From the course: Success Habits

How to assess possible risks

From the course: Success Habits

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How to assess possible risks

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- Successful people do take risks. I don't think you can get ahead of the pack without taking some risks, but they don't take too many, and they think about the risks before they take them. They get as much information as they can from experts, from history, from thinking about all the things that might happen, and then they calculate using actual numbers whether they're prepared to run that risk. That's not to underestimate the importance of your gut feelings, your instinct, as well. Ideally, you do some calculations, and also see how you feel, and compare the two. Then, if the two don't agree, then one of them must be wrong. It could be the numbers, but it could also be your instinct. So, let's look briefly at how you can apply numbers in order to think scientifically about risk. The procedure is that you compare the financial value of taking the risk with the value if you don't, and you see which one is better. Here are a couple of examples. One's about risking money to try to get something good, and one is about risking money to try to avoid something bad. First, should you invest in some new software that's going to cost you, say, $1,000 a month if it will get you two more customers a year, and each customer is worth $5,000? Well, the do-nothing case has a cost of zero. No software and no new customers. The doing it option gains you two customers worth $5,000, so that's $10,000, minus the cost of the software. For 12 months of $1,000 a month, that's $12,000, which works out at a loss of $2,000 overall, so you shouldn't do it. If you were getting three or more customers, then it would be worth it, but it's not worth it for only two. But what if it wasn't two or three new customers, but just a higher chance of getting a big new one? What if the chance went up from 30% to 80% of getting a customer worth 50 grand? The do-nothing case is worth 30% of 50 grand, which is 15,000, because there's still a 30% chance that I'll get the customer even without the new software. So, although the outcome will be either 50 or nothing, either I get the new customer or I don't, because of the 30% probability, this option has an overall value of 15,000. On the other hand, the doing it, purchasing the software case, is worth 80% of 50K, which is 40K, minus the 12K cost, which comes to 28K. So, you should do it, take the risk, and sign up for the software. And now, my second quick example, this time to do with avoiding a problem, when there's a risk that your investment of money may not work. Suppose you have a key person who might leave. You know they're a bit unhappy at the moment, and you estimate that they are 70% likely to leave this year if you don't give them a pay rise. You estimate that a pay rise of $3000 will reduce their chance of leaving down from 70% to 20%. They still might go, even with the pay rise, should you give them the extra pay. Well, we need one more number, the cost of them going. Say it's going to cost you $10,000 to replace them. I know that sounds like a lot, but it's probably right when you consider the recruitment cost and then the months required to get a new person up to speed. The do-nothing cost is 70% times the cost of them leaving, 10,000, which is 7K. The doing it cost is the weighted cost of them leaving, 20% times 10K, which is 2K, plus the cost of the pay rise of 3K, which is a total of 5K. The cost of doing it is cheaper. You should give them the pay rise. Sometimes you have lots of risks and lots of options to deal with them, and sometimes the options lead to other risks. For example, what if we get a new customer, and they turn out to be no good? Or what if we get rid of someone, and they take us to court? There's a whole chain of risks and solutions and new risks, and this is called a decision tree. There's more information on this in my problem-solving course, if you want to find out more about them. So, what's your biggest risk at the moment? What are your options for dealing with it? Could you try putting some numbers to the cost of it happening, the probability of it happening, and the benefit of it happening, or the cost of dealing with it? Do the numbers say that it will be worth spending some money in order to prevent that risk?

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