Michael Raynor’s great book - "The Strategy Paradox" - should be required reading for any investor or executive seriously interested in understanding the real connection between risk and return in the modern economy.
Raynor’s basic premise is that almost everyone - because of how human beings are fundamentally wired – over-rate the consequences of “things going bad” and consequently default to seemingly safe strategies way too often.
Raynor goes on to make the point that while this may be perfectly fine from a personal health and safety perspective, it is disastrous business and investment strategy.
The reasons, he cites, are both subtle and obvious.
The obvious reasons revolve around classic “agency” challenges - namely that there are a different set of incentives in place for operators versus owners of businesses.
The owners - i.e. the shareholders - main goal is investment return. As such, they usually evaluate strategic decisions through the dispassionate prism of expected return.
The operators of businesses, in contrast, usually act as who they are - namely highly emotional, emphatic, and personal-safety focused human beings.
And while, as professionally trained managers, they are of course aware and focused on expected value and shareholder return, their analysis of those rational probabilities often get overshadowed by more "human" concerns.
Like the stable, comfortable routine of a job. Of co-workers. Of a daily, comfortable work rhythm.
And the result of this natural human bias toward more of the comfortable same is executive decision-making that defaults way too often to the seemingly (that word again) conservative option.
Now as for why this conservatism is a huge strategic problem, Raynor delves into the concept of survivor bias and how it pertains to traditional studies of what factors separate successful companies from the unsuccessful ones.
Survivor bias can be best illustrated by all of those statistics that too many of us unfortunately know by heart regarding the abysmally low percentage of companies that make it through their first year of business, the number that make it to five years, to 10 years, to a Million, Ten Million, a Hundred Million in revenues and so on.
Now most of us naturally interpret these statistics as to mean that the leaders of these failed businesses were too aggressive, that they took too many risks, made too many big bets that didn’t pan out.
But Raynor's research actually demonstrated the opposite.
As opposed to Jim Collins’ famous (and famously flawed) Good to Great analysis, Raynor found that when the full universe of companies were surveyed – not just those that survived – that there was a direct negative correlation between those that didn't make it and the relative conservatism of their leaders and their pursued business strategies.
Or from the other perspective, the successful businesses were led and managed far more so by leaders who could be described in those seemingly pejorative terms - "aggressive," "risk taker," "bet the house" types.
So what should the entrepreneur interested in building a big business do? And what should the investor looking for executives to back look for?
Well, to quote the title of a famous self-help book from many years ago, "Feel the Fear…but Do It Anyway."
Accept that as human beings, we are wired to be afraid.
BUT to prosper in in our modern age we must step out and into the brave new world of modern possibility, opportunity, and wealth.
And leave fear in the hunter - gatherer caves from which it came and where it belongs.