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Wednesday, March 6, 2013

Questions for assessing risks and rewards

Does the reward outweigh the risk?

The article “Risk and uncertainty stymies decision making” described the impact of risk and uncertainty on making decisions.  Being unsure of outcomes and aware of possible risks has a negative impact on the decision process.   When the potential for reward outweighs the risks, the decisions become easier. 

This consideration is often part of the design of certain clinical trials.  Prior to starting certain cancer trials, a common question may be, “does the potential benefit to the patient outweigh the risks?”  This is especially true when the disease is in the last stages and there are no other alternatives for the patient.  The patient experiencing no potential harm may gain a benefit so the study proceeds.

The issue of weighting risks and potential rewards come in everyday life.  The photo above was taken after the photographer had been told the story below. 

A tourist was visiting Page, Arizona and wanted to see Horseshoe Bend.  The limestone that forms the structure is in sheets and has potential to sheer.  The visitor was on the edge looking down.  As the story goes, the limestone gave way and the visitor fell more than 1000 ft. to his death.

The risk of demise to the photographer was similar to that of the visitor.  The perceived reward was obtaining a good photo.  Taking the photo in stages and splicing the images together solved part of the problem.  The risk of sheering the edge was reduced by lying flat to spread the weight while shooting down the cliff face.  The risk was always there and taking the photo in limited steps reduced risk to the point where the photographer felt comfortable enough to complete the task. 

The ability to reduce risk occurs in making financial investments.  Some people will hedge stock investments by using options or other instruments.  Investors may invest in mutual funds or select several companies to spread risk.  Potential reward is higher with greater risk, but well-informed non-professional investors usually take the conservative route to protect what they have.

Areas you may wish to explore in risky situations:

1)      Tranche:  Sometimes staging the approach to the situations lessens the risk.  Take a few steps, reassess the issues, and take more steps.  The process of stepwise approach may allow you to stop before your exposure becomes too great.  This step may help in many situations like testing a new service provider or manufacturing partner.    

2)       Share:  Occasionally, having others participate alongside you helps share or spread the risk.  VCs tend to do this when they form syndicates.  They may use the Tranche method in addition to reduce risk even more.  If your business fails, they do not lose as much.  The sharing can apply to a variety of risky situations in your business like shared sales, marketing, or product development.

3)      Diversify:  Selecting more than one vendor, supplier, or sales person is a way of reducing risk.  The risk would be that one of them leaves abruptly or fails to deliver.  In investing, one can invest in more than one opportunity or company.  Diversification tends to average out risks of losses with rewards of higher performing activities.  Single product companies can diversity by adding new products.  This reduces the risk of a product failure.

4)      RUN:  Everyone should monitor the risk to reward aspects of business situations.  Set parameters that you feel you can accept and learn to GET OUT if the risk levels are too great.  Going over a cliff is no fun and neither is losing all of your investment.  That investment can be progress attained in your business or your money.  Run away so you can return to fight on a new day!

Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon