Assessing Immediate and Future Risk for Your Business
Working with risk is risky. Every business venture comes with some degree of it. Although your mind can assess risk logically, psychologically, you handle risk in a totally different way. Here, you learn how to calculate risk in your mind, look at how human psychology works when facing risk, and, finally, show you how to avoid underestimating risk.
Identifying business risks
Calculating risk rationally engages your mind in a way that identifies the risk and assigns a value to how serious that risk is. Follow these steps:
- Start by asking the question, “What can possibly go wrong?”
The answer identifies potential risks arising from different sources. These are unique to the situation. For instance, in bridge building, one way you’d use this lens is to uncover potential engineering flaws. In marketing, you’d use it to identify assumptions being made about the market.
- Ask yourself, “What is the probability of this event happening?”
Assign the probability a high, medium, or low rating. This step separates the big risks from the tiny ones and helps you identify the likelihood that you’ll face the risk in reality.
If you detect a risk that is lying on the periphery of what everyone is paying attention to, name it.
- Identify the seriousness of the event’s effect on your business, using the high, medium, or low rating.
This step isolates the risks that may have a low probability of happening but very serious consequences if they do — a reactor failure in a nuclear power plant, for example. On the other hand, a number of risks may surface that have both high probability and high seriousness.
By looking at probability and seriousness together, you identify risks that you need to address in the decision-making process, either by making a contingency plan or by addressing the risk early on in the process to prevent it entirely or mitigate its effects.
- Develop and incorporate ways to prevent, mitigate, or eliminate the risk into your decision-making process.
If you can’t prevent it, plan to have a backup plan. For instance, in the case of electrical outage, most buildings have a backup generator. How far you take efforts to mitigate risk depends on the seriousness of the consequences.
Considering people’s response to risk
When a risk is real, specific, concrete, or immediate, it is much easier to relate to. For instance, when you jaywalk across the street in a high traffic zone, the risk of being hit by a car is pretty real. Conversely, a risk that is possible but not tangible — such as the chance of needing trip interruption insurance — is treated differently. Why? Human psychology. Consider the following points:
- People naturally tend to focus on the tangible and discount the theoretical. In other words, you’re more likely to pay attention to a specific risk you’re facing in the moment than to anticipate a risk that may happen in the future. This tendency explains why attention goes to what actresses wear to the Oscars rather than rising sea levels, or why a contractor substitutes inferior, low-cost materials to meet budget rather than focus on probable future risk (the stability of the building and the possibility that the inferior product may fail).
- Especially when making complex decisions, few people see unintended consequences, the unanticipated, wider effects that result from an action. Think of a spider web. If you jiggle one strand, the whole system is affected. The decisions you make can have similar effects. If you limit your attention to only one strand — that is, you make a decision looking only at one part of the whole picture — you won’t see how the strands are interconnected. Such tunnel vision causes decision-making errors
When you see the big picture, you can more accurately identify the direct consequences of a decision and action plans, and you can predict the indirect effects. Doing so reduces the chance that you’ll be blindsided or make a decision that takes a nosedive. Use a mind-mapping process to see how a decision may play out and to see who will be affected directly and indirectly.
- People perceive the future as distant, unknown, and not concrete. Traditionally, the majority of companies have operated on the assumption that climate change wasn’t relevant to business sustainability over the longer term. The probability of climate change, given the way risk is assessed psychologically, has not traditionally been factored into decisions about how resources are used or the carbon footprint of business activity. Consequently, actions that could have reduced carbon outputs were not taken. Now, according to the Carbon Disclosure Project’s survey, S&P 500 companies estimate that 45 percent of the risk will surface in the next one to five years, with some costs of production already being felt. The effect of the psychological tendency to see potential futures as a slide show is that action is delayed, resulting in a higher cost later on.
In the traditional sequence of think-plan-do, risk isn’t real until you reach the doing stage. As long as you’re thinking or planning, things that go bump in the night — the consequences of your actions — aren’t real. But when you take action, people react, and consequences show up. To assess risk, you must be able to conceive the reality of things going wrong. You can reduce the risk of making errors in risk planning by imagining the possible scenarios and describing in real terms what would happen as a result of the options you’re considering. This exercise gives you a better sense of whether a particular path improves the situation, makes it worse, or has no effect. Looking at each option through this lens better prepares you for implementation.
A fresh mind sees things a tired mind can’t. If you’re confused, hold off your decision until you have regained clarity, which may take only minutes or a day or two. Sometimes the best way to gain clarity is to relax and not think about the decision or situation at all. Take a break and remove yourself from the environment: Take a walk in the woods, see a show, go to the gym, spend time with family.
In situations where uncertainty reigns, the human tendency is to decide now — even if it means being wrong — just to restore certainty. Those who are uncomfortable with the unfamiliar or who feel unsure may commit to an option far too soon.