Sunday, November 16, 2008

Calculated Risk

I am noticing more focus on risk these days when I read/study governance and boards of directors' material as well as the documents I receive from accounting firms. Many seem to approach this as "risk is bad".

As an entrepreneur, I believe that part of my job is to take risks and I think we have to be cautious not to become a business culture where we tolerate no risks. Success in business will be had only by taking calculated risks.

I have often said, "Fail often, fail fast, fail cheap" because having small failures is the best way to experiment to determine what will be the best business successes.

Of course my analysis would be if there is risk to make sure that the fail cheap part is followed. What this means is that you are not necessarily risking the entire company and that any risk that is taken is recoverable.

It also involves entrepreneur pessimism which is not a very common characteristic. Most entrepreneurs are highly optimistic so tend to look only at the upside. By looking at the downside, you are able to structure things such that the downside is not as painful. This should be the only role that risk management has. Risk management should not take the role of preventing companies from taking risk.

I also do understand that part of the role in risk assessment is for disclosure. I am seeing risks from floods, tornadoes, hurricanes and the sky falling added to the risk list so the disclosure becomes almost meaningless because no one has time to sift through to figure out what the real business risks are.

I will also say that equity investors need to understand that they are investing in equity so there is risk.

I plan to invest my money with executives who plan on taking risks. Without risks, companies will not be able to thrive.


At 9:36 PM, Anonymous Anonymous said...

Nice post, Jim. What you say seems to echo Warren Buffett's approach. Many people characterize this approach as "safe" or "cautious," which it certainly is in comparison to, say, Lehman's.

But Buffett's approach is really about minimizing downside risks, isn't it? When you buy something at a bargain, which he insists on doing, you have much better odds of limiting your downside than if you buy it at a premium. The same holds for buying an asset at close to its book value: if all else fails, you can sell the parts for scrap and still come close to breaking even.

The financial excesses against which people are now rightly reacting were, in many cases, about financial actors taking risks without *any* serious thought to downside risk. From individual mortgage-holders on up to Wall Street titans, investors waded into waters where risks were opaque, and where they didn't know how deep the deep end really was.

At 9:06 AM, Blogger Jeff said...

It amazes how many organizations want new ideas, new products and new development but create cultures where failing is frowned upon. It's not enough to say it's okay to fail it has to actually be okay. I think this is the hard part for many.

At 10:54 AM, Anonymous Anonymous said...

Risk, CALCULATED risk that is, just like you say, yes, absolutely.

Recklessness, which seems to be the prevailing corporate behaviour, absolutely no!

Recklessness = Risk - Calculation.

Alex Revai

At 3:52 PM, Anonymous Anonymous said...

You're talking about two kinds of "risk" here, Jim. There's risk of loss due to political factors or currency fluctuations.

But when you try something to see if it will work, you're not taking a risk. You're experimenting.

At 8:10 PM, Anonymous Anonymous said...

Hi Jim,

I think that those people who take risks are being leaders and we need leaders now more then ever. Keep the great content coming and look in your inbox for a message from me.

Mark Edward Brown


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