Risk Taking and Decision Making
Wednesday 14 November 2007
In association with Abingdon Management
Risk Taking and Decision Making: The art and science of making good decisions and taking calculated risks
Caspar Berry's career path has been unusual to say the least. As a teenager, he acted in the Children's BBC drama Byker Grove, alongside the young Ant & Dec. In his early twenties, he sold two screenplays for feature films and worked for Miramax and Disney. Then, at 25, unhappy that he couldn't write the kind of scripts he enjoyed or work with the kind of people he admired, he experienced a "quarter-life crisis".
This involved three months of fretting, he said. Then came the "logical and reasonable decision that the only thing left for me was to move to Las Vegas and become a professional poker player." Berry never became a stand-up comedian, but he could have easily done so, judging by this performance at the London Business Forum.
This gist of his presentation was this: to achieve great success, you have to take risks, but that doesn't mean you should gamble per se. Rather, it means you should develop your ability to distinguish which risks are worth taking, and which are not. "We take decisions hundreds of times every single day, and I bet we put a lot of thought into the actual subject of those decisions, but how much time do we actually spend thinking about our decision-making process?" he asked. "Very little, is my guess."
By analysing the way you make decisions, you can make better ones. And by analysing the way other people make decisions, you can encourage them to make different ones too. Nevertheless, Berry said, it was necessary to begin with a disclaimer: "Risk-taking is fun... but so is boating."
He explained that, as a boy, he regularly went sailing with his father on a lake where the local council had put up a sign depicting a man falling into the water. And underneath were the words: "Remember, boating is fun until death occurs." So, he concluded, "if you do feel very pumped up to take more risk in your life [after this event] then please let those words ring in your ears, by way of a sort of indemnity on my part."
With that, he turned to his core area of expertise: poker. The similarity between poker and business was first brought home to him, he said, in the Grand Poker Room of the Vellagio Hotel in Vegas, where a stranger told him that many of the experienced players were there to make a living. "When you're playing poker, you're playing against the other players around the table," the stranger pointed out. "The house makes a profit by just taking a small proportion out of each pot. But you will make or lose money depending on the quality of the decisions that you make."
Berry thought this sounded like "the perfect meritocracy," and was soon earning about $70,000 a year from poker, playing for thousands of dollars per hand. Eventually, he got bored and moved on, but not before he had learned some valuable and transferrable lessons.
"Uncertainty is what dominates all our lives. Every time we make a decision we do not know for sure what the outcome will be," he said. And yet we "tend to go through our lives in the illusion that tomorrow will be much the same as today." Business history is littered with people who failed to recognise the significance of breakthrough technologies, such as the telephone, the radio and the computer.
The essential problem here is that we're unwilling to lose in the short-term, in order to win more in the long-term, Berry said. And to demonstrate the point he enlisted a member of the audience to stake some imaginary money on a series of coin tosses. If a winning toss paid odds greater than 1-1, he explained, then with enough coin tosses you would eventually make money. "And yet, if you had a four or five-turn losing streak, and a little old lady passed by, wouldn't she shake her Presbyterian head and say, 'That's what happens when you gamble'?"
As a society, we are conditioned to be cautious, he said, displaying a graph on the screen behind him. The x-axis of this graph measured "likelihood of success", the y-axis measured "percentage return", and the line that started in the top-left and dipped sharply to the bottom right represented "break even". "Everything under that line is a negative expectation proposition," he said. "It might be really good fun, but it is not gonna make money in the long run... Everything north of the line - a much bigger space - is a calculated risk. It will make you money in the long run." Most people, he continued, tend to live in a tiny bubble above the line on the far right-hand side of the graph, where small returns are virtually guaranteed. And as a result, they miss out on much bigger opportunities.
As a species, we're risk-averse because of our emotions. We rely too heavily on instinct, and therefore balk at decisions that could result in sharp losses. The way to overcome this fear, Berry said, is by calculating risk more precisely and by "defining failure as a long-term phenomenon." We need to remind ourselves, in other words, that if we make adequate preparations and are willing to fail enough times then we will eventually succeed.
To begin with, we should try to stop "embracing uncertain futures" and start expressing risks as percentages. "A percentage makes a certainty out of the uncertainty of the future," he suggested. You never hear a football fan arguing that his team is 70% likely to win, you hear him saying, "You're not gonna win tonight, for the following reasons." Yet in certain situations we can express the risk of doing something as a percentage, and thereby feel confident that we are investing our time and money in the right opportunity.
For example, a typical winning hand in poker might pay $400 for a $40 stake. If you were good enough at poker to feel that you could win 25% of the time, then the mathematics of staying at the table might look something like this:
I expect to win 25% of the time and win a $400 pot when I do so. In other words, I expect to win an average of $100 per hand. I expect to lose 75% of the time and stake $40 on each hand while doing so. In other words, I expect to lose $30 per hand. Therefore, I expect to win an average of $100 - $30 = $70 per hand.
In this case, it's well worth staying at the table, even though you are losing three out of every four times.
In business, of course, we can't be so precise about how frequently we're likely to invent a hit product or service, and we can't be so precise about how much we're likely to earn from something that hasn't been tested in the marketplace. What is certain, however, is that we're letting our fears prevent us from seizing many opportunities.
"The apotheosis of taking calculated risks is in the process of creating new ideas," Berry suggested. "We live in a world where, 100 years ago, we sold muscle; for most of the twentieth century we sold our time on a punch-card basis; and now we sell ideas. One idea can make a difference between a life of success and failure."
Great companies, Berry argued, realise that great innovations depend on embracing failure. For example, Paypal, the on-line transaction service, says its business is 70% about core work that "brings home the bacon"; 20% is about prototyping and new product development; and 10% is about blue-sky thinking. "In the same way, Microsoft divides people into pioneers and settlers," he said. "Settlers are the people who live safely in the valleys [i.e. who take few risks in their innovative thinking]. Bill Gates says they are crucial because they are what make your company good. But pioneers are the people who make your company great. No one, Gates said, ever wrote a book about a settler. It's pioneers that keep striding on and keeping you number-one."
And yet, Berry added, "here's a terrifying statistic: [research shows] 98% of ideas proposed in British companies do not even get written down." As a consequence, we don't have a "gene pool of ideas" in which the best can rise to the surface. We're too scared of trying something new and having it fail. And people "eventually stop putting their hands up... stop taking the calculated risk of saying something, in case it's shot down." The problem is best summed up, Berry said, in a quote by John F. Kennedy: "There are risks and consequences associated with action, but they are not as great as the risks and consequences associated with long-term inaction."
Ultimately, Berry concluded, "the greatest loss that we can make as human beings is not in terms of money or time. It's in terms of status and face and reputation. And once we can start taking risks with that, there is no limit to what we can achieve."