How to Manage Risk, Uncertainty and Opportunity (The Smart Way)

Having spent many years as a business consultant, Stephanie Thomas says she has “a long history with risk.” But although many people view risk as a negative thing, Thomas says that risk is more like the flip side of opportunity.

Now an economics lecturer at Cornell University’s ILR School, Thomas joined Chris Wofford to discuss the relationship between risk, uncertainty and opportunity as part of eCornell’s WebSeries.

An abridged version of her presentation follows.

Thomas: It’s important for people to realize that, risk isn’t necessarily a negative thing. Without risk, there’s no opportunity. If we never take a risk, we can’t really ever move forward to build, grow, develop and expand. So we have to take calculated risks but not stupid risks.

Wofford: To make sure we’re all on the same page, how do you define risk?

Thomas: Risk can take a variety of forms. There are four kinds of risks within the business setting: hazard risks, financial risks, operational risks and strategic risks.

The first, hazard risks, are usually the kinds of things that we think of when we hear the word ‘risk.’ This is the risk of something bad happening – natural disasters, floods, car accidents, those kinds of things.

Wofford: The risk there is not having prepared for them, right?

Thomas: Yes, and it’s really difficult to prepare for them because oftentimes they’re unanticipated. But when they do happen, they’re going to impact the business. Hazard risks are things that happen to the organization from the outside. Insurance, contingency planning and emergency preparedness plans can really mitigate hazard risks. So even though hazard risks are unanticipated, we usually have some pretty good mechanisms in place to deal with them.

Most organizations will also have protocols and policies in place to manage financial risks. These are things like fluctuations in interest rates, debt, asset losses or shrinkage if you’re in a retail environment. We all face these kinds of financial risks, but they’re typically well controlled and well understood as a part of routine discussion.

Then we can talk about the operational risks like supply chain issues and cost overruns. These are things that you might not plan for or take insurance out to mitigate against, but they’re still risks that are pretty well understood. If you have supply chain issues and can’t finish your product because something has happened to the person that you’re relying on – their truck broke down or they’re behind in production – this can really blow everything up.

But again, these kinds of risks are usually able to be managed pretty well. As an organization, you’re going to have a sense of what could go wrong and what you’re going to do to mitigate that situation.

Wofford: So that leaves the big category.

Thomas: Yes, the fun one. Strategic risks. Here we’re talking about things like customer retention. We’re talking about R&D projects. We’re talking about industry or sectorial issues and broader macroeconomic fluctuations. You’ve forecasted demand and it turned out that your forecasts were wrong and you have all this excess inventory. What are you going to do with it? Or you manufacture a toy and all of a sudden it becomes the “it” toy for the holidays and everybody is buying them and you haven’t produced enough to satisfy demand. What now?

These are examples of strategic risks and you really need to think about how they can potentially impinge on your strategy and what you’re going to do.

Wofford: So do you get everybody in the same room and sort of talk through these different possible scenarios and your responses to them?

Thomas: Absolutely. I’d like to turn to some real-life risk examples. When Apple did their R&D to create the iPhone, they didn’t really know for sure if it was going to be a success. It was a touch screen; it looked nothing like the flip phones or the clam shells of the day. It was a huge risk. But what was the upside? Well, it was enormous. The iPhone is now on its seventh generation and everybody has one.

To give another example, do you like to cook?

Wofford: Yes, a lot.

Thomas: Okay, let’s say that you’re making a new recipe for the first time. If it doesn’t turn out the way that you hope it does, what’s the downside?

Wofford: Well, I’d certainly be disappointed myself, and I could have unhappy guests. Worst case, someone gets ill.

Thomas: Let’s not even get into the getting ill part. Let’s just say it doesn’t look the way it’s supposed to look or it doesn’t taste the way it’s supposed to taste. The downside is, well, you can’t eat it and you have to order take-out. This is relatively minor in the grand scheme of life. But the upside is you prepare something wonderful for your family, you’ve learned a new skill and you’ve added to your credentials as a chef.

Wofford: Right, it’s not a huge downside if we have to order pizza because I messed up dinner.

