Business decisions are an exercise in risk management.
Is the decision right or wrong?
What is the impact if it’s right? If it’s wrong?
Can the decision even be made with the information available?
Are there alternatives that should be considered?
Who should be part of making the decision?
Is the timing right for this decision?
Businesspeople make hundreds of decisions a day, some small and inconsequential, others large and impactful. While the questions above may not be individually, explicitly answered for every decision a person makes, as a group they comprise a risk-tolerance framework.
Companies, teams and individuals have their own risk frameworks. Personally, I may be more risk-averse than the team I’m on or the company I’m a part of, but my framework contributes to the overall team and company framework. Risk-tolerance fluctuates over time as internal and external factors are modified.
What is Risk?
In my experience, risk is the decision-driver for action versus inaction. It’s used to describe the impact of an outcome happening, usually the negative potential outcome. Conversely though, if the impact of the negative outcome can be determined, that means the positive outcome ‘risk’ can be as well (Note: The impact should not be confused with the probability of impact).
What is the Risk-Tolerance Intersection?
Risk-Tolerance is the intersection of opportunity and valuation (see Intersection 6 image below). The risk-tolerance framework, whether for a company, a team or an individual, determines how decisions are made, which leads to the eventual success or failure of the company, team or individual.
Opportunity
Opportunity, and its close relative opportunity-cost, are key in the risk equation. Let’s take a new product introduction as an example of risk. Specifically, the decision whether to release the new product this quarter or to wait until next quarter. Following are some of the risk considerations.
The Opportunity
Speed-to-market (i.e. first-mover advantage)
Speed-to-revenue (i.e. ROI)
Industry perception (i.e. early innovator)
The Opportunity-Cost
Quality (i.e. not a fully tested product)
Product-market fit (i.e. is the market ready?)
Deployment readiness (i.e. can the company handle demand and support?)
Both the opportunities and the opportunity-costs must be considered in any decision, especially major corporate decisions around people, product, strategy, marketing, investments, etc. Without understanding opportunity, an evaluation of risk will be incomplete.
Intersection 6: Risk-Tolerance = Opportunity + Valuation
Valuation
Valuation is the ability to quantify or qualify the value of the opportunity (and opportunity-cost) for any given decision. The result of valuation is an assertion of measure around impact. Without the valuation side of the intersection, decisions become guesses rather than informed choices.
Establishing the quantifiable or qualifiable value of an opportunity includes subjectivity as well as objectivity. The reason for this is that predicting the future with 100% accuracy is not guaranteed (or possible). Therefore, valuation must be done with the imperfect information available and judgment.
Using the new product introduction decision example above, valuation considerations include:
Speed-to-market -> Historically, do products in this space benefit from first-mover advantage? If so, how much? Is there risk of a competitor bringing a similar product to market sooner? How much market share will be captured upon initial product introduction versus once a competitive product is released?
Speed-to-revenue -> How much revenue can we expect in the first week / month / year and how much does that revenue cost? What is the payback period for product development? What factors influence customer acquisition? How can we accelerate awareness and order-to-cash?
Industry perception -> Is there value in this industry to be seen as an innovator? If so, how does that value manifest itself?
Quality -> Will we lose sales if product quality is low? How much will it cost in revenue and customer goodwill if our product is viewed as having quality issues? Do the other valuation considerations above make quality a non-issue (i.e. because there is so much demand / need for the product regardless of quality)?
Product-market fit -> Is the market craving this product? Is the product a need or a want? Will customers understand it? What is the price elasticity?
Deployment readiness -> Does the company have the funds and other resources needed to promote and execute the product rollout? What will the ongoing product maintenance and support costs be? Is the company’s operational infrastructure ready to scale with the projected product demand?
These are just a few of the many valuation considerations that could be listed for this example. Valuation is complex and its importance as part of the risk-tolerance intersection should not be minimized.
What Can Leaders Do?
Risk-tolerance starts with acknowledgement that there is risk associated with decisions. Leaders must first understand their own risk-tolerance levels and how that influences their decisions. Next they need to recognize the risk-tolerance of their team(s) and the company itself. This frame of reference sets the stage for determining if the current risk framework is acceptable (i.e. leading to desired results) or not.
If the framework is acceptable the leader’s goal is to make sure it continues to be maintained as the company grows and moves forward. This is done by diving into the intersection components…opportunity and valuation…and being methodical in ensuring key decisions include consideration of both.
If the framework is unacceptable leaders must explore how decisions are being made and inject analysis as well as the use of opportunity and valuation into the process.
Wrap Up & Up Next
Leaders are known for their decision-making. Given the breadth and depth of the decisions they’re required to make, a static level of risk-tolerance won’t always work. Leaders must adapt their own and the company’s risk-tolerance to what each new situation and decision calls for at a given point in time.
Next time we’ll examine the 7th intersection of performance, which is the Awareness Intersection.
In this series of articles, we explore The Intersections of Performance, of which there are 30. The Intersections of Performance framework is based on the experience and insights of Brett Simpson, Managing Director of Elevate Simply, over his 20+ years of leadership in large and small organizations, and as an entrepreneur, advisor and investor.