Classifying Risk

Note to future self…

For a while now I’ve been very interested on this idea of risk as part of the human experience. That might sound a little bit out there but I think that the role of risk in our lives is something that’s seldom talked about but deserves more attention.

For my first post on “Thinking about Risk” I wanted to come up with a basic framework to evaluate risk and help me think about things and I think I found it in this post by Adam Nash. Adam talks about risk in the context of startups but I think that it can easily be applied to people(:

Framework #1

According to him (I agree) risk are actually decisions with potential outcomes that fall in one of three categories:

  1. Fatal Risk
  2. Painful Risk
  3. Embarrassment Risk

Here’s how he defines each type of risk:

  1. Fatal risks are true bet-the-company issues. They are not that common, but they deserve clarity and focus. If you get the answer wrong here, the company is dead. These risks are unavoidable in early-stage startups, but as companies grow they become more and more uncommon. In fact, most large companies lose the ability or even recognition of these type of risks as they age.
  2. Painful risks involve decisions that have significant repercussions if they go the wrong way. You might miss a key goal, or lose key people. They are recoverable, but there are real ramifications to getting the answer wrong.
  3. Embarrassment risks have no significant impact if they are missed. All that is necessary is to acknowledge the mistake, change course, and move on.

This approximates the way I intuitively think about risk but it’s really helpful to have a way to put things in context and really understand the type of risk you’re facing.

In most cases, we never deal with fatal risks. For a person, a fatal risk is dying, getting really physically hurt, starving, becoming homeless or something of that severity.

Painful risks are decisions where you know that there’s the potential downsides and you’re ok with assuming that loss even if truly hurts (it’s a loss after all). I think this is the best type of risk and we should maximize our tolerance threshold for this type of risk!

Embarrassment risk on the other hand tends to be the more common in my opinion. This is when you think a situation is risky because it might hurt your ego. Adam correctly notes how “embarrassment risks are particularly difficult for smart & ambitious people, largely due to insecurity and ego. People want to be perceived as intelligent and successful, and they incorrectly map that to always being correct.”

Framework #2

Awesome now we have a basic framework for classifying risky decisions. Now how do we figure out whether we a decision falls in bucket #1 or #2. Nash offers Bezos’s famous two tier decision to help us solve that:

“Jeff Bezos has more recently popularized a different framework, based on two types of decision. This framework is often described in the context of the decision to move forward with Amazon Prime, which at the time was mostly a judgment call versus a data-driven decision.

In his framework:

  • Type 1 decisions are irreversible. Spend time on them.
  • Type 2 decisions are reversible, like walking through a door. Make them quickly and move on.

Overall, this framework is helpful. Thinking through the reversibility of decisions helps prioritize speed vs. perfection. When it comes to execution, the perfect truly can be the enemy of the good enough.

The problem is that almost every decision at a company is reversible, so it tends to not provide that much insight into why some risks feel harder to take than others.”

Note: This framework is not perfect but it’s a good starting point. Right now, I honestly rely on intuition to help me assess the type of risk that I am facing. I will report back if this changes.

That’s it for now. This post is getting long so maybe I will right another one with just my thoughts on risk and it’s role in our lives.

Now back to work….