Thomas: It’s not catastrophic. But in some cases, the downside of strategic risk can be catastrophic. If we look at Exxon Valdez, if we look at Deepwater Horizon, those things have huge potential downsides in terms of not just money and resources but in terms of human life. So how we balance these risk-versus-reward situations depends on what’s at stake. Context is super important when we talk about managing these risks.

Wofford: When we think of risks, we sort of associate them with trying new things. But can you think of any examples in which it is better to stick to what you were doing? I ask because I’m from Rochester, New York, the home of Kodak. And that’s a company that willfully decided to neglect the burgeoning digital market to their peril.

Thomas: Again, I think it depends on the situation. In the case of Kodak, it was a strategic choice that they were the leader in what they do and wanted to focus on that core capacity. I certainly can’t speculate on the decision-making process, but if I had to guess, I would say that they felt that even with this new digital marketplace coming, there was still going to be a need for the old analog film. And there are still photographers and artists that use film even though the market has gone overwhelmingly digital.

Wofford: I know it depends on the situation, but typically, how do companies typically deal with risk, uncertainty and opportunity?

Thomas: I think that you need to take a holistic approach. There’s not necessarily one single correct answer but we can assign likelihoods to things. To go back to the cooking example: if you’re trying a new recipe, what is your level of cooking ability? Can you read a recipe? Do you know how to measure ingredients? If you’ve never cooked anything before, the downside for you is a lot more likely than if you’re an experienced cook. You need to really think about what those potential upsides and downsides are and how likely they are to happen.

The classic expression is “nothing risked, nothing gained.” If Apple had not taken the risk to move forward on their R&D project, they would have lost a lot. The iPhone really helped make Apple one of the world’s leading consumer brands.

There are a few common approaches that are used to address risk. The first one is to be like an ostrich and put your head in the sand and ignore it. Not a good idea. Ignoring everything around you is a catastrophe waiting to happen.

A second approach is to say, “Okay, so we know last quarter this happened. And the quarter before that, this happened. And two years ago this happened, so we’re going to predict what we’re going to do in the future based on historical information.” That often works, especially if you’re in a stable environment and producing a product or service that hasn’t changed in the last 10 to 15 years. In that situation, looking at history is going to help you predict the future.

But if you’re in the tech world, you certainly don’t want to look at what’s happened in the last five years to try to predict what’s going to happen in the next five. Things change too rapidly.
To tie it back to your Kodak example, they had been a leader for a number of years so they might have thought that what worked in the past was going to continue to work in the future.
It didn’t. Projecting the past into the future is like driving on the highway looking only in your rear view mirror. You’ve got some information — you know where you’ve been — but you’re still missing what’s in front of you.

Wofford: Let’s talk about the distinction between risk and uncertainty.

Thomas: The way I think about risk is that it is something that can be known. If I cross the street, there are certain inherent risks. With uncertainty, on the other hand, we have no way to quantify it. It’s the realm of unknown unknowns.

If it’s risk, we can manage it. We can manage hazard risk through insurance policies. We can manage financial risk through standard operating procedures and audit controls and generally accepted accounting principles and so on. But if it is truly uncertain, there’s really not much you can do. Uncertainty in my mind is a lot scarier than risk. If it’s true uncertainty, you’re not able to even articulate the array of possible outcomes.

Wofford: So we’ve made that distinction and we’ve talked about a couple of risk case studies. Do you have any advice for putting risk assessment into practice?

Thomas: I think that when coping with risk, particularly strategic risk, you really need to understand what it is that you do and what your customers expect. What is it about you that distinguishes you from your competitors? What is your strategy? You need to have a firm grip on these things in order to think about what is likely to happen in the future.

Do we want to go from making widgets to digital switches? Are we going to transition into that new area to cope with the new business environment or are we going to stay on track and continue to do what we’ve always done? Again, depending on the scenario and the environment that you operate in, both could be viable alternatives. But when you choose one path, you should be able to articulate a set of reasons as to why you made that decision. You need to understand the opportunities as well as the risks and make a calculated decision.

Wofford: Stephanie, thanks for that practical advice and thank you so much for joining me today.

Thomas: Thanks, Chris.

Want to hear more? This interview is based on Stephanie Thomas’ live eCornell WebSeries event,How to manage Risk, Uncertainty and OpportunitySubscribe now gain access to a recording of this event and other Entrepreneurship topics.