Risk is a huge factor in business success. Taking a risk, that is, especially in the form of investments in innovation.
Victoria Mendoza, CEO of Media Peanut and a former CFO, said that companies too averse to risk have a “bad strategy.”
The pandemic may have added to the problem. It has made some organizations more conservative, not less, in their approach to research and development, capital allocation, fixed asset investment, and other areas.
Although the economic disruption from the pandemic has forced some companies into a corner, taking calculated risks has become essential.
“The risk of failure increases with creating a new product or launching a new service, but the payoff is much larger,” said Jon Siegler, co-founder of compliance software firm LogicGate. That reason alone can motivate companies to change from risk-avoiders to avid innovators. But it’s not an easy transition to make.
Conservative finance executives might think “playing it “safe” and avoiding risk, especially when making large outlays of capital, is a prudent strategy to ensure a long existence.
A company too risk-averse “gives up opportunities and new ideas in favor of safe investment and steady profit,” said Jamie L. Smith, co-founder of Amplify Advisors, a business accounting and growth consulting firm.
But risk aversion as a cultural trait can be a side effect of something else. Smith said that some companies’ obsessive focus on the short-term encourages risk aversion. “Short-term focus happens when you are publicly traded and driving quarter by quarter or if you are otherwise pushed by stakeholders and investors to deliver results in the immediate future.” Taking risks requires some concentration on the long term.
Being overly sensitive to risk in decision-making can also arise from using only “gut feel” and qualitative information when planning and investing, said Siegler. To be effective risk-takers, organizations need to include a third measure — a quantitative analysis of risk — in their evaluations, Siegler said.
Adriana Carpenter, CFO of expense management company Emburse, agreed. Most companies are risk-averse because they “approach making risk decisions based on anecdotal evidence versus hard factual data,” she said.
An example of quantitative risk analysis is assigning a numerical value to risks based on quantifiable data such as costs, logistics, or completion time.
“Innovative companies have a much better recognition and understanding of how risk quantification can inform a risk’s monetary impact,” Siegler said. The approach allows companies to take on more strategic risks — such as entering a new market or launching a new product or service — and still reduce risk exposure in areas that are simply cost centers.
Risk quantification also helps management communicate, Siegler said. “Companies discussing risk in monetary terms rather than qualitative labels such as ‘high, medium, and low,’ ensure everyone understands the potential risks of the company’s investments.”
Just because companies quantify innovation bets doesn’t mean they make the correct decisions.
Chris Townsend, chief marketing officer of Wellspring, a provider of innovation and IP management software, works with CFOs at SoftBank, Johnson & Johnson, and Panasonic.
His clients use the “same rubric to measure innovation bets that are used for all other capital expenditures,” he said. The measures include internal rate of return, net present value, hurdle rate, and payback period.
The result is a per-project analysis that “seems to make sense,” said Townsend. But really, he explained, given the time and consistent investment needed to assess innovation-related risks, the case-by-case approach works only for the most straightforward, near-term bets.
In other words, Townsend’s clients might be playing it too safe.
Getting the best ideas “right” takes time. For example, it took more than a decade for Nestlé to perfect Nespresso, Townsend said. “Where would the company be if it shut it down after a bad couple of quarters based on the project’s rate of return?” he asked. “No metrics can replace a long-term strategic vision.”
“In our space, we haven’t seen companies becoming more risk-averse; rather, we have seen them addressing risk head-on.” — Marcus Alexander, CFO, Capacity
Companies don’t want too high a risk exposure, so they should limit their “misses” as much as possible, Townsend said. However, by embracing a holistic and operationalized approach to risk-taking and R&D, “even the misses can help provide key learnings that can aid businesses in ongoing strategic growth efforts,” he said.
For a risk-averse company to change its ways, it has to develop a capacity for managing risks with the right tools. In addition, management has to ensure the risk tolerance of the main stakeholders evolves alongside the enterprise’s risk tolerance.
“If you are an all-or-nothing start-up, for example, you [and your investors] will have a much higher risk tolerance,” said Marcus Alexander, CFO of Capacity, a knowledge-sharing platform.
Capacity had the “good fortune” of solidifying its balance sheet during the pandemic, Alexander said. That let it capitalize on opportunities, such as the general trend towards artificial intelligence and automation. “In our space, we haven’t seen companies becoming more risk-averse; rather, we have seen them addressing risk head-on,” he said.
For more mature companies, reducing the risk of failure and winning large payoffs starts with strategic planning. Management should ask: “What big, strategic investments must we make today to acquire more customers and win more market share in 18 months, or five years?” Siegler said.
Many historic commercial flops prove a large, risky bet on a product or product category innovation can be dangerous. But there’s little to no evidence of the undeveloped or never-launched products that perish in conference rooms and would have been successful. Companies indisposed to risk-taking don’t last long; that makes them the riskiest businesses of all.
Karen Epper Hoffman is a freelance business writer.