A vital ingredient for success
Why understanding risk really matters
Is the UK averse to risk? Is this holding back the economy and encouraging companies to choose to list in the US rather than the UK? Many observers think so. William Hague, the former Conservative party leader, wrote in The Times this week: “Over the past few decades, we British have, slowly, unintentionally but unmistakably, become too risk-averse to own and fund our own future.”
He is not alone in this view. Peter Harrison, chief executive of Schroders, the asset manager, told Financial News: “How do we create a system that is more willing to accept risk? Everything is about risk reduction. That has been the thing that has undermined growth, and importantly it has undermined returns.”
Entrepreneurs and founders of tech companies say similar - their great idea hasn’t got the support it deserves because we don’t like to take risks in this country.
However, I think the issue is about more than the UK being risk-averse, it is about a lack of understanding of risk more generally.
While interviewing business leaders and studying business history for our Business Studies podcast I have found that a small collection of key themes are emerging at the heart of the stories. Risk might be the most important. Not just whether people take risks or not, but their understanding of risk, using it to their advantage, and reducing it where possible. It is a vital ingredient in success stories, failures and innovation.
Hague was right to identify risk as a key issue for the future of the UK, but it is not just about being risk averse. There is risk-aversion among US investors too, particularly in the venture capital world. It is a different sort of risk-aversion - FOMO, fear of missing out. This has meant money has piled into average businesses at crazy valuations because investors are worried about missing out on the next Amazon or Apple. The risk for these investors is missing out and having to explain to their clients why other investors have done better than them.
Risk has not traditionally been a glamorous concept in business. Risk assessments are often considered a box-ticking exercise for staff - in corporate training sessions they often are. But understanding risk - the potential upsides, the potential downsides and why others won’t tolerate it - is a powerful advantage. This goes for all parts of the UK economy - households, entrepreneurs, boardrooms, local authorities and the government.
In Berkshire Hathaway’s annual letter to shareholders last month Warren Buffett wrote: “Our chief executive will always be the chief risk officer - a task it is irresponsible to delegate.” In his book, Leadership with Soul, Andre Lacroix, one of the longest-serving chief executives in the FTSE 100, says: “My view is pretty straightforward: recent failures by leaders to recognise and mitigate emerging risks in the world have led to just about every major crisis we’ve faced this century.” This includes 9/11, the financial crisis and Covid-19, he adds.
I have interviewed Lacroix for next week’s episode of Business Studies. In the episode he talks about the brilliance of Formula 1 driver Ayrton Senna and how it was linked to his understanding of risk. Lacroix recounts meeting Senna’s engineer and being told that the Brazilian driver was obsessed with risk and this was one of the reasons he pushed for more safety in the sport. This obsession with risk, his engineer added, allowed Senna to understand the risks he could take while racing. Senna was often considered reckless by rivals, but he understood what he was doing. Tragically, of course, Senna was killed in a crash in 1994.
Using risk to your advantage is a trend that has emerged again and again in Business Studies.
Ed Smith, the former chief selector of England cricket, explained in episode seven that understanding risk is a key component of innovation in sport and business. Innovation happens when someone is prepared to accept a risk that others are not because they believe the upsides can outweigh the downsides. Examples of this include Spain playing without a forward in the 2012 European championships and Houston Rockets taking more long-range three-point shots in basketball. Spain’s innovation involved the team accepting the risk of not playing a striker, a finisher, in return for the upside of having an extra midfielder and keeping the ball better. They won the tournament. The Rockets recognised that three-point shots were riskier but felt the upside of the extra points outweighed the risk. Now teams across the NBA go for three points more than ever.
A great example of this thinking in business emerged in the interview I did with Roger Madelin about regeneration projects. Madelin said that in the 1990s he was perplexed as to why there weren’t more restaurants and public spaces beneath office buildings. Madelin felt this could make town and city centres in the UK much more enjoyable places to be. He was told that this didn’t happen because of concerns that office workers would get annoyed by the smell and disruption from the restaurant or shops beneath their office. It was a risk that developers weren’t prepared to take. However, Madelin thought that he could control these risks - by carefully selecting the restaurant and putting measures in place to control any smells, ie bin storage - and that the upside of boosting the local area outweighed the downside risks. Now the idea of putting restaurants or shops underneath an office is widespread.
In contrast, an example of someone misunderstanding risk came in the episode about the downfall of Gerald Ratner. By making a joke about the quality of Ratners’ products, Ratner showed a misunderstanding of the upside and downside risks. The upside was that he got a laugh. The downside was that it upset customers. “It was my own fault for being who I am and taking that sort of risk,” he said.
Successful financial traders have a deep understanding of how much risk they are taking on with each trade and get comfortable with it. Michael Platt, the billionaire Preston-born hedge fund manager, said: “I think the two biggest mistakes traders make is that they don’t do enough homework and they are a bit too casual about risk.” A profile of Platt by the Minds of the Market newsletter said he is obsessed with risk and wants each of his traders to understand where their big losses could come from.
