The price of risk

This morning’s Akenhurst Newsletter by Alastair Dryburgh had some interesting comments about risk and reputation damage, which of course, can be much higher to an organisation than the dollars needed to rectify a realised risk.

Dryburgh points out that when we think about risk, we tend to combine it with reward, but that’s only part of the picture. He offers some models you can use to make sure you aren’t avoiding good risks and not realising that you’re taking some bad ones.

  • The Horseburger Risk, named after the recent horsemeat in beefburger scandals in Europe: This is a risk that, when you’re lucky, produces a small benefit and even produces a small benefit when you’re mildly unlucky. But when you’re really unlucky, you’ve got a catastrophe on your hands. This type of risk could also be called the BP Deepwater Horizon Refinery Scandal or the Apple iPhone 4 Scandal (see the Theory to Practice Box ‘The Well from Hell and Bad Apples on page 520 of the text). The danger of The Horseburger Risk is that we can see the regular, small benefit of taking it, but are blind to the catastrophe waiting to happen.
  • The Convex Risk is one where you gain a lot when you’re lucky but lose less than the equivalent amount when you’re unlucky. This taps into the brain heuristic that programs us to avoid risks more than to go for gain. Alastair’s example is offering you $150 if he tosses a coin and it comes down heads, but if it comes down tails, you give him $100. Few people take that one because the psychological pain of losing $100 outweighs the pleasure of winning $150, but if you made a logic-based decision, you’d say yes to this bet every single day and be better off to the tune of $90,000 in ten years time. (See pages 520 – 523 of the text for more on brain heuristics.)
  • The 50 Shades of Grey Risk, named after the self-published book of the same name. It could also be called the Harry Potter, Lady Gaga or Rolling Stones Risk: When you are unlucky, you have a small cost (no sales); when you’re moderately lucky, you still have a small cost (small sales); but when you’re very lucky, you have a huge and lucrative win and become fabulously rich; this doesn’t happen often.
  • The Sausage Machine Risk is a predictable risk, just like a sausage machine: put the meat in, turn the handle, sausages come out. The more meat, the more sausages. This is a good risk when it produces a big enough payoff.

Dryburgh advises putting this to practice this way:

  • Look at what you’re doing and eliminate the horseburger risks; every time you do something to reduce costs or improve efficiency, work out where the potential catastrophic risk lies and manage it properly.
  • Overcome your psychological bias against convex risks; work out the odds and take more of convex risks when the odds are in your favour.
  • Experiment with potential 50 Shades of Grey risks when you have time (but know the odds are against you).
  • Build a sausage machine that produces a good payoff.

Discussion questions

Just the other day, we learned that Flight Centre has been found guilty of price fixing, despite its strong anti-bribery and corruption policy. On the day of the Federal Court’s guilty finding, Flight Centre’s shares dropped six per cent. What other reputational damage might Flight Centre expect? What advice would you offer Flight Centre branch managers in responding to staff and customer concerns?

What type of risk would Dryburgh call Flight Centre’s attempted price fixing? Would you have taken it?