Do you understand risk? Probably… not so much.

I bet you fancy yourself pretty decent at calculating risk.

I also bet you suffer from overconfidence in this area. Possibly severe overconfidence.

Here’s a three question quiz to determine if you have even a fundamental understanding of risk:

Did you (a) take and (b) pay attention in statistics class in college?
Are you comfortable putting your trust in numbers when your direct experience and instincts suggest the numbers are wrong?
You just flipped a coin and it came up heads three times in a row. What are the odds it comes up heads again on the next, fourth flip?

Answers:

If the answer is no, forget it, you don’t know risk. You may have an intuitive sense for risk, but you don’t understand the concept well enough to use it in business. You can’t. The concept of risk is not an art, it’s a science. It’s a well understood science, too, with stable, predictable mathematical models that will outperform your intuition every time. If you haven’t taken a class, it’s very unlikely that you even know the language of risk, let alone the fundamental principles. Managing risk is about two things: (1) knowing what equations to use when, and (2) knowing how to test and modify your underlying assumptions, both of which require study to do. (Don’t believe me? Come over to my house for a game of blackjack, we’ll use standard Vegas rules and payouts, and I’ll be the house.)
As humans, we need to know when to trust our guts and when not to. Our instincts sometimes deceive us because we have created an artificial world (literally: think civilization, buildings, cars, processed food, etc.) that in some respects no longer resembles nature… yet our instincts are based on our interaction with natural elements. Fight or flight works when you stumble across a bear in the woods, not when determining the risk in a new branding campaign. So we go along and create artificial triggers for our instincts, based on our experiences, but because our world is artificial, those triggers can become void as our world changes… the game changes and we have no idea. We’re all kinds of screwed up. Statistics is our way of correcting for this, so if you can let go of your experiences, excellent.
Odds are 50% (also known as 1 in 2). In fact, you could throw 900 heads in a row, and the odds that your next flip would come up heads would still be 50%. Each flip is treated as an individual event. Now, the odds of flipping 4 heads in a row is only 1 in 16… but the odds of any one flip being heads is still 50%.

So? How’d you do? Still think you’re the one to give the presentation to the Board about your risk mitigation plans?

Don’t worry, if you want to manage risk and you’re not a statistician, here’s what you should do:

Pay attention to the people. Specifically, concentrate on answering this question: “What is the likelihood that the people charged with executing my plans can and will do so faithfully?”

I do this for clients using a proprietary tool I call a Swill & Will Assessment. You can do a basic version of the same thing by looking at each person involved and asking the following four questions:

How closely does his/her problem solving capability and style match the demands of the role?
How closely does his/her personality/temperament/energy level/maturity match the demands of the role?
How closely do his/her interpersonal/communication/sales abilities match the demands of the role?
How closely does his/her management style match the demands of the role?

All together, you want to know how much friction your plan must overcome in order to become reality. This will start to give you a sense for the risk in your organization, and even if you can’t run the statistical analysis, it will get you asking the right questions and focused on the right activities.

The hard part in this exercise is knowing when your own ego blinds you to the world as it is, so make sure you include yourself in your analysis, and/or get an outsider to help you.

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Tagged as: assessing others, decision making, ego