enabled me to see almost what ATC was seeing on their scopes and to better interpret their reports with what I could actually see around me if there was visibility. Accordingly, I learned the ATC radar is not 100% accurate and there are time delays which can significantly affect navigation. Accordingly I learned how to work with ATC to provide them with real time weather updates, including wind direction/speed, turbulence, precipitation, cloud bases/tops and other facts which could affect flight for a small aircraft similar to what I fly. All of this involves risk taking, but on the basis of taking an action and having one or more possible corrective actions which can be taken if required. A few years ago I lost the DG (Directional Gyroscope) while in IMC (Instrument Meteorological Conditions) immediately after departure from a non-towered airport. My Angel Flight destination was a major airport about two hours distant. I considered the risks to attempt a return to the airport behind me which had one ILS/GPS (Instrument Landing System/Global Positioning System) runway and the inability for ATC to see me on the radar due to altitude versus flying two hours in IMC without a DG and landing at major airport with a variety of emergency support facilities. Having six and one half hours of fuel on board, I made the decision to fly to my destination. I explained everything to the passenger and invited the passenger to be "involved" in the decision making. She concurred. The story is not over. I was to conduct a hand-off of my passenger to another pilot for the second leg of the mission. Midway, my destination airport became shutdown due to unexpected icing conditions. I diverted to another major airport 100 miles south which had IMC conditions, which had superb support available as well. ATC at my request relayed a message to my second leg pilot to change airports. The second leg pilot departed from the original destination airport when the weather allowed it, despite landings were not allowed. Landing an aircraft in IMC conditions down to minimums without a DG would be a new experience, and I still had options of going elsewhere where there was no IMC. ATC calmly worked with me on the approach which took about 30 minutes before I could nail the ILS and land. Upon landing, ground control (with a chuckle in his voice) asked how much fuel I had left. I laughed and responded that I had at least four hours remaining. Upon refueling, I discovered I had about four hours 30 minutes fuel remaining, due to my fuel management technique and the typical inaccuracy of fuel gauges installed in my aircraft.. The key to risk taking is the decision process: evaluating probable outcomes and choosing the course which has the best possible outcome until an event occurs which requires further decision making. Alan M. Hoffberg Longwood, Florida
I would say You have it upside down, way You propose is minimizing risks, therefore it is less risk taken, actualy. More risk would be to invest in just few projects heavily, as loses would also be heavy if something went wrong. I also ptopose zo investors to invest in my WindSolars in stages, where each stage would be semi autoomous and capable to bring profit by itself. If they invest in prototypes or just prototype testing first, then in case concept is not proven only small money is lost. If small prototype of my new wind turbines show good results, they could go into serial production for home use without waiting for results from bigger models, that would be for industrial use. Since I know unofficial results of one hand made small model showed 400% greater efficiency over standard models, I am quite sure that present bigger model made in small factory would only give better results, and at worst, same as first one. However even if risk is small, investors wait to see results first, and I cannot even buy adequate electricity generator, made for small Windpower Station because my Business Bank collapsed and took all my liquid assetts away, while at same time making my best clients insolvent just like me. Clients filled for bankruptcy and liquidated companies leaving big bills for goods and services received unpaid. Therefore I was left in debt to suppliers which I am still paying. So I would say that title or heading should have read: Too little of risk taking is too dangerous, as world could perish in the meantime while we wait that risk wanish altogether......
Senior Vice President Marketing & Sales | Insurance Underwriting, Marketing and Sales Strategy
12 年Sometimes, you just gotta do it! Believe and do. Make it happen. MJB
Island AI Summit / Venture Investing / Founder Necker Cup / Technologist / Producer of Iconic Events / Connector of Great Ideas & People / Helped raise $$$ for worthy charities.
12 年Do the exact opposite of this. Fortunes can been made in volatile and uncertain times and lost in good times. Real entrepreneurs take risk in both types of economies. This theory seems like a very conservative way to evaluate risk/reward..