In business, a successful outcome is never guaranteed – risk and ambiguity affect every decision managers make. Worse still, cognitive biases can prevent even the best strategists from seeing the wood from the trees. So how can we understand risk?
According to behavioural economists, choices made in uncertain conditions can be split into two groups – risky decisions, where we know the probabilities of various outcomes, and ambiguous ones, where the likelihood of the outcome is not entirely known to the decision maker. Minimising risks while maximising rewards is a priority for every business leader, so what are the best strategies?
LAY DOWN THE LAW
Most obviously, companies should actively seek to mitigate the most avoidable risks, particularly those which affect operational processes, like dated equipment or unethical employee behaviour. But some risks a business will face are not easily controlled. In the murky world of cyber security, for example, however rigorous your formal processes, it is still possible that a careless employee will cause major damage to an organisation by unwittingly facilitating a breach. Similarly, staff who aren’t trained, or who break the law, can cost a company millions in court, hammer its share price, and inflict irreversible reputational damage.
To deal with such problems, Robert Kaplan and Anette Mikes propose a system of “active prevention”. They told the Harvard Business Review that managers should develop rules-based control models, monitor operational processes closely, and “guide people’s behaviours and decisions towards desired norms” to reduce preventable risk. They should also encourage the exchange of information between departments to ensure risk identification procedures are standardised across departments, so rogue operators are detected early.
THE AMBIGUITY HEADACHE
Unlike risky scenarios, ambiguous ones engage a different part of the brain, according to research by Duke University, and the opaque nature of ambiguity may make it more difficult to navigate.
Ambiguity is especially dangerous in business because it encourages people to act in desperation, and often irrationally. Writing for Fast Company, Jane Porter describes our “impulse for clarity”, or what social psychologist Arie Kruglanski terms “cognitive closure”. “According to Kruglanski’s research, the more stresses we’re put under, the lower our tolerance for ambiguity becomes,” says Porter. “Those stresses include time pressure, a lack of sleep, loud background noise, and alcohol – all of which have been shown to make us less tolerant in moments of uncertainty.” If ambiguity cannot be eliminated, managers should at least ensure that these stresses, which may impair judgement, are minimised.
Interestingly, Porter also notes that younger managers may be better able to cope with ambiguity than their older counterparts, as a study by the economist Agnieszka Tymula suggests. The report claims that “the higher level of risk-taking observed among adolescents may reflect a higher tolerance for the unknown.”
DON’T FOOL YOURSELF
When it comes to a business’s strategic expansion or investment, an element of the unknown will always hang over business decisions. But managers can prepare themselves by eliminating any cognitive biases which may skew their rational perspective.
People often respond to particular choices differently, depending on how they have been presented. Known as the “framing effect”, we tend to avoid risk when our current position is sugar-coated, and take the riskier option when the status quo is presented in a more negative light. Equally, managers who make decisions without consulting others may be prone to seeing phantom patterns in large samples of random data, or fall victim to “Bayesian Conservatism” – the failure to adapt your stance enough when presented with new and contrary evidence.
Algorithms and independent technical experts are valuable solutions to this variety of C-suite myopia, by providing you with impartial information about internal and external risks. But managers should also seek to foster a culture where silos and self-reinforcing views are disrupted by employees who are encouraged to voice frank criticism.