4 Assumptions About Risk You Shouldn’t Be Making24 August, 2016 / Articles
“Two roads diverged in a wood, and I—I took the one less traveled by, and that has made all the difference.” The line is instantly recognizable as the conclusion of “The Road Not Taken” by Robert Frost. And, the misunderstood poem helps to highlight how innovation-seeking executives need to reframe the word risk.
Most readers assume Frost’s poem is hopeful, describing the value of the rugged individualism that has long served as an American hallmark. However, a measured reading shows a wistful tone that borders on regret (“I shall be telling this with a sigh”), with critics arguing that the poem’s key message is how we rationalize bad decisions after the fact.
Similarly, when the word risk comes out of an executive’s mouth, it’s usually accompanied by one of four mistakes:
Assuming that taking action is the biggest risk. In many cases, the riskiest action is in fact inaction. The pace of change in today’s world means that standing still leads to falling behind current and emerging competitors. The way in which many companies make investment decisions blinds them to this reality. Most executives know that the present value of an investment comes from projecting its cash flows and discounting those numbers into today’s dollars. The general rule is projects with positive net present values should get funded, and those with negative ones shouldn’t. That assumes, however, that the base case is zero. If doing nothing leads to decline, projects with marginal projections actually are better alternatives than inaction (this misuse of financial tools for innovation is discussed in depth in a 2008 Harvard Business Review article by Clayton Christensen, Willy Shih, and Stephen Kaufman).
Believing that good entrepreneurs seek out risk. They don’t. Good entrepreneurs recognize the inherent risk of creating new businesses. After all, it’s well known that most new businesses fail, and that most of the ones that succeed do so in modest enough ways that the entrepreneur gets at best a modest financial return on his or her effort. As Noam Wasserman noted in The Founder’s Dilemmas, “On average, entrepreneurs earn no more by founding startups than they would have earned by investing in public equity – less, in fact, from a risk-return perspective.” What good entrepreneurs excel at isn’t taking risk, it is managing it. Working with partners, raising money from a syndicate of investors, building a team, scrappy ways to earn revenue are all examples of smart risk management.
Celebrating failure to encourage risk taking. Dictionary.com offers a reasonable definition of risk as “exposure to the chance of injury or loss; a hazard or dangerous chance.” There can be no innovation without risk, as innovation necessarily has uncertain outcomes, some of which can be bad. Encouraging risk taking, therefore, can help to boost innovation. However, that doesn’t suggest a blanket endorsement of failure. In many cases, failure is bad. Sometimes people fail because they didn’t do their homework. Sometimes they fail because they lacked skills or hadn’t practiced enough. These categories of failure should never be celebrated. Rather, executives should recognize that the path to innovation success is never a straight line, so fumbles, false starts, and, yes, sometimes failure are part of the game.
Thinking that rewarding success will boost risk-taking. Innovation-hungry executives at large companies often gnash their teeth about the challenges of compensation, lamenting that their system simply won’t allow them to offer the unbridled upside that awaits entrepreneurs at unicorns (which, in reality, are an incredibly rare breed). True. But that’s not really what holds innovation back in most companies. It isn’t the lack of rewards; it is the presence of punishment. Execution-oriented companies are used to rewarding people who hit their numbers and punishing those who don’t. But the uncertainty that accompanies innovation means that sometimes people will do everything right and still have a commercial failure. And if that result carries stiff punishment, don’t expect anyone to ever take any risk. While it is well known that quick wins build confidence in change efforts, companies seeking to build their innovation capabilities should have a quick loss, where a project gets shut down and everyone celebrates rather than looking for a scapegoat. It helps to signal that the company is ready to think and act differently.
Next time you clear your throat and prepare to make a speech on risk, pause to make sure you aren’t making one of these mistakes. That will make all the difference.