The author Nassim Nicholas Taleb has written extensively about risk, particularly the foolishness of placing bets that offer either a small win or a gigantic loss. Russian Roulette is an example he gives for this. Five times out of six you avoid the bullet. But the sixth time you are shot and killed. How many businesses and investors are playing their own version of Russian Roulette? Taking an extraordinary risk for small gains when the one-in-six downside risk is that you are finished. This sort of risk-taking is a common theme in many corporate scandals.
Taleb also writes in Antifragility and Skin in the Game about the importance of aligning risk between different stakeholders to get the best outcomes. For instance, Roman engineers had to sleep under the bridges they built to ensure they recognised their responsibility to make them strong and safe.
This alignment of risk is clearly relevant when thinking about the remuneration of executives and how they are encouraged to think about risk. What is at risk for an executive whose remuneration revolves around short-term performance? In contrast, what are the risks for an executive who owns half the company? They are different, and not necessarily aligned with the long-term health of the organisation.
Thinking long-term rather than short-term creates a very different understanding of risk. Failures are more palpable, indeed they make success more likely if you learn from them.
In his recent letter to investors Buffett also wrote: “In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so.” He then added: “Our satisfactory results have been the product of about a dozen truly good decisions…The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.”
Ed Smith referred to similar comments by Howard Marks, another US investor, in our podcast interview. “In order to have the benefit of being different and better, you have to bear the risk of being different and worse,” Marks said.
When you start to think long-term rather than short-term the risks change. Missing out on something is riskier than doing something.
As the UK struggles to level-up the economy there needs to be a greater appreciation and understanding of risk to support businesses and infrastructure. Look at the delays and mounting costs of HS2. The short-term and long-term risks for that project are different.
This week Business Studies features an interview with Duncan Johnson, chief executive of Northern Gritstone, which is backing promising businesses spun out of Manchester, Leeds and Sheffield universities.
The episode is a great insight into the challenges of levelling-up. One of the reasons that Northern Gritstone needs to exist is because so little money has been making its way to promising businesses outside London. Only 1.8 per cent of the investment in science innovation in the UK went to the north of England in 2019 according to research by Beauhurst. That’s £22 million, Johnson says in the episode, compared to £900 million for London, Oxford and Cambridge in the south-east.
“So why did that happen?” he adds. “Well a lot of people don't travel to the north of England. The north of England, I don't think, has necessarily shouted enough about what it's so brilliant at. I think these things compound over time. There has been a polarity that means things come to London, to the south.”
Northern Gritstone has raised more than £200 million to fund its ambitions, mostly from international investors, local pension funds and British Patient Capital, the government-backed venture capital investor. “But I'd like more of that mix to be UK institutions,” Johnson says.
The concept of risk is central here too. There has been an aversion to risk in the sense of investors not distributing money outside the comfort of the south-east. But there has also been a lack of appreciation for the risks of missing out on opportunities in the north of England and the long-term benefits of supporting the entire UK economy.
You can listen to the latest episode of Business Studies on Substack here, Apple here and Spotify here. You will also find all previous episodes of Business Studies there. The episode with Andre Lacroix, chief executive of Intertek, will go live on Tuesday.
Other stories that matter…
How times change. At the start of this week there were concerns that Sheffield-based data company WANdisco could be the latest promising UK company to move to the US. But on Thursday WANdisco announced it had discovered “significant, sophisticated and potentially fraudulent irregularities” linked to orders booked by a senior sales employee. Annual revenues are now expected to be $9 million rather than $24 million and the company has “no confidence” in the record $127 million of bookings announced in January. “On reflection, New York, perhaps you can have this one,” Helen Thomas writes in the Financial Times in a thorough analysis of the story (Financial Times)
More delays to HS2. The Birmingham to Crewe and Manchester section is being delayed by at least another two years. Oh, and train services are likely to stop at Old Oak Common just outside central London rather than at Euston when the line opens. It sounds like the new station at Euston could be delayed until 2041, much later than the 2029 to 2033 date set for the start of services between London and Birmingham. Henri Murison, chief executive of the Northern Powerhouse Partnership, said the news was “disappointing” (BBC)
250,000 people have died younger than expected in the UK over the last decade and life expectancy has increased by just eight weeks over the same period (staying at 81 years old). This is according to research by The Economist. There are big differences across the country, particularly between rich and poor areas. Those living in less wealthy areas are 20 per cent more likely to be diagnosed with cancer at a later stage (The Economist)
Twelve women leading big businesses in the UK have shared their best career advice (The Sun) Speaking at an event to make International Women’s Day, Dame Sharon White, the chairman of the John Lewis Partnership, said she finds it “quite hard to recruit men” (Telegraph)
Elon Musk is looking to develop his own town just outside Austin, Texas, where staff working for his companies could enjoy cheaper rents and high-quality amenities (The Wall Street Journal)
Start-ups in the US have been advised to withdraw their money from Silicon Valley Bank after its shares fell 60 per cent due to concerns about its future (Newcomer)
The boss of OpenAI, the company behind the ChatGPT AI technology, has also put $180 million into a company trying to extend the life of humans by 10 years (MIT Technology Review)
And finally…
An amusing moment from a congressional hearing on Twitter and Elon Musk…
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Graham