Business: Risk Management vs Risk Avoidance: How To Protect Your Downside
Sir Richard Branson was wildly successful with his record company, Virgin Records.
After going on so many horrible flights, he had the idea to start an airline. He could create an airline that’s fun, hip, and high quality.
The reaction from his board of directors wasn’t too positive… Starting an airline sounds kinda high risk lol.
But Branson had an ace up his sleeve.
Before he gets into any business venture, he “protects the downside.”
This means he tries to lower the risk of a deal to almost nothing.
In this case what’s the risk if his airline business idea fails?
The airline company would fail and their parent company would be stuck with an airplane or two that they can’t sell.
So Richard went to Boeing and negotiated with them. He’d buy their aircraft on the condition that if the airline fails, Boeing will buy the aircraft back from him.
Boeing agreed because they wanted someone to compete with British Airways.
British Airways were the only main buyer, so they were able to screw Boeing down on price.
Now Branson had a stronger position to negotiate from.
What’s his worst case scenario?
They lose 6 months of profit.
Best case scenario?
They end up with a wildly, successful business that could generate hundreds of millions.
Risk Management vs Risk Avoidance – What’s The Difference?
Everyone thinks entrepreneurs love taking risks.
It couldn’t be further from the truth.
What entrepreneurs are good at is risk management.
Risk avoidance: “That’s too risky, I’m not going to do it”.
Risk management: “That looks risky. How can I minimize the risk and protect myself?”
Here’s an example:
A lot of people look at starting a business as risky.
I take a different view.
Everything you do in life is a risk – it’s all about how you approach it.
If you go into credit card debt to start a business, that’s risky.
If you borrow a ton of money from friends and family on a whim, that’s risky.
Maybe you can mitigate the risks of borrowed money somehow, but I wouldn’t do it.
When I first started affiliate marketing my friends thought it was too risky for them.
But they didn’t see it from my perspective.
- I was writing articles to build up some money for campaigns
- My expenses were low so I could invest more of my salary in my business
- My job was a secure 9-5, so I had time at night to work on campaign
Always try to weigh up risk management vs risk avoidance. One is running away from opportunities, the other is being a businessman.
My 4-Step Process for Risk Management
1. Analyze the Risk vs Reward Ratio
Some scenarios are high risk, but they don’t have a high reward.
Example: If you drive around without insurance, it’s super high risk. You could crash and have to pay out tens of thousands of dollars. The reward is that you don’t have to pay insurance.
Whenever you take on a high risk, you want a high reward to make it worth it.
2. Protect the Downside
You never want to risk more than you can handle.
Just like Branson knew he would never lose everything if Virgin Airlines failed, you’ve gotta protect your downside.
What happens if your business model doesn’t work out?
- Will you be wiped out with no savings?
- Can you get a job to help you get things back on track?
I know some guys who’ve gone into credit card debt trying to start businesses, and they failed. Now they’re $30k in debt and they have no income and no job.
When you’re 20 years old it’s not a big deal to have no savings and no job.
But when you’re 40 and have a family + mortgage? Now you’ve gotta be a bit more strategic.
Never invest more than you can afford to lose.
3. Increase the Odds of Success
What can you do to increase your odds of success?
The smart people will try to “hack” success.
For example, there’s more to affiliate marketing than mindlessly launching campaigns.
The smart affiliates build relationships, invest in education, look at emerging trends and opportunities etc.
Here are some tips to help you increase your odds of success in ANY venture.
- Find a mastermind mentor/expert help
- Read and learn about mistakes that others have made
- Learn how to become more productive so you create more time
- Look for unique angles and opportunities instead of “following the herd”
- Leverage existing skillsets
Everyone is trying to make more money. You’ve got to do everything possible to increase your odds of success.
No matter what you got taught in school, everything in life IS a competition.
4. Make a Decision
Problem-solving and decision-making skills are one of the most important tools in the businessman’s belt.
There are different systems for making decisions.
Zero-based thinking is one of my favorites, but that only works after you’ve made a decision.
Here are my thoughts on how to make better decisions.
Examples of Protecting Your Downside
I use this concept multiple times every day, but it’s most useful when you’re making big decisions.
Here are some times when I’ve used this framework.
1. Hiring an Employee
Hiring an employee is a big decision.
What’s the downside?
