The “lean startup movement” is all about failing fast. It’s based on the idea that in order to create more successes, you’ve got to encounter more losses. It’s simply a game of statistics. In theory, healthy risk is good. But it’s not easy, and McKinsey analysts have found that managers across the world are shockingly terrible risk-takers.
Last year the consultancy asked 1,500 executives from 90 countries to react to investment scenarios, and found that “even at a risk of loss of 75 per cent, most respondents were unwilling to accept it on those terms. Instead, they were only willing to accept a risk of loss from 1 to 20 per cent.”
According to the study’s authors Tim Koller and Zane Williams of McKinsey and Dan Lovallo of the Sydney School of Business, this high level of risk-aversion has everything to do with inherent behavioural biases:
“The first is loss aversion, a phenomenon in which people fear losses more than they value equivalent gains. The second is narrow framing, in which people weigh potential risks as if there were only a single potential outcome—akin to flipping a coin only once—instead of viewing them as part of a larger portfolio of outcomes—akin to flipping, say, 50 coins.”
In many companies, one big loss by an individual can be a career-ender (and in some cases, like when financial firms fall by a single trade, it should be). But the study’s authors point out that this philosophy is generally flawed. First of all, the law of statistics prove that “a large number of projects are extremely unlikely to fail,” unless they involve all of the same risks. Second, outcomes are always affected by some uncontrollable factors. With these things in mind, companies need to make it easier for employees to take risks — because the potential gains are staggering. They give two easy ways to do this:
- Evaluate performance based on portfolios of outcomes, not single projects
- Reward skill, not luck
The trick is getting over that first hurdle and accepting that some losses are a good thing. This is how the most innovative companies operate, and initiate the downfall of others.
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