As business owners, we buy insurance to mitigate the negative consequences of unexpected events such as a fire. But we cannot purchase insurance for all risks. For example, when launching a product we face the risk of lower than expected sales. Another common scenario is the need to safeguard against reputation risk in the age of social media. How do we deal with risk that we cannot insure against?
Uncertainty and risk
Uncertainty means a situation has multiple possible outcomes. We can assign a probability for each possible outcome. As a simple example, let’s assume that our construction company is submitting a bid on a large project. Based on our understanding of our competitive position in the marketplace, we might estimate that there is a 75% chance we will be unsuccessful and a 25% chance we’ll get the work.
Risk builds off this concept. It’s a state of uncertainty where at least one of the possible outcomes involves a loss. If our construction company mentioned above spends $20,000 in employee time and expenses to prepare the bid, then we can say the risk of bidding on this project is $20,000 if we don’t win the bid.
In general, higher risk scenarios should have potential to yield greater returns. For our example with our construction company, it’s possible the reward is a project with $2,000,0000 in gross margin. Larger projects with greater gross margin tend to require more time and expense to submit a bid.
So what makes a project risky? Generally, people consider situations risky where the chance of success is low or where the scope of loss is high. But one other consideration is ambiguity. When we have difficulty predicting the outcome of a situation or the scope of our loss, our perceived risk increases.
How do I stack the deck in my favor?
No, I’m not talking about doing anything unethical. My reference to stacking the deck means altering your situation to create a higher level of certainty in your outcome (avoiding risk) or lower the potential loss related to an undesirable outcome (mitigating risk).
Reduce ambiguity. Information helps us understand the possible outcomes and the possible magnitude of loss. Most important, being informed helps us understand why a situation may occur. Knowing what causes situations to unfold gives us something to work with. We can use our skill, experience and judgment to adjust our approach. Our approach is our strategy. It might be how we structure our sales force, explain the value we offer customers, or set our price.
Let’s assume we’re expanding into a new market. The advertising campaign we use successfully in our home market promotes product features. But will that message resonate with our potential customers in this new market? Possibly not, if those customers want something different than our existing customers. Or maybe a competitor is already providing the same thing we plan to sell, and our message does not differentiate our product. Information about the customers and operating environment would provide insight that we can use when making strategic decisions.
Adjusting how to manage risk
There are two things you can do.
1. Get the customer and industry information you need to make good decisions.
This typically involves talking to customers, suppliers, and peers. Don’t be a hermit. You need a lot of information to build a practical strategy. I see this often when a company develops a new product. An entrepreneur might see a product at a trade show and say ‘I can sell that!’ Maybe. But complement your instinct with customer feedback before making the investment.
2. Build in process, policies and procedures to reduce uncertainty.
Entrepreneurs tend to push back against structure, but in this case don’t look at it as a pair of handcuffs. It’s a way of improving the odds that your desired outcome will materialize.
Let’s say our greatest perceived risk is the uncertainty of customer acceptance regarding a new piece of equipment we are launching into the mining industry. One way to address this involves adopting an iterative launch process, where we release a simple version of our product to a test market. We aim for success, but we also learn from this initial experience and use that information to build on what is working. We may adjust the product or service or aspects of our marketing strategy such as the price we charge.
Reputation risk is top of mind as social media continues to influence business. Our younger employees frequently post their opinions online about companies they buy from. What are they saying about you, their employer? A frustrated employee describing her workday on Facebook can leave a lasting impression with potential customers. There are ways to monitor your company’s reputation online. But many employers are also creating social media policies to guide behavior while respecting the rights of employees.
Managing risk involves increasing the probability of a positive outcome and decreasing the potential loss. You do this by informing yourself, and by implementing certain processes. It allows you to capture the upside of an opportunity while reducing the ‘riskiness’ of a situation.