- A bad hire could be a ton of lost money and time / opportunity cost
- Affect the culture of your business
- They could make some big mistakes if they don’t know what they are doing
No hiring strategy is perfect, and it’s easy to b.s. an interview or a resume.
So how can you protect the downside?
I’ve learned that people can bullshit their resumes and interviews. The only way to judge to see their work.
I don’t ask too many questions during interviews. Seriously, how is asking what their biggest weakness is going to help gauge their abilities?
Instead, I prefer to give them tasks to do during the interview.
If I’m hiring a customer service person, then I’ll give them 10 emails to respond to in 30 minutes.
If you’re hiring an executive assistant, have them book a trip for you on the spot.
You also need to see how they’re a culture fit.
Instead of bringing them on as a full-time employee off the bat, have them start as a contractor. Put them on a one month probation period and make them earn their way into your organization.
Work with them as a contractor first for a few weeks. That way you can see what work they’re capable of, and how they fit into your culture.
You can see how fast they work, how they communicate, and what they are like as a person.
If it doesn’t work out, it’s much easier to end with things with a contractor compared to a full-time employee.
2. Hosting a Seminar
A friend of mine wanted to throw his first seminar in a different industry.
He was excited and booked a $20,000 room.
The problem was he could only fill 30% of the room up and was about lose money on the event.
Instead, he could’ve:
1. Sold early bird tickets first to get an idea of how many people would come. Then he could book an appropriate size venue.
2. There are ton of venues out there. He could’ve easily negotiated one that could give him a full refund within X amount of time.
His worst case scenario is that he’s out of pocket $20k. That’s a lot of cash to waste.
Best case scenario is that he fills the hall and gets a standing ovation.
But the point is that he kinda wasted that $20k.
He didn’t need to blow his cash on a fancy room to get that best case scenario.
He could’ve done what Branson did and negotiated with them.
“Hey, I’m a professional speaker and I’m looking at new venues. Can I book in this big room for one day, and if I only manage to sell X tickets, then I’ll go with the smaller room?”
Here’s a situation I’m proud of….
3. Opening a Restaurant
I have a friend who’s a chef.
He wanted to start his own restaurant.
What happens at this point? You start getting massive loans to open your first restaurant. Some guys will mortgage up their family home and invest their entire life savings to get started.
But I told him I think that’s a horrible idea.
He’s taking a huge risk on an unproven concept.
A lot of restaurants don’t make it out of their first year, and I didn’t wanna see him lose everything.
Instead, he should find a way to test his idea cheaply.
So he found a way to get a food stand in a popular mall for $250 a weekend.
- He tried his first concept. It failed.
- Tried a second concept. It failed.
- Tried his 3rd concept. It was a success.
Now he’s taking his 3rd concept and turning it into a restaurant.
What’s the difference now?
The 3rd concept is proven.
He can also ensure that there will be “buzz” before he opens his restaurants.
There’s a hungry audience ready to support him before he ever opens his doors.
When you have to pay rent and staff, you don’t want to sit around waiting for steam to pick up.
What else did he get from testing his concept?
- He’s already got raving fans who will give him great reviews on Yelp etc.
- His regular customers are begging him to open up a restaurant.
- He knows which products are hot sellers.
- He knows his target audience.
Imagine if he opened a restaurant with his first idea.
He would’ve wasted all his money. Then maybe his second restaurant would’ve failed too.
It would’ve cost him $50-100k minimum to learn which business model works.
Instead, he spent a few thousand testing, and now he’s got a profitable business + a proven concept for a restaurant.
He can get someone to take over his small food stand while he gets the restaurant started.
A lot of guys wouldn’t want to do this.
People want to launch the perfect business.
They want to have a grand opening, champagne, and everyone congratulate them on their success.
They don’t think they’ll be one of the failures.
But the truth is that you don’t know if your idea will take off or die.
Always test before you invest your life savings + years of time into something.
How Can You Protect Your Downside?
The next time you take a risk, realize you’re not locked into the downside.
Sit back and think what can you do to lower the risk.
There’s always another strategy you can take.
- Can you negotiate?
- Who can help you/train you/mentor you etc.?
- Can you test first?
- Are there other options?
- Can you do this idea part-time while you work?
If things turn bad, you don’t wanna be out of the game for good. Business is a game of balance – risk management vs risk avoidance.
Don’t be fooled into thinking you have to take massive risks to do great things.