Warren Buffett, the legendary American investor, describes the chief executives of his businesses as the “chief risk officer.” It is a task that is irresponsible to delegate, Buffett says.
Risk has not traditionally been a glamorous concept in business. Risk assessments are considered a box-ticking exercise for staff and big businesses – a list of threats you must show you are taking seriously even if they are unlikely to occur.
But understanding risk is crucial to success and failure. It impacts the core facet of a business – how to innovate, how to recruit, how to protect what you have and how to avoid disaster. It is about how well you understand the upsides and downside risks, the long-term and short-term effects, and, crucially, where you may have an advantage because you can take fewer risks than others to succeed, or you are prepared to accept a downside risk that others aren’t. For instance, a recent survey of Norwegian entrepreneurs found that the wealthier you are the more likely you are to start a business. It also found that you are more likely to start a business when stock market returns have been high. The reason for this, in short, was that people in these circumstances are more confident and have less to lose. They are taking less of a risk.
“The model of the lone entrepreneur – the poor boy with a brilliant business idea who rises single-handedly from poverty; the isolated scholar scribbling brilliant ideas in a garret or country village – is largely mythological.” That was what John Kay and Sir Mervyn King, the former governor of the Bank of England, wrote in their book Radical Uncertainty. “The most common profile of the successful entrepreneur today is the individual who draws on his or her past experience in a larger organisation, and works from inception with a team of like-minded individuals. And such individuals can contribute to society only in a supportive social context.”
Until recently humans considered risk a matter for the gods and superstition. As Peter Bernstein, an American historian and economist, wrote in Against the Gods: The Remarkable Story of Risk: “The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk: the notion that the future is more than a whim of the gods and that men and women are not passive before nature.”
Humans find it inherently difficult to think about risk rationally. Research has shown that we overestimate the risk of good or bad things happening in the short-term and underestimate what we can achieve in the long-term, like building a business. Amos Tversky and Daniel Kahneman, the psychologists, developed the concept of prospect theory. This is the idea that human beings don’t always make a rational decision when presented with the probabilities of the potential gains and losses. They found that people can have an inherent aversion to loss.
Those who seek to understand risk and the balance between risk and reward can thread a path through this. Avoiding risks completely is not an option, at least according to Mark Zuckerberg, the co-founder of Facebook. “In a world that’s changing really quickly, the only strategy that is guaranteed to fail is not taking risks,” he has said.
Wizz Air is now one of the largest airlines in Europe. It was founded in 2003 by Jozsef Varadi in Budapest, Hungary on the belief that the expansion of the European Union would encourage more travel to and from Eastern Europe. Today it flies well over 60 million passengers every year.
Varadi knew that Wizz Air would have to do things differently – and take risks – to survive, let alone thrive.
“We felt that one of the ways we can differentiate ourselves is taking more risks than the others,” Varadi says. “Of course, all these risks are calculated. You have to be mindful of the consequences. But at the same time, I also think that if you want to be an entrepreneur, a business, you must take risks and you must fail. If you are not prepared to fail, then you never test your own boundaries, you never stretch yourself beyond your comfort zone. That is philosophical to me, but it’s also practical to me.”
Wizz Air does not risk the safety of its plane, of course. The risk-taking for Wizz Air involves testing new routes and destinations for its planes that other airlines would not try.
“Many times we feel that there is an opportunity to start a new route. But maybe we were wrong because we didn’t have all the data points. No matter how analytical you try to be, the reality can turn out to be different than you thought,” Varadi says. “We call it applying the 80-20 rule. So as opposed to trying to be perfect – making sure that whatever decision I make is 100 per cent right – when we get an 80 per cent sense this is probably okay, then we go. That of course contains the possibility of failure. But that’s okay.”
As this example shows, even when businesses fail there can be upsides – such as learning from your work. Successful entrepreneurs understand this when they are seemingly risking it all to build their business. As Phil Knight, the co-founder of Nike, said in his book Shoe Dog: “Wisdom seemed an intangible asset, but an asset all the same, one that justified the risk. Starting my own business was the only thing that made life’s other risks – marriage, Vegas, alligator wrestling – seem like sure things. But my hope was that when I failed, if I failed, I’d fail quickly, so I’d have enough time, enough years, to implement all the hard-won lessons.”
Yet truly understanding and accepting this is difficult, as the work of Tversky and Kahneman demonstrated. “People put much more weight on losses than gains,” Kahneman said. “People hate losing.”
Those who appreciate and understand risk have often developed it over time or something has happened in their life that has shaped it. Tom Beahon is the co-founder of sportswear brand Castore, which sponsors the Red Bull and McLaren Formula One teams, German football champions Bayer Leverkusen and Sir Andy Murray, the tennis player. When he was younger he wanted to be a professional football player, but he was let go by his local club in his early 20s. That failure would drive the creation of Castore. Beahon was willing to take risks to succeed because, in his mind, he had already failed. “To my mind – my little uneducated brain at 20 years old – the worst has happened. But you realise that the sun still rises the next day,” Beahon says. “What it instilled in me was whatever I do, I need to be in control of my own destiny. I’m not getting called into the manager’s office again. Failure doesn’t scare me. I’ve failed. The worst has happened. What scares me is not being in control.”
About the Author
Graham Ruddick is editor-in-chief of Business Leader magazine and host of the Business Leader podcast. He founded the podcast and the Off to Lunch newsletter in 2022. He is also author of new book Risk Roulette: The surprising reasons why some businesses work, and others fail, published by Kogan Page.
This post was originally published on here
