Philosopher Eric Hoffer said, “When people are free to do as they please, they usually imitate each other.” This quotation describes how executives handled risk in the past. From 2002 until 2008, capital was easy to obtain, growth rates were consistently up and the best way to predict the future was to look at the past. There was much discussion about risk, but there was a clear herd mentality at play. Imitating others seemed like the right path to take.
Then the financial panic occurred on September 18, 2008. It was the largest panic since October 1908, and it dramatically accelerated the recession that had started in December 2007. Between Third Quarter 2008 and First Quarter 2009, the U.S. government made unprecedented changes in the country’s capital structure. There is no longer safety in following the crowd.
Most executives have spent the past several months in some form of shock and awe. Some have found alternative employment as their companies failed, but most of us are still here. We are a bit worn and tired—it feels like a Florida neighborhood in the aftermath of a hurricane. During the storm, no one was visible. After the storm passes, we are all walking around the neighborhood greeting fellow survivors and assessing the damage.
How to View Risk
Now that the panic and the recession are basically behind us, the way executives look at risk needs to change also. There remains tremendous uncertainty as we look to the future. There is a strong sense among executives that many cards have yet to play themselves out globally. Nevertheless, every business executive is now faced with the call to action, “What are you going to do now?”
Every executive will either make clear choices to take the lead or be forced to react to competition. There are some guiding principles that may help manage the risk, but there is no pixie dust to eliminate it. If anyone tells you that they have the answer and you follow it because of anxiety, then you are abdicating your responsibilities as an executive. If you are weighing risks properly, then you are supposed to wake up in the middle of the night wondering if you are right.
The guiding principles below are offered for consideration with the caveat that there are no guarantees in this new world.
All the talk about a V-shaped economic cycle is gone, and the emerging view is that it will be an L-shaped cycle. This implies a new definition of normal. Consider what you need to do to operate in an environment that is somewhat brittle and fragile for the next several years. Imagine a continual series of announced surprises that move the markets way up and way down. Imagine a monthly published misery index. Think about how your customers and supply chain partners will define their new normal. Try to determine what will become more important or less important. Success in the new normal world will require doing new things rather than just the same things better. Challenge yourself and your team to develop a list of the new things and go spend some money on “proof of concept” pilot projects.
Access to Capital
Over the next several years, access to capital will continue to be difficult. There are two major considerations for senior executives with regard to capital access. First, firms that need capital now are strategically much weaker than those with strong balance sheets. Firms with strong balance sheets need to capitalize on competitors’ weaknesses to gain market share. This means investing and taking risks to do it well. A firm with a strong balance sheet cannot be paralyzed by fear and just hunker down and wait for the world to change. If they do, the weak competitors will regain their strength over time and the opportunity for competitive advantage will be lost. Hope is not a viable strategy, and hunkering down often just makes you a target. Never forget that in a down market, the sources of growth are the opposite of up markets. In an up market, growth comes from more demand.
In a down market, growth comes from reductions in market supply. You can get significant growth in a flat market with consistent consumption if your competitors are forced out of business. Choosing to take a large timeout with hope as a strategy leaves most of your potential growth in the hands of your weaker competitors.
The second major impact of limited capital access has to do with your emerging value opportunities in the supply chain. Your upstream and downstream supply chain partners had their own sources of capital that used to be sufficient. Your firm may now have a supply chain partner with an unmet need for capital. Meeting this need can be part of your value proposition. Over the last five years, being a public company has been somewhat out of fashion. Over the next five years, a public company capital structure may become a significant competitive advantage based on the ability to raise capital and have many investors who can get in or out easily.
This is the ideal time for a bottom-up rethink of your company’s strategy. Just because an assumed or imitative strategy worked in the past doesn’t mean it is sufficient for the new reality. Today, every player in every B2B market is re-examining every line of their income statement. If you don’t have a clearly articulated strategy and provable value proposition, your revenue is at serious risk. You can no longer count on tomorrow’s sales following a “plus or minus” past trend line.
The point is that you will make better risk assessments with less analysis and more real-world examination of your assumptions. The military has been facing “asymmetric threats” that don’t follow established patterns for many years. It has embraced scenario-planning as a key tool to deal with rapidly changing situations and underlying assumptions. A scenario starts with the phrase, “Just suppose X happens. What would we do?” By thinking it through in advance, two powerful things occur. First, your firm can recognize a change earlier, thereby gaining more time to react than your competitors. Second, by thinking through the early actions, you can execute violently and quickly. This enables you to capitalize on opportunities and minimize threats. Consider losing a major supply partner, upstream or downstream. Also consider losing your key lender relationship. The idea in all of this is that in times of high uncertainty, there is significant advantage to being light on your feet and responsive to the market.
To test your scenarios, ask if they are herd-conforming or outliers. If they are herd-conforming, you may not be thinking independently. If you are thinking independently, chances are that most of your answers will be outside the majority view.
Do-Overs and Hedging
Rahm Emanuel, Barack Obama’s chief of staff, said that one should never waste a good crisis because it is a great time to make changes. Before you go off making investments and taking risks, make sure that your car is ready for the trip. Think about doing over your sales management processes, incentive structures, product offering and even staffing—including executives. Ask yourself, “If all my employees quit on Friday, I found qualified replacements over the weekend, and then my old employees reapplied for their jobs on Monday, what percent would I rehire?” Ask this question again and limit it to only managers and executives. If the answer isn’t 100 percent, then fix these problems first before you look for new challenges.
Once your house is in order, you should always hedge against potential surprises when making your investments. Take the maximum amount of risk when the cost is low and the potential gain is high. Nassim Taleb wrote a book called The Black Swan about the inability to account for all of the random events that can take place. This book should be required reading for executive risk-takers. He suggests being hyper-conservative when it comes to managing downside risk, and hyper-aggressive when it comes to taking advantage of opportunities that cost you very little. He made a strong case that the banks did just the opposite in the years preceding the current financial crisis. They had no real upside and a lot of downside—to be more precise, they got a little bit of cash flow to have all the downside.
This hedging concept runs counter to the way most untrained risk-takers think. It is bit challenging to understand completely, but doing so can pay high dividends.
There are no paths forward that do not involve some degree of uncertainty and risk. This causes anxiety, or as Kierkegaard called it, “the dizziness of freedom.” It is much easier to give advice to a client who is playing the game to win rather than one who is playing the game not to lose. Winners understand that anxiety is part of the game.
Author Hugh Prather said, “Fear is static that prevents me from hearing my intuition.” Listen to your intuition, plan for surprises, take some risks, avoid being part of the herd and, most of all, enjoy the ride.
Meet the Author
Michael Marks is managing partner of Indian River Consulting Group, located in Melbourne, Florida, and on the Web at www.ircg.com.