Life is full of risks that can lead to loss: survival, damaging relationships, injuring your health, or losing money. There are also positive risks associated with many decisions: playing a sport to improve one’s health, joining a new group to develop positive contacts, or taking on a new business venture to increase profits.
In a world of uncertainty, there will always be risk, but managing risk is key to living a fulfilling life, especially when you are an entrepreneur. Being a successful entrepreneur does not require a bold leap of faith into the unknown but making decisions based on calculated risks that can lead to improvement, and greater profit, rather than financial loss.
Understanding the importance of calculated risk and how to make better risk-based decisions will help you in your growth as a successful entrepreneur.
Why is calculated risk important to being an entrepreneur?
Being an entrepreneur, versus pursuing a position as a manager or CEO inherently involves risk because you are trying to do something that hasn’t been done before; where there is uncertainty in trying to achieve a goal, there will be a risk.
Many mistakenly believe that being a successful entrepreneur requires a person to have a daredevil, almost death-defying view on risk and success such that any and all risky decisions are merely obstacles to achieving success.
Such people are more likely to encounter death-defying situations rather than reap success as they will more likely than not take on risky scenarios that are excessive. Calculated risk becomes critical to achieving entrepreneurial success because it gives the entrepreneur a sense of control amid a world of great certainly and a guiding premise for how to respond amid uncertainty.
If you don’t know what can potentially happen while pursuing a goal, a deviation in the protocol that might require some further analysis and reconfiguring may seem like an insurmountable obstacle. When you’ve calculated your risk, you essentially know what you are getting yourself into and what you can and need to do to achieve what you wish to achieve.
What is involved with calculating risk and entrepreneurial success?
There are a variety of factors involved in calculating risk relative to entrepreneurship. Calculated risk involves evaluating the potential returns from making the decision versus the effort invested in achieving a successful outcome.
Further, the potential impediments along the way, the resources available to correct these impediments, and any persisting problems that would limit the possibility of achieving a successful outcome also factor into the decision.
Ultimately, calculated risk involves determining what is the potential gain from every decision that could be made and what is the potential loss. If the gain involves any costs and potential losses involved, then making a riskier decision is worthwhile; if there is some degree of certainty that costs and losses will outweigh any gains, then the decision isn’t worthwhile regardless of perception.
There is some subjectivity to making calculated risk-based decisions. This subjectivity is undermined by the entrepreneur’s familiarity with the subject at hand and the market being pursued. Understanding the market and your product or service’s possibilities can improve the possible gain associated with potentially risky decisions because there is a greater familiarity with demand, the nuances of production and marketing, and the effort involved in bringing an idea to fruition.
Likewise, the value of certain markets may not seem inherently apparent to outsiders regardless of any specific valuation. For example, buying and selling rare stamps may not seem particularly profitable to someone invested in the oil business, but a skilled entrepreneur can still turn this passion into a profitable business with appropriate market knowledge.
How to improve one’s ability to calculate risk?
You don’t have to be a Nobel Prize-winning economist to improve your calculated risk-taking abilities (and even if you were, you might not make the decisions you need to succeed as an entrepreneur!). Improving your ability to calculate risk requires certain investments in understanding the responsibilities of an entrepreneur.
First, you need to evaluate all possible risks that occur with regard to succeeding with your specific goal. For example, if you want to set up a business selling ice cream, potential risks could include a skyrocketing price of milk, a new ice cream business coming to town (or a successful one expanding into your area), a news report on the dangers of ice cream or your ice cream making machine breaking.
Once you are familiar with what risks you are most likely to encounter, quantify the risks based on the potential loss that may occur and the probability that these events may occur.
An ice cream machine breaking would be a significant loss because that’s how the product is made, and it will happen eventually since machines have fixed lifespans.
On the other hand, a news report on the dangers of ice cream is fairly low, though potentially damaging, only because ice cream is still popular despite health concerns otherwise (and most journalists probably like ice cream!).
Once you’ve quantified these potentially risky decisions, categorize them from low to high risk. Once you’ve done this, identify contingency plans to deal with the high-risk situations and how much it would cost to deal with them.
How much does it cost to fix a broken ice cream machine or freezer? What would you do with your business in the meantime? Are there other products you can sell to make up for a loss in income?
Likewise, what happens if another ice cream business starts across the street and tries to follow in your wake with the same business model? How can you differentiate yourself from the competition and maintain your competitive edge?
Factoring in labor costs, supporting revenue streams, marketing funds, and product popularity will all help you recognize the potential costs that can arise. While doing this, you should also be aware of and quantify the potential gain from these decisions. Will a year-long social media campaign to differentiate your business be more worthwhile than offering free samples at a fair?
Will investing in a state-of-the-art ice cream machine be more worthwhile if it costs twice as much but only lasts 50% longer than a conventional machine? How much ice cream can you produce?
Once you’ve identified the costs and potential gains, identify any decisions where the costs approximate or outweigh any gains, as these risks can’t be overcome effectively. Create contingency plans for any other risks that can potentially arise, particularly if a great profit is anticipated if plans do succeed.
Ultimately, when calculating risk, you should always be aware of how decisions can affect profits. Every decision you make as an entrepreneur directly affects your business. Identifying which decisions can improve performance will directly impact and improve the outcomes of your profit-seeking considerations. Properly identifying and calculating risk can differentiate your business from those of the reckless and help you to be an entrepreneur that turns risk into reward.