Most of us think about risk in terms of statistics – what’s the chance I will win the lottery? What’s the chance of a major earthquake, flood, or wildfire?
How People Understand Risk
While certain risks are static – like the chance a roulette ball will stop on your number or color, business risks can easily, yet imperceptibly, become dynamic. This change in business risk can be dangerous to your health, and to business survival!
The Economist Magazine wrote, “People are consistently bad at dealing with uncertainty, underestimating certain risks and overestimating others,” (“Freud, finance and folly – Human intuition is a bad guide to handling risk” – 1/24/2004).
How Does this Happen?
What happens when you discover a certain risk to your business is low, very low, or nonexistent? Most business owners, with already full plates and limited resources, more or less ignore that risk completely. The change can be subtle or even unnoticeable, but it happens all the time.
Consider your driving prowess and the statistics about accidents. Most of us feel risks decrease over time as we become more experienced. That can lead to paying less attention, or allowing distractions to creep in. We become less vigilant or more complacent, and can more easily be victims of the statistics of auto accidents, serious injuries, or death.
This doesn’t mean people are stupid (despite Einstein’s opinion!) – they adapt to their environment, which may also be a good thing.
Thinking about risk in two additional ways can be helpful when you don’t want to overlook something important.
1. Consider likelihood and cost impacts of possible losses – what’s the chance that something might happen and how much could it cost to fix? That can help prioritize your more important risks.
2. Consider frequency and severity. Something that has very low frequency can have catastrophic severity. These are often called black swans, and need to also be prioritized and carefully handled.
Remember the Deepwater Horizon oil spill in the Gulf of Mexico? The risk of failure was considered impossible and no plans were in place to handle the catastrophe.
Let’s not let complacency take over when we think something is unlikely to happen. Prevention and contingency plans are still important to business survival.