Optimus Think

In an earlier blog post that discussed non-market factors and their implication on business strategy, the concept of risk was explored a bit. More conservative businesses seek to manage risk, while more daring ones seek to actually leverage the risk and harness the opportunities that go along with it. The emergence of these different “cultures of risk” is psychological in nature, as different organizations perceive risks in different manners. And then, based on the perceived magnitude of the risk, together with the perceived ability to realize a reward, each organization has a different reaction. Let’s explore these concepts of “risk” and “cultures of risk” a bit further.

What is “Risk”?

Why do some young adults say they plan to set aside more money for retirement only after looking at an avatar of themselves at retirement age? Aging and the need to save for a rainy day are facts of life, so why should a vivid picture make any difference?

A clue can be found in the International Organization for Standardization (ISO)’s surprising but useful definition of risk—“the effect of uncertainty on objectives”. Normally, we think of risk in terms of external influences, but the “effect of uncertainty” also includes internal factors such as individual choices, priorities, and behaviours. Perception and reaction of the different uncertainties are part of what makes a threat a risk. As such, risks that may appear identical from an actuarial perspective are not actually identical in reality.

While many risk management experts consider these internal distortions to be rational choice, three distinct layers (at least) prevent humans from consistently making “rational” risk responses.

Nuclear Power: Genius or Disaster?

To illustrate the prevalence of these layers, a blog entry by marketing guru Seth Godin offers a powerful quantitative snapshot of the power of asymmetrical risk perception. Godin points out that by measuring the number of deaths per watt of power generated, coal production causes 4000 fatalities for every 1 caused by nuclear power production. Let’s now define each of the layers and see how they relate.

Layer 1: The Effect of Visual Representations

People react psychologically as individuals to visual stimuli. The perceived interest, intensity, and proximity of images in turn affect each person’s perception of the risk involved. In Godin’s article, his focus is on the first layer, stating “I think that any time reality doesn’t match your expectations, it means that marketing was involved”. Indeed, the sensational, wild-card nature of nuclear risk has been amplified through a tremendous amount of press and propaganda. This layer also helps explain why a persuasive image such as the aged avatar example invoked, in some cases, a strong will to save more money.

Layer 2: The Effect of Risk Modes

Different modes of risk affect perception and response too. For example:

i) People tend to focus on the blame that follows events or actions, rather than the outcomes themselves.

ii) The source of the threat is significant to many—for one thing, is it a natural or man-made hazard?

iii) Also important is whether a risk comes from action, or inaction. Think of the distinction between sins of omission and sins of commission.

Coal has been available by centuries and is perceived to be a natural resource. Nuclear energy on the other hand is new and mysterious, and is seen by some as “playing God”. This is a classic example of a “natural” versus a “man-made” hazard. Because coal power has been engrained into our lives for generations, people are more accepting of the risks involved. Nuclear risks, however, are often not treated as a “given”. These risks are often viewed as man-made and more easily preventable.

Layer 3: The Effect of Cultures

Risk is also shaped by the way of life of any group that shares risk. This layer of risk is often ignored or forgotten, in part because it is hard to quantify. It is very prevalent, however, in Cultural Theory, which is a discipline that has covered nuclear risk perception closely and is associated with the prominent intellectuals Aaron Wildavsky and Mary Douglas. Essentially, Cultural Theory examines four cultures based on characteristics of social stratification and personal control:

1. Egalitarian: Tend to minimize formal strata and exert strong personal control.

2. Individualist: Tend to minimize formal strata and exert weak personal control.

3. Hierarchical: Tend to maximize formal strata and exert strong personal control.

4. Fatalist: Tend to maximize formal strata and exert weak personal control.

Cultures of Risk

Each of these four cultures views the world in different ways, fears different things, and produces different kinds of leaders. Cultures of risk are created, as each culture also analyzes risks in different ways. Egalitarians are largely against nuclear power as their focus is on the threat of catastrophe. Individualists, on the other hand, are in favour of nuclear power as their focus is instead on the resulting opportunities.

This is merely an example. Cultures of risk affect every organization and help define each organization’s constituents, customers, and competitors. There is no right answer as to which culture of risk is the best. Since organizations can be effective with very different strategies and management styles, it follows that organizations can be effective with different risk cultures.

Risk is truly a multi-dimensional concept and can only be captured so well in the actuarial definition. The organizations that understand this tend to be more successful, as their strategic planning and execution efforts are based on a more complete picture of risk. Consequently, business processes and developments may be more truly optimized for minimal risk and maximum reward.