The Baseball Theory

If you are failing seven times out of ten, most of us would take that as nature’s way of suggesting a different career field. But for a major league baseball player, that’s a .300 batting average – millions of dollars in salary and endorsements, and a shot at the Hall of Fame.

Most of us know that Babe Ruth also held the major league all-time strikeout record. Some of us know Charles Lindbergh’s other record – he’s tied for the most emergency parachute bailouts of all time. His safety record was so poor that the first company he approached to sell him a plane to cross the Atlantic refused him as a customer.

And there’s the infamous screen test report on Fred Astaire: “Can’t sing. Can’t act. Balding. Can dance a little.”

Success writers often tell these stories to give you hope. Yes, you may be a loser, but so were all these other people, and look how they turned out. But that misses the point:

If you are batting 1.000, one thing’s for sure – you’re not playing in the major leagues.

Successful people frequently have a shocking track record of failures and reverses on their way to the show. It’s what we call “paying your dues.” The things that matter have risks associated with them success isn’t free. Losing is an essential part of winning.

The baseball theory of life is very simple. If you don’t swing, you can’t hit. If you do swing, the odds are against you. For some people, that’s a deeply disturbing idea. But you can also look at the baseball theory with great hope: failure isn’t the long, circuitous road to the top; it’s the only way to the top.

In earlier entries, we’ve talked about the concept of risk (R=PxI, or the value of a risk equals the probability of the event times the impact of the event if it happens).

In pure risk (threat only), you can lower your risk by reducing the probability or by reducing the impact. In business risk (threat and opportunity combined, as in an investment decision), you have four ways to improve the situation: reduce the probability or impact of the downside, or increase the probability or impact of the upside.

When it comes to applying the baseball theory, where the odds of success are always low, the big trick is to reduce the consequences of failure. The cheaper it is to fail, the smarter it is to take a chance.

When salespeople cold-call clients, they expect rejection far more often than success, but one success pays the bills for a hundred rejections. People who’ve known me for a long time know I’ve always got some sort of scheme going. Most fail — I doubt I bat better than .200 — but I know how to keep the cost down so that the occasional winner is good enough.

In other words, it’s not whether you win or lose — it’s how you structure your bets.

What is Risk?

Most people think a risk is something bad, which is often, though not always true. More specifically, a risk is a future event that would have a significant impact on you or something you care about if it should happen. The effect may be bad (threat) or sometimes good (opportunity).

You and I – every single one of us – live in a world of risk. Risk is uncertainty. It’s future tense, as opposed to “problem,” which is present tense.

We often manage risk by denial, declaring ourselves helpless in the face of implacable destiny, or checking our horoscope to find a propitious day to ask for that promotion. We deny the existence of randomness by chanting self-help mantras – “I’m good enough, I’m smart enough, and doggone it, people like me!” – declaring ourselves solely responsible for all that befalls us.

There is, however, a science of risk. We tend to notice the work of risk professionals only when they fail, when the patchwork of convertible debt swaps backing subprime mortgages unravels due to faulty pricing. But it’s not only the economy, stupid. Risk managers keep airplanes in the air, buildings from collapsing, and secure every bit of a modern infrastructure.

Fundamental Concepts of Risk

A risk event may be likely, or it may be unlikely. You have to take into account both the severity of the impact and its likelihood.

How likely is it that this risk will occur? Sometimes we know with mathematical certainty. More often, the best we can do is guess: pretty low, or almost certain. Impact can sometimes be turned into a number: $1000, or €50. Other times, it’s about as specific as that scene in Ghostbusters when Egon explains what will happen if they cross the streams: “It would be bad.”

The standard risk formula is R = P x I, or the value of a risk is its probability times its impact. That’s particularly helpful in pricing financial risk. If there’s a 10% chance of something happening that would cost you $1,000, then the value of the risk is $100. That means if you can get rid of the risk for under $100, it’s clearly profitable to do so. If it will cost more than $100 to get rid of the risk, you have to consider whether other factors justify the additional cost.

Because risks can be threats or opportunities, you have to know the difference between a “pure risk” and a “business risk.” A pure risk is all downside. If you didn’t get in an accident today, you’re not better off — you avoided becoming worse off.

A business risk — a stock market investment, for example — has an upside and a downside. There is a possibility you will make money, and a possibility you will lose money. The risk formula’s P x I has to be determined for the upside and for the downside, so you can see how the risks balance. If the result is favorable, that’s an argument for the investment; if it’s unfavorable, perhaps not.

For example, let’s say you’re offered an investment for $5,000. In return, you are guaranteed a 70% chance of $50,000, and a 30% chance of losing your investment. That works out to an expected monetary value of $33,500 (the value of the opportunity risk [$35,000] plus the value of the loss [-$1,500]).

