Tuesday, July 12, 2011


Risk, what exactly is it?  We talk about it all the time, especially in regards to business and money.  Currently, there is a big fad in regards to the term 'entrepreneur' and we marvel at these individuals because they are "...accountable for the inherent risks and the outcome of a product."

If we look at risk as a mathematical formula we would basically have:

Risk = (Probability of failure) X 
(Expected loss in case of failure)

Is it the 'probability of failure' variable or the 'expected loss' variable that makes someone an entrepreneur?  If you are young, unmarried, and either in college or of college age then the reality is you most likely have little to nothing to lose, regardless of the probability of failure in whatever is attempted.  So, does that qualify one to claim to be an entrepreneur?

As one matures, it is logical to assume that while the variable 'expected loss' will increase the probability of failure in turn decreases due to the fact that one has gained more knowledge and thus it could be assumed that one would make decisions that while no less risky are much better thought out.

But honestly, when attempting a new endeavor, how many people actually calculate risk of failure?  

The reality is that most individuals are risk adverse, which realistically means that they not only avoid and or fear risk but they will most likely avoid attempting any calculations of risk and loss altogether.  Entrepreneurs are no more or less risk adverse than others but where they differ is in  their decision making; risk adverse individuals have no calculations for "regret."  

Regret is a variable for the cost of not taking advantage of an opportunity.  Risk adverse individuals prefer the status quo not only due to the fact that they prefer the status quo to any situation that could lead to a worse off position than the status quo, but because they have no concept of "regret" or that one is worse off by not pursuing an opportunity; regret is the belief that one is in fact worse off by doing nothing.

In my experience with a variety of start ups and turnarounds the most likely causes for failure were lack of execution, lack of capital (which has always been due to sales outpacing inventory), and the inability of the founder/owner to entrust others, a belief that they had to do it all, and or the inability to acknowledge employees who were in fact, stakeholders.

In my post on Entrepreneurship I make mention of "opportunity driven" entrepreneurs and "necessity driven" entrepreneurs and I commented that:
"The world of internet based start ups is an example of opportunity driven entrepreneurs, while the rest of our economy fosters entrepreneurship as necessity driven, or people striking out on their own due to financial necessity."
In an environment where one is forced and or compelled to strike out on their own, of course the risk of failure will dramatically increase; there is no calculation of risk because there is no choice, there is no sense of regret, because their is no choice.  If one strikes out on their own out of financial necessity and if a major cause of failure is a lack of capital then logically the statistics for failure will create a sense that entrepreneurs are risk takers; but the reality is that if less than 1% of all start ups get funding, and well over 50% of small businesses are struggling because they have no access to capital the reality is that even the most talented, even the most obvious of ideas will not be successful because they will only be attempted out of necessity; and thus doomed to fail.

The reason we see more young people being innovative and striking out on their own, is because they are opportunity driven rather than necessity driven.  While the young focus on the internet as entrepreneurs the reality is that we no longer lead the world in innovation because outside of internet/technology, we are devoid of any opportunity to innovate; every week we hear of mega million dollar financing deals for another innovative tech start up, from time to time we hear of some tech start up that reaches greatness and creates billions of dollars for the founders and investors in the start up.  We celebrate this as "proof" of the greatness of our society and or our economy, we use this as an example of what the rest of the economy should do,  we even have politicians now jumping on the bandwagon of the start up model as a way to create jobs, and a great debate is occurring within our colleges about the need to teach entrepreneurship. 

The reality is all we have to do is return to a basic calculation of risk and create an environment where risk is calculated in an opportunity driven environment rather than a necessity driven environment.  We need to accept the fact that the success of the tech/internet start up world is as much of a desire to create wealth, in the sense of wealth within a bubble, as it is to "change the world."  Start ups such as Jewelmint and Beachmint, and the mega million dollars of funding they receive do not represent innovation nor will they change the world, but rather they are the equivelant of flipping homes in 2006.

We need to return the calculation of risk to an environment of risk vs. reward rather than the current environment of necessity.  We need to base our concept of risk on a more rational sense of 'value' or to a scale of base hits rather than home runs.  We do not need more risk takers, nor do we need more education in regards to entrepreneurship, and there is absolutely nothing the government can do, but rather we need more investors who value a return on an investment rather than scoring on an all or nothing gamble.

The reality is that risk is irrelevant in an environment that is necessity driven; no calculations of value are relevant in a world where opportunity has been replaced by necessity.  To calculate a formula assumes rationality and the calculation of risk without a corresponding calculation of reward is irrational.  




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