The topic of risk came up recently as I was taking my son on his first bike ride on our local mountain trails. Frequently, we would encounter obstacles that forced us to choose one of two or three paths across the obstacle. The trail builders had typically created an easy, safe option and one or two more exotic alternatives that involved more risk of falling and getting hurt.
Naturally, as he was a beginner (much like me, by the way :-)), I’d encourage my son to take the least-risky path across the obstacle. His response back to me, however, was, “but, didn’t you tell me that I had to take risks?” He had a good point. I had frequently advised him that risk-taking was a critical aspect of life and that we had to take on many discretionary risks in life in order to achieve our ambitions. But, was this sort of risk something I’d be supportive of him doing as a beginning biker? It caused me to really think about the nature of risk and its types.
Risk is the balance between upside and downside: upside is the positive outcome hoped for when a risk is undertaken; downside is the risk itself, the potential outcome we do not desire.
Life is a risk management sport; in it, you move from one decision to the next, taking a risk at each step. One’s life story is the amalgam of his/her risks.
1. Calculated Risk
Calculated risk is a discretionary bet we make understanding both the upside and downside potentials, but with the presumption that we’re going to attain the upside. In short, with calculated risk, we’re driven by the upside potential. We do this on a regular basis both in our personal and professional lives:
- We invest in securities knowing there is a great deal of downside risk but with the understanding and expectation that they’ll pay off.
- We buy a car betting that the benefits in terms of function and performance will outweigh any risks of reliability or safety.
- Flying in a plane is a form of calculated risk; there is a plausible chance for a plane crash that is rarely survivable; however, the upside benefits in terms of convenience and comfort far outweigh the very unlikely downside risk potential.
- In a business context, we launch a new product into a new space as a calculated risk that we’ve found a new, previously-untapped market that we can enjoy early mover advantage in. It won’t always work our way, but we certainly hope it does most of the time.
Clearly, just because a risk is calculated, doesn’t mean it will go our way; however, it is quite difficult to get through life without taking many calculated risks through the journey and thus all we can do is give such risks their due diligence.
2. Mandatory Risk
Unfortunately, we don’t always have the luxury to calculate risk and make a discretionary decision on whether or not to pursue a risky bet. Mandatory risk is a non-discretionary bet that we’re forced to make with frequently lower chances of upside. In fact, unlike calculated risk, forced risk is typically driven by fear of not taking the risk instead of hope for the upside.
- Firefighters and policemen/women place themselves in harm’s way in the course of their day-to-day job. In many cases, the odds are not even in their favor let alone strongly to the upside. However, they are forced to take on mandatory risk because the cost of inaction (e.g., not entering a burning building to save occupants) is much higher than the downside risk.
- While we might normally not cross a busy freeway for fear of getting hit, realizing that there is a helpless child in the median unaware of the danger he is about to endure by crossing might well trigger us to take on a risk.
- In business, we are constantly responding to competitive and disruptive threats to our business that may force us to take on risks that we’d otherwise not undertake. However, the potential of not taking the risk outweighs the downside.
3. Luxury Risk
Aaah, the kind of risk that triggered this whole topic: the kind that is completely unnecessary and is purely a risk of lifestyle and luxury. As its name implies, this is very discretionary risk-taking that we choose to do. However, unlike a calculated risk that we’re taking in the hopes of a clear upside, this sort of risk typically has little quantifiable upside and only subjective, lifestyle-related benefits. The downside, on the other hand, may be quite quantifiable.
One modern example of luxury risk that is unnecessary to take on but we do so for the benefit of our lifestyle is using a cell phone while driving. To text while driving is a horribly risky move with horrendous downside and very little upside. However, millions of people do it on a daily basis. As an aside, I now place my cell phone completely out-of-reach while driving so I’m not tempted to even touch it let alone use it.
Over the past decade or two, extreme sports have become a cultural phenomenon with everything from mixed-martial arts to downhill mountain-biking to extreme rock climbing. They all involve tremendous risk of bodily injury and, frequently, death. However, we take on this risk on a regular basis for the thrill and exhilaration of the experience. Strangely enough, while we might take the risk on ourselves, we’d frequently advise our own children against it (a sure sign it’s a risk of luxury :-)). Should we take on such risk? Some of this lifestyle risk is necessary to bring excitement to life, but the line between a reasonable and an excessive amount of luxury risk is a gray one. And, I must admit, the older I get, the less-inclined I am to take on such risk when I have so much of the other two types I’m already taking on :-). At the very least, we should not make the mistake of confusing the types of risk with one another: taking on luxury risk under the guise of calculated risk is a recipe for disaster.
This article was featured on Wired’s Innovation Insights blog available here.