Reasonable Risk

Top professionals do not like risk, but they recognize that few people succeed in a big way without taking significant risks. A lot of professionals are "totally risk averse," according to Doug Bain of Boeing, "because they don't want to take responsibility for things going wrong. However, the higher you go up in the food chain, the less you see that, and the more people are willing to take reasonable risks." The key to successful risk taking is a skeptical, unemotional, and analytic approach to risk management. People who get "risk rushes"—as an executive of Westar Corporation once described it to me in a critical way—might enjoy a few victories, but they will tend to lose it all on one of their big gambles. For example, many senior executives of conglomerates that went around acquiring companies left and right during the 1990s got caught up in the "risk rush" mentality, and they are paying a dear price for that approach today.

A residential real estate agent who read my book on avoiding financial risk lamented to me, "It might sound strange, but I spend a lot of time trying to talk young couples out of buying a particular house. They fall in love with the first impression and they then become blinded to the plumbing and roofing problems and the fact that they really cannot afford the home. Yet so rarely can I convince them to go for something a little more reliable and a little more modest. Two years later the house is back on the market, and half the time there is a divorce to go along with it." Vulnerable executives often make exactly the same mistake. A business acquisition or transaction looks so appealing at first glance that they ignore, downplay, or distort the true risks when they become apparent. A few months or a couple of years down the road, disaster strikes.

Tom Gunn, who has sold more commercial and military aircraft than just about anyone in the world, notes that "the person who loves the least controls the relationship." That means if you become too wedded to the idea of a deal or transaction, the person on the other side is in total control, and you bear all the risk.

The disdain for risk that is common among top professionals causes them to evaluate the potential downside of every deal or opportunity in a detached, unemotional manner. In fact, they tend to take specific steps designed to wring the emotion out of their decision making—to objectify the process. There are three ways to obtain this objectification—and many senior managers use them all.

1. Have outside help. Hire a qualified, trustworthy outsider to investigate the risk for you, as Susan did in the example at the beginning of this chapter when she was considering the offer to become a CEO. While invincible executives tend to believe that companies overuse consultants in "soft" areas such as marketing, branding, and strategic planning, they almost all agree that organizations tend to underuse consultants as objective reviewers of specific risk points in potential projects or deals. "You have to put the appropriate team together to evaluate risk, and that includes outsiders, where necessary," according to Richard Bell, CEO of HDR, Inc. The outside viewpoint ensures that your in-house staff has not become "collectively jaded," as one management consultant put it.

2. Get it in writing. The second way effective managers evaluate and reduce risk is through the development of a standardized, written risk evaluation process. Tom O'Neill, CEO of Parsons Brinckerhoff, a New York-based engineering firm with annual revenues of over $1 billion, recommends that, when projects with serious risk present themselves, the process of risk identification and analysis should be reduced to writing.

There are three parts to such a process: risk identification, factual development, and risk analysis. For example, when Parsons Brinckerhoff considers bidding on a construction project, the executives involved in the project must fill out a set of forms. Based upon prior experience of the company, the forms identify the major risks attendant to construction projects, such as the likelihood that the project will not proceed, currency fluctuation risks for foreign transactions, reliability of subcontractors, liquidated damages provisions for delays, uncertainties about the site of the construction, labor issues, issues with obtaining appropriate government approvals, etc.

Then qualified people gather facts about each risk and write them down. Based upon the facts, each potential risk is analyzed and a risk factor is assigned to the project based upon that analysis. "By the time it gets to me," O'Neill says, "the decision as to whether to proceed has practically been made." Through this process, biases, emotions, and instincts are supplanted with reason and analysis. As a result, the decision becomes easy.

3. Develop ways to quantify the risk. The third way effective managers wring the emotion out of decisions concerning risk is through quantitative analysis. A critical part of the quantitative risk analysis process involves "developing clear reference points that will determine your rate of return on an investment," notes Richard Bell of HDR, Inc. You have to develop specific, reliable economic models that translate the risk into dollars and cents.

But quantitative risk analysis means much more than reliable profit projections. It means outperforming the competition. During his twenty-seven-year tenure as CEO of Anheuser-Busch, August Busch III increased the market share of his company from 25 percent to 49 percent, while the share of his nearest competitor dwindled to 19 percent. Many industry analysts attribute a lot of this success to Mr. Busch's decision to use computer models to assist in such areas as brewery location and targeted marketing. Mr. Busch began to use such methods in the 1970s, when most Americans had barely even heard of computers.

Sam Fox's company, Harbour Group, has turned around over one hundred floundering manufacturing companies over the past three decades, and he too attributes a lot of its success to the innovations in "statistical process control"—the development of reliable quantitative methodologies that measure the quality and reliability of manufacturing processes.

The Washington University Medical Center is consistently ranked as one of the top five medical treatment and training facilities in the United States in many areas of medicine. The center works hard to maintain its hard-earned reputation. Two of its top lawyers, Executive Vice-Chancellor and General Counsel Michael Cannon (a Rhodes Scholar and graduate of Yale Law School) and Deputy General Counsel Mark Eggert (a graduate of Harvard College and Law School), use a sophisticated software program to evaluate the legal risk associated with any claim that a doctor at the center performed in a substandard way. That program helps them determine whether there is liability, and if so, how great the liability is. "You cannot rely solely upon the numbers when you evaluate risk, but having the added dimension of a quantitative analysis helps keep the multiple variables and emotional aspects of any given risk situation in control," according to Eggert. They consider their quantitative tools as an essential element of a broader risk management and evaluation process.

Invincible executives stay on the leading edge of technology. Technology adds that essential element of detachment to any risky situation. Successful managers do not have to understand every aspect of the technology applicable to their fields, but they have to know enough to do two things: authorize value-added technological tools and reject the unnecessary bells and whistles that the tech geeks will try to sell them.