Risky Business: An Analytical Approach

By Jonathan Higuera
January 14, 2008 11:00 AM

As business journalists we often hear corporate captains talk about the need to take risks, and we frequently end up writing about inappropriate risks taken by a company or even an industry.

But what we don't do often enough is systematically analyze the risk.

Leave it to a business dean at a major university to help us frame our thinking on risk into an academic exercise. Study risk based on the decision-making processes employed, said Robert Mittelstaedt, dean of the W.P. Carey School of Business at Arizona State University. From bounded rationality/satiate (rarely consider truly worst case) to mini-max regret (underestimates risk) to total risk avoidance (overestimates risk), each decision-making practice equates to a unique type of risk.

While academic, there are real-life applications and consequences.

Apple's iPhone was an idea whose time had come. But if the company had not dropped the price rapidly after the initial product rollout, the onslaught of competition could have stung sales badly.

"Many times the risk is in the execution, not the idea," said Mittelstaedt.

In fact, the funny thing about risk is that it can hurt if you don't take any and it can backfire if you do, he added.

JetBlue gained a reputation as a lean airline company doing more with less. But when a crisis hit - planes left literally frozen on the runway during a major storm - the airline did not have the manpower to address the emergency.

The company did not even realize the risk they had taken with their "lean" strategy, Mittelstaedt said.
On the other hand, Southwest Airlines took a calculated chance that fuel prices would keep rising and began hedging costs for its fuel five years ago. The result: the airline has consistently paid less for its fuel than competitors, enabling them to offer lower fares.

"What you want is managed risk, not zero risk," said Mittelstaedt, who serves on three corporate boards.

During a speech to Reynolds Center fellows last week, Mittelstaedt explained that the failure to properly assess risk and act accordingly often bites you in the butt - whether among companies or individuals.

"We always think we know what the risk is, but we don't work very hard to minimize it," he said, pointing to the many homeowners who live in flood zones but do not carry flood insurance.

The sub-prime crisis is another example. Many people and institutions either failed to act on the risks or didn't understand the risks involved in the ubiquitous lending practices that took root.

It didn't take a genius to figure it out, either. I was covering the housing industry during the 2005 boom for The Arizona Republic, and I recall the rationalizations of prospective homeowners opting for adjustable rate mortgages.

The plan called for refinancing and locking into a lower fixed rate before the new higher rates came along. It was clear they were repeating a strategy their broker told them about. It's a plan that turned out badly for many.

Even Mittelstaedt concurred that the concept of originating home loans through mortgage brokers, who subsequently sold the loans to banks for ultimate financing, was a bad idea.

"It's bundled and tied to something else, and you don't know what it's tied to," he said.

As business reporters, understanding risk theory could help us strike just the right tone when reporting on companies in our area. Maybe then we can provide the nuanced tone that business leaders say is missing from many of our stories.

Take McDonald's and its many reinventions of itself. Will our stories paint the company's strategies as a wayward entity searching to find a new identity amid stiff competition or will we portray the fast food giant as a well-managed company that has surveyed risk factors and is responding accordingly?

For business journalists, this will be our charge: to understand risk and the decisions behind it and to cover it accordingly.

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Copyright © 2008 Donald W. Reynolds National Center for Business Journalism