The future seems to be coming at us at an ever-increasing rate. As effective managers and practitioners, we must think proactively about all of the possibilities that the future may bring, but those possibilities have uncertain outcomes. We call those possibilities opportunities if we believe they will have positive outcomes. For example, we have the opportunity to successfully complete a project and make a substantial profit, or we have an opportunity to introduce a new product into the marketplace first and capture the lion’s share of that market. We call those possibilities risks if we believe they will have negative outcomes. For example, we have the risk of not successfully completing that same project and losing our investment, or we may have the risk of our competition beating us to the marketplace with a new product and losing market share. To quote Tom DeMarco, “Moving aggressively after opportunity means running toward rather than away from risk.”
As illustrated in Figure 1, good risk management practices are a balancing act between risk and opportunity. We need to identify and manage both the risks and their associated opportunities. Not paying attention to the opportunities and managing the balance between those opportunities and the risks can lead to the loss of important opportunities. It may also lead to projects and product where the risks so outweighs the opportunities that there is little to no chance of success.
Walking the Board
To demonstrate this point, let’s assume that I place a 2x4 that is 10 feet long on the ground. It is 2 inches off the floor and 4 inches wide. If you can walk across it toe-to-heel, without falling off, I will give you $10. Would you do it?
What is the risk in this scenario? The potential problem is that you would fall off the board.
Let’s analyze the risk, what’s the probability that you fall of the board? For most of you it may be fairly low. However, I have had both knees replaced and I still don’t have good side to side balance, so for me the probability is higher. What’s the loss if you do fall off? Don’t say $10 – because you are not losing the $10 – you don’t have it yet. The loss might be that if you are the only one who steps off the board, others might point and laugh, causing you to be embarrassed. Or you could actually twist and sprain an ankle, or even fall and crack open your head – but what is the probability of that happening?
Now let’s analyze the opportunity -- the $10 reward for success. What is $10 worth to you? What’s the probability that you receive this reward? If we were in a room together running this experiment, how many of you trust that I would actually give you the $10? When we talk about this in my classes, most students are willing to take on this challenge for the possibility of a $10 reward.
Changing the Challenge
Let’s take the same board and place is between two seven-story buildings -- assume that the board is reinforced and locked down so that it won’t break, twist or fall.
Is anyone still willing to do it for $10? Why not? What did I change? Of course, the answer to that question is that I changed the risk side of the balance. So let’s analyze again.
Did I change the probability that you fall off? Maybe -- outside, between two seven-story buildings, there may be a breeze, or you may be nervous and shaky, which might increase the probability that you fall. But mostly what I changed was the loss if you do fall – from 7 stories up, if the risk turns into a problem and you do fall – you will go splat.
So, to bring this challenge back into balance, I have to increase the opportunity side as well. How about imitating the Fear Factor TV show – I will give you $50,000 if you are successful. Any takers?
At this point someone in my class usually starts asking questions about harnesses or airbags. AH – RISK MITIGATION! When you really want the reward (and which of us couldn’t use $50,000), but the risk looms too large for us to be willing to take it on, so we want try to figure out ways to reduce that risk.
We can do that by reducing the probability that the risk turns into a problem (for example, we could practice down on the ground for a while until we got really good at walking the board, or we could get out of our five-inch stiletto heels, and put on good tennis shoes). We can also reduce the loss if the risk does turn into a problem by having the harnesses or airbags. We could also transfer part of the risk to someone else. For example, maybe we could hire a world class gymnast to walk it for us and split the reward with them.
Risk management is all about identifying and analyzing our risks in order to decide:
- Which risks are small enough, and the associated opportunity good enough, to accept the risk?
- Which risks are so big that the associated opportunity is just not worth it, so we avoid the risk?
- If we really want the opportunity, but the risk is large enough that we must actively mitigate that risk?