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Use Strategic Prudence and Tactical Risk Taking - The second principle of Riding Randomness

November 15, 2017

This is an excerpt from my my new book – Riding Randomness: Another kind of success story.  

If you like my writing and know a publisher or literary agent who would be open to getting the book in print, I will be forever grateful for the introduction.

 

Success stories and motivational speakers over-emphasize on taking risks and preach risk-taking as the panacea for achieving success. What they fail to say is that taking risks is what made a lot of people bankrupt or even dead. Taking risks exposes you to all sorts of outcomes that depend on pure chance. Sure, you might win ten million dollars, but you might lose everything you have and jeopardize your children’s future.  

 

Throughout the book, I argued that people who took risks and lost everything are not characters in success stories. Instead, they are forgotten by popular culture and even their peers. Some success stories are hindsight exposés of stupid risk-taking and dumb luck. But other success stories are a mix of using strategic prudence and tactical risk taking that fail to tell the bit about strategic prudence.

 

  

Strategic prudence

 

Strategic prudence refers to never exposing yourself to risks and compound risks that, if things go bad, can ruin you. Simply put, if you are exposing yourself to a risk, you need to have your back covered if things go (very) bad. Before taking the risk, make sure that you can take the loss without derailing your and other’s lives.

 

Most people who became successful had their backs covered even if this bit is left out of the story. For example, Bill Gates and Mark Zuckerberg dropped out of Harvard to pursue their businesses and everyone is in awe of this fact. What very few people realize is that dropping out of Harvard implies that they were able to get into Harvard in the first place. It also implies that they had the means to pay for a Harvard education.

 

If things would have gone wrong for their businesses, there was nothing stopping either Bill Gates or Mark Zuckerberg from returning to Harvard and completing their education. Both of them started their businesses early on in life which meant that they had very little to lose and they were not responsible for someone else. If Microsoft or Facebook would have been failures, the two now-famous entrepreneurs would have had a cushion to fall on. Bill Gates’ parents were lawyers and Mark Zuckerberg’s are psychiatrist and dentist. These professions aren’t going to make anyone a billionaire, but they provide a very good and steady income. If their businesses would have proven to be busts, we can imagine either of them going to their parents saying: Mom, Dad, I tried starting a business and I failed. Can I, please, go back to Harvard now? Pretty please? Followed by the answer: Oh, honey, you tried and you didn’t make it. There’s nothing wrong with that. Of course, you can go back to Harvard in the fall.

 

Not that I want to put myself in the same category as Bill Gates and Mark Zuckerberg, but I, too, exercised strategic caution when I opened my first business. I opened the first business in the summer between my third and fourth year of bachelor studies. It went bust rather soon and when I realized that I wasn’t going to make it big quickly, I returned to complete my university studies. I didn’t drop out of college, I didn’t risk large amounts of money. After completing my bachelor studies, I tried again, but before doing so, I thought hard if it is the right thing to do. I came to the conclusion that it was the best time to try again. My parents wouldn’t kick me out of the house, so I had a bed, a roof, and food on the table. I didn’t have a family to be responsible for. I didn’t even have a girlfriend at the time. I was taking a risk, but even if things went very bad there was little to lose, I had a safety net to fall on and, if things went bad, I could have looked for a job.

 

Taking risks is highly over-rated, not because it is unimportant to take risks, but because the whole plethora of risk-taking preachers sing the wrong tune. Risk taking is good only if you can afford to take the loss if things go bad. Under the spell of misinformation on risk-taking, some people risk everything they have on a business or an endeavor that might be nothing more than a fantasy.

 

My wife watches the TV show Shark-Tank and I sometimes eavesdrop. I remember that once, a lady in her thirties said that in the business, for which she was looking for additional investments, she put in all her savings, her retirement savings, and her parent’s retirement savings. That’s a risk no one should take. If things go bad, she is ruined and, even worse, her parents are ruined.

 

It is wrongly believed that such risk-taking, where the stakes are huge, will motivate people to do their best for the business and that they will act responsibly because they have skin in the game. People who start a business and put their own money into it are motivated enough and, most likely, motivation it isn’t what they lack. Having a lot to lose if things go bad can also be a source of stress. Believing that people who risk everything they have will behave responsibly because they have a lot to lose is naïve.

 

People who have the prospect of a huge loss will, most often, take additional ridiculous risks in the hope that they will be able to cancel the potential huge loss. That is simply irresponsible – the exact opposite of what is desired from people who have a lot to lose. Long story short, risking everything you have simply is irresponsible. 

 

We tend to admire the people who risked everything and made it big, but we forget about the huge majority of people who risked everything they had and lost everything they had. They don’t make the headlines. They’re not in the success stories. Probably they’re on the streets.

