Wall Street has made risk dirty word, associated with recklessness, gambling and certain moral vacuum. Yet, calculated risks are exactly what company requires if it wants to shift from being merely good to become truly great. Whilst most companies seek steady, unspectacular growth, it is those that identify ways to create disproportionate returns that really stand out. And that requires different mentality – not often supported by analysts and shareholder meetings.
Here’s little test to gauge your company’s appetite for risk. Imagine your business is founded on very simple task. Your sole purpose is to determine the outcome of coin toss. Whenever you’re wrong, you lose your investment. However, whenever you’re right, you’ll get $2.50 in total for every $1.00 invested.
First question; is this source of business your company would embrace? Well, in the long run it seems to be pretty healthy business – your expected return on investment over the long run is 25 percent (50 percent of the time you’ll lose $1.00, 50 percent of the time you’ll win $2.50). So the answer should be yes, right?
Now let me ask the question another way. In the above example, 50 percent of the time, you’ll lose your entire investment. What would your appetite be for taking strategy to the board that was certain to result in total failure every second time? Would they have faith in the long-term expectations you carefully take them through? How long would they give you to demonstrate success?
When he took over the England captaincy, cricketer Nasser Hussein lost the toss 14 times in row, picking heads every time. Would you be allowed to survive such variance?
This is the point at which adherence to long-term strategy pays dividends. The difference, perhaps, between good companies and great ones is that it takes nerve and determination to remain on course when the world around you does everything it can to make you doubt yourself.
Great CEOs keep their nerve, and focus on assuring those around them of the principles upon which everyone agreed before the bad run kicked in.
So, back to you. What would the appetite be in your company for this sort of business? If the prospect of delivering short-term bad news fills you with dread your company is probably culturally opposed to risk. So jumping in to strategy that incorporates the likelihood of failures along the way is unlikely to deliver anything beyond sleepless nights. This is where ring-fencing can help.
Any company with significant investment in R&D must inherently have healthy respect for short-term failure. Pharmaceutical companies, for example, understand the large payoff approach. They’ll fail many times in the pursuit of disproportionate returns for when they hit the right formula. Tech firms follow similar approach. Consider for moment how you might apply the same methods to your own business.
The key to the success of any risk-based long-term strategy lies in the levels of investment you’re prepared to allow at any one time. Gamblers call this ‘bankroll management’. The long-term pursuit of the 25 percent returns guaranteed by the coin toss example is great, as long as you don’t run out of money before the positive expectations become reality. Putting 100 percent of your capital at risk on single 50:50 proposition is never going to be classified as good business.
When your strategy embraces risk, and the likelihood of short-term failures, you need to be sure that you adopt the right investment strategy from the beginning. You’re looking for small investment/large payoff strategy, that won’t send you broke if the losses all come at once.
So to move away from corporate culture that fears losses more than it craves growth you need to adopt strategies that plan for risk from the outset. Second to this, you need to shift expectations around investment – away from mindset that requires all investments to be at worst break-even. Finally, you need to remain steadfast in your belief in the long term, ensuring that your strategy stays the course, and allowing small-scale risk along the way. M
Simon Lendrum is MD of communications agency JWT NZ and author of the blog, simon-says.co.nz
