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The High Price of Risk Aversion

April 17, 2015

Marc Andreessen, speaking with Fortune in San Francisco last week:

One of the things that’s so striking about the current environment is public companies are so risk averse and then, as a consequence, a very large percentage of kind of interesting new, innovative high-ambition, high-investment things are happening on the private side.

Active and Passive Risk Aversion

From studying how businesses compete, I’ve noticed that risk averse companies are either “passive” or “active” in their risk aversion. Companies in the “passive” group ignore the necessity of risk and ignore the upside. Those in the “active” group focus on the downside and retreat from innovation.

In a technology company (my focus area), here’s how these types of risk aversion can manifest themselves: On the “passive” side, if a company leader is overly focused on traditional sales and marketing*, he or she tends to underestimate the amount of product or technology risk required to deliver a compelling product. On the “active” side, companies that run into a financial hurdle might, “temporarily”, reduce investment in R&D. Either path effectively reduces a company’s ability to satisfy consumers in the future.

Passive Aversion Leads to Active

Very often, the passive aversion to risk leads to the active one. For instance, without a product- or technology-competent CEO, investment (or effective project selection) in R&D atrophies, and products become less competitive. To reduce expenses, senior leaders opt to further reduce R&D. On paper, reductions appear minor, but in practice, the remaining resources are usually only enough to support the current product pipeline. They’re usually not staffed or equipped to do development that goes beyond the next product cycle. At this point, while it might actually help to trim the product portfolio (so that select R&D staff can focus on higher-order work), every revenue stream is considered important. So, the higher-order – riskier — work waits.

Even if a company recovers […] it has often lost the ability to set ambitious goals, hire additional talent, and effectively manage new risk.

If You Don’t Take on Risk, You Reduce Your Ability to Do so Later

Even if a company recovers, by that point it has often lost the ability to set ambitious goals, hire additional talent, and effectively manage new risk. Key people have likely left, remaining employees are weary, and focusing on cost-reduction “is obviously what works best”.

In addition, to manage high risk in one area – say part / feature / product / initiative “A” – a company might need to invest in another: for instance, in a back-up component program, a much higher level of prototyping, the acqui-hire of an important partner, or in hiring multiple subject matter experts from around the globe. These are mitigating actions, but they appear risky to a company with a risk averse mindset.

If you don’t take on risk, eventually your competitors will deliver it to you.

And so the dynamic, and perils, of being risk averse continue. The lessons so far: if you don’t take on risk, eventually your competitors deliver it to you. And your ability to create leading products or capability will be compromised.

Technology Isn’t the Only Domain – by far – for Taking on Good Risk

While I’ve outlined a dynamic related to a usual source of risk (technology R&D), there is meaningful risk and reward in other functions, too. The pitfalls of risk aversion apply there just as well, and so do the opportunities.

For example, if a company invests and innovates in new ways of selling and reaching markets, there’s great value to be had in working through that kind of risk. Even building core sales and marketing capability is a risk, if the ambition is to reach a level of performance far higher than the company has ever had. (Without, again, compromising future products.) Recent examples of include:

  • Amazon: Prime membership
  • Uber: How it reaches consumers, dynamic pricing
  • Airbnb: Connecting hosts with guests
  • Warby Parker: Shifting an intensive hands-on transaction to on-line.

Or the risk might be in pursuing a supply chain model that’s different from incumbents’ (Dell in the 1990s). Or new HR practices (Reddit is experimenting with a “no salary negotiations at time of hire” approach to reducing gender inequality at work).

Hire people who have the skills and ability to take focused risks and adjust. And let them do so.

Information and People

Finally, the quote I chose from Marc Andreessen, and this post, are about “risk” in a way that’s essentially an abstraction. More tangibly, risk is an information problem, about the specific activity you want to undertake. Sensing a risk means “I don’t know if my action will produce the outcome I want. And if that will be valuable to my consumers at the time that I deliver it. And if I find something unfavorable, I don’t know how to improve.” So, risk averse leaders and managers are saying, through their actions, “I don’t know enough”, and – critically — they’re not taking action to find out more.

Get past “I don’t know enough” and on to “how can we move forward?”

That’s the most important take-away. When you’re finding board members, executive staff, or subject matter experts, hire people who have the skills and ability to take focused risks and adjust. And let them do so. (That may mean changing how you identify candidates, select interviewers, and design questions.) These individuals will help teams and companies get past “I don’t know enough” and on to “how can we move forward?”

______

*The value of sales and marketing is unquestionable. They are as valuable as product development. What we don’t want to do is deprive our great sales and marketing teams from having a great product.


Note: This started as a rapidly-written post. In response to the higher-than-expected traffic, I re-read it. I didn’t like it. So I made it better. I’ve made a number of adjustments and clarifications.

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Filed Under: Innovation, Leadership, Product Development

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