 

Tactical risk-taking

 

Earlier I argued against taking risks that could lead to your or others’ ruin. This doesn’t imply that you should take no risks at all. In the third chapter of this book, I argued for poking your luck which implies taking some risks. Tactical risk-taking refers to occasionally taking relatively small risks that, if things turn bad, you can take the loss.

 

Personally, I very much like drinking beer and talking with my friends and family over beers. When I was living in Romania, for me beer meant only one thing – a yellow fizzy drink with 5% alcohol that tasted somehow bitter. The reason for this was that in Romania in the early 2000s, virtually all beer was your typical lager – blond beer, 5% alcohol usually brewed as a pilsner. When I moved to The Netherlands, I discovered that beer is a much wider concept. On one of the first shopping trips after moving to Rotterdam, I went to the beer aisle and bought one bottle of each beer that was available. I sampled them and found the ones that I found to be nice. Hoegaarden, a white wheat beer from Belgium, became one of my favorites, even if I never had a white beer before.

 

When my wife and I moved to the USA, I had in mind the axiom that American beer is awful. Regular American beers such as Budweiser, Coors, and Miller are for me, to put it politely, barely drinkable. Luckily for me, we moved to the USA in 2015 when the craft beer phenomenon became widespread in the USA and I could sample hundreds of craft beers. As an European, I have to admit, though not without great reluctance, that some American craft beers are better than European beers.

 

Throughout my beer sampling in the USA, I tried beers that I literally poured down the drain, beers that were interesting in the sense that I finished the glass, but didn’t ask for seconds and beers that became my all-time favorites.  

 

In all three countries that I lived in, Becks and Stela Artois are sold and they are quite good pilsners. I could have gone for satisfaction guaranteed and buy only these two brands, but I didn’t. I took tactical risks of trying new beers. I could afford to lose 7-10$ on beers that I didn’t like. I even bought a six-pack of Bud Light (big mistake). Of course, some beers I tried were awful, but I also found some that I liked so much that I brought back a couple of them to Europe and shared them with a friend over a wonderful conversation.

 

The personal story with beer sampling might seem trivial, but it illustrates tactical risk taking: trying things that, if they go bad, you can take the loss. When I had my training business in Romania, some of the training programs in our portfolio were almost guaranteed hits – we knew that we could easily sell ten-twelve seats in an open session. But we didn’t focus only on them. We tried innovating and bringing in more diverse programs that would appeal to certain market segments such as marketing for software development and e-commerce management. Some of these programs were complete busts – we couldn’t even sell one session and, I have to admit, it wasn’t a reason to celebrate. But neither was it something to cry over. We simply acknowledged that they weren’t easy to sell and we moved on. Other training programs that we simply tried out turned out to be big hits and we kept them in the portfolio.

 

Introducing a new training program in our portfolio wasn’t cheap as it meant either developing it on our own or reaching an agreement with a specialist to develop it for us. This meant costs in terms of effort, time, relationship capital, money etc. But, if things went bad, we could take the hit. We kept on doing the programs that we knew would sell relatively easily and the resources we allocated to the new offerings were, more or less, expendable.

 

In the big-business world, things are rather similar. Big businesses put into innovation and development some big-money, but, in doing so, they don’t give up their core business. Take the example of the all-famous Apple which, according to a CNBC news piece, spent, in 2014, on research and development $6.04 billion. Of course, the absolute amount is huge, but it represents only 3% of Apple’s revenue in that year.

 

Apple is praised for its innovation capability and innovation implies taking tactical risks. There isn’t any guarantee that a great innovation will become a market success and big businesses know this. They risk a relatively small proportion of income on trying out new things – innovation and continue to deploy strategic prudence – focusing on their flagship products. If a research and development project fails, the company can take the loss.

 

Remember the widely publicized Google Glass project? It got huge media attention and popular buzz, but it turned out to be a failure even before it reached the market. Alphabet (the mother company of Google) spent, in 2014, on research and development $9.83 billion which is approximately 15% of its revenue. Google, Alphabet to be more correct, didn’t risk its advertising business to try out Google Glass. The latter was an on the side project. It was one of the many projects that R&D worked on. Moreover, it was shut down as soon as it became apparent that it would be a failure.

 

Too many people are crippled by loss aversion – avoiding the prospect of losing something they have – and they don’t take even the most benign risks. Not missing your favorite team’s game on Sunday might prevent you from bumping into interesting people at a larger get-together you were invited by a remote acquaintance. Avoiding the loss of, say, $100 might prevent you from discovering a new hobby or passion if you don’t join the pottery club. For individuals, tactical risk-taking involves trying out new things that don’t jeopardize your way of life including your main source of revenue.