But the real outcome isn’t $33,500. You’ll receive either $50,000 or lose your $5,000. There are three possible strategies — bet on the upside (go for the $50,000), hedge the downside (avoid losing the $5,000 by not betting), or bet the expected value (take the investment because an expected $33,500 means more than keeping an actual $5,000).

Your personal choice may be influenced by how much is in your bank account.

Ways to Manage Threat Risk

• Avoidance (change the environment so the risk no longer exists)
• Transference (give or sell the risk to someone else; buying insurance is a common risk transfer strategy)
• Mitigation (do things to reduce likelihood or impact of the risk, even if you can’t get rid of it completely)
• Contingency planning (come up with a plan to follow if the threat should start to develop or seem likely)
• Acceptance (ignore it for now and deal with it if it happens)

Ways to Manage Opportunity Risk

• Exploitation (take the value and cash it in)
• Enhancement (try to grow the value to a higher level)
• Sharing (give, trade, or sell the value to someone else
• Contingency planning (come up with a plan to follow if the opportunity should start to develop or seem likely)
• Acceptance (ignore it for now and deal with it if it happens)

Residual and Secondary Risk

Most risk strategies can’t get rid of every bit of risk. You start with an initial level of risk, and whatever’s left after you identify your strategy is the residual risk. You can come up with additional ways to reduce the residual risk further, but at some point you normally accept some level of residual risk and move on. We take our lives in our hands every day we get behind the wheel of a car, but really, what choice do most of us have?

Secondary risk is new risk created by your proposed solution to the original risk. If you spend time and energy to get rid of Problem A, and that means less attention to Problem B, it’s possible you’ve made things worse overall. Make sure you inspect any proposed solutions for secondary risk before rushing to implement them.

* * *

While some risk tools are enormously sophisticated, and their use only appropriate for specialists, you and I can use many of the techniques of experts to make our lives safer more prosperous and more successful.

We don’t want to sweat the small stuff, but the truth is, it’s not all small stuff. Some risks we can, and should, accept.

Others, we can't — though sometimes we have to.

The Fine Art of Making Bad Decisions

Butch Cassidy and the Sundance Kid are trapped on the edge of the cliff. “What I look at it, we can either fight or give. If we give, we go to jail. If we fight, they can go for position and shoot us, wait and starve us out, maybe start a rock slide and get us that way. What else can they do?”

“They could surrender to us, but I wouldn’t count on it,” replied the Kid.

Butch thinks for a minute. “Wait! We’ll jump!” It’s 300 feet down into rock-filled, treacherous waters. And after some argument ("I can't swim!"), both men eventually jump.

What kind of idiot makes a blind jump into uncharted waters? Answer: the one who’s otherwise dead anyway.

Making good decisions is easy. A good decision implies the existence of a good alternative, and anybody can do that. If there is a good choice, problem solved. But what if all your alternatives are rotten? Well, in most organizations, that gets kicked up the ladder. The higher you are, the nastier the choices that end up on your plate.

Actually, Butch and Sundance had a pretty easy choice: the certainty of death if they stayed, the probability of death if they jumped. Not a pleasant decision, but not a hard one. Real leaders have it worse. They have to choose among strategies each of which makes sense given a specific future. But the future is like Schrödinger’s Cat: depending on the actions of unknown random variables, the cat is both alive and dead until the moment the box is opened. The future become real only when it becomes the present.

Risk managers distinguish between the concepts of “pure risk” and “business risk.” Pure risk only contains a downside. If you didn’t get into a car accident yesterday, you’re not better off. You just failed to become worse off. If pure risk is avoided, it’s status quo. Business risk, on the other hand, combines threat and opportunity in the same decision. If you launch a new product, you might make a lot of money. If it doesn’t succeed, you’ll lose a bundle.

There are four parts of the business risk equation: the probability of the downside, the effect of the downside if it should happen, the probability of the upside, and the effect of the upside if it happens. In classical risk, you know the probability and the impact, so calculating the expected value of the decision is fairly straightforward.

What do you do when you don’t have the numbers? Try asking these four questions when evaluating potential bad choices:

1. What’s the best that can happen? (Can I make it better?)

2. What’s the worst that can happen? (Can I mitigate the impact?)

3. Is #1 worth risking #2? (Is the probability of one higher than the other? Is the impact of one higher than the other? Am I looking at an absence of good options?)

4. Can I live with #2 if it happens? (If not, do I have a less bad option available?)

The buck has to stop somewhere, and the available options may not be what anyone would prefer. Making bad choices is one of the unavoidable burdens of leadership. Do it as well as you can. That's what SideWise thinkers do.