GET RISKYFight biases to increase top line growth
Risk Bias   McKinsey Quarterly   Idea: it’s important    for organizations to    have a thoughtful    stance on how to  ...
A Scenario With Two Choices   You’re a sr. exec at a high-tech firm that needs    to meet your earnings and has a project...
This should be simple, right?   Finance textbooks discuss using IRR, NPV, MIRR    and other tools to determine capital pr...
Behavioral (Psych) Biases   The problem is that our biases can lead us to    make irrational decisions   Overconfidence ...
A Test   What: McKinsey decided to test mid-level    execs capacity for risk   Who: 1500 execs from 90 countries   Resu...
Biases to be aware of   Loss Aversion: people fear losses more than    they value equivalent gains     Inother words, I’...
Loss Aversion Example   You choose:     Up-frontinvestment = $50M     With two potential outcomes:       50% chance fo...
What Happened   Managers needed PV = $170M to do the    project (70% risk premium)   But, if you told them, you would po...
Five Lessons   Don’t just consider projects in isolation   Adjust reward systems to match portfolio of    project outcom...
Upcoming SlideShare
Loading in …5
×

Get risky

523 views

Published on

A quick take on risk and project capital allocation.

Published in: Business
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
523
On SlideShare
0
From Embeds
0
Number of Embeds
69
Actions
Shares
0
Downloads
2
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Get risky

  1. 1. GET RISKYFight biases to increase top line growth
  2. 2. Risk Bias McKinsey Quarterly Idea: it’s important for organizations to have a thoughtful stance on how to evaluate and judge risk in project approval process.
  3. 3. A Scenario With Two Choices You’re a sr. exec at a high-tech firm that needs to meet your earnings and has a project with two financing options: 1. Up front $20M with an expected return of $30M over three years 2. Up front $40M with an expected return of $100 million over five years (and a bigger dip in earnings in the early years) Both plans have same likelihood of project failure. Which do you choose?
  4. 4. This should be simple, right? Finance textbooks discuss using IRR, NPV, MIRR and other tools to determine capital provisioning for projects  Debt increases risk of financial distress – and we know managers often focus on short-term results  Therefore, managers may avoid risky projects even if they have positive NPVs. Textbooks would say to choose option #2 But…most executives choose #1.  If you did that, you would lose out on $20M  Not a lot, but it happens many times per year  $2B if you assume 20x/yr over 5 yrs
  5. 5. Behavioral (Psych) Biases The problem is that our biases can lead us to make irrational decisions Overconfidence vs Risk Aversion  CEOs forced to make decisions on multi-million dollar investments are typically risk averse  Mid-level execs are typically risk neutral; they usually make many decisions on smaller investments and SHOULD be more risk-tolerant The problem: too many leaders follow safe, straightforward paths with slow growth rates & lower investments
  6. 6. A Test What: McKinsey decided to test mid-level execs capacity for risk Who: 1500 execs from 90 countries Result: “They demonstrated extreme levels of risk aversion regardless the size of the investment, even when the expected value of a proposed project was strongly positive”
  7. 7. Biases to be aware of Loss Aversion: people fear losses more than they value equivalent gains  Inother words, I’m not going into a bet if I can lose as much as I gain. Narrow Framing: weighing risks as if there were only one outcome (don’t flip a coin once)
  8. 8. Loss Aversion Example You choose:  Up-frontinvestment = $50M  With two potential outcomes:  50% chance for PV = $100M  50% chance for PV = $0 So, should you do it? Should you go for the quick (safe) win as a mid-level exec?
  9. 9. What Happened Managers needed PV = $170M to do the project (70% risk premium) But, if you told them, you would pool the project with others, managers only needed a 2-3% risk premium This makes sense, because in sum, you should expect to have a positive NPV – the risk becomes much smaller with many projects
  10. 10. Five Lessons Don’t just consider projects in isolation Adjust reward systems to match portfolio of project outcomes Request riskier projects Scenario analysis: consider upside/downside  Flops / home runs --- what have we seen before? Reward skill not luck  Ensure you know what’s controllable vs. uncontrollable

×