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Every day, we make countless decisions that have the potential to affect our lives in both positive and negative ways. Each decision involves some degree of risk, whether we realise it or not. Risk decision making is a critical part of our lives, and it's essential to understand the factors that determine the outcomes of our choices.
From physical risks to financial risks, legal risks to reputational risks, understanding the types of risks we face and how to navigate them can help us make informed decisions that lead to positive outcomes. Effective risk management strategies can help mitigate these potential risks, but it's important to acknowledge that even the best strategies cannot eliminate all risks.
In this article, we'll explore the art of risk decision making, and provide insights and tips to help you make better decisions that maximise rewards while minimising potential harm or loss. You can also read about how the use of artificial intelligence (AI) in business decision-making offers numerous benefits but also comes with risks that must be carefully considered.
What is Risk?
Risk is the possibility of harm or loss, and it is an inherent part of any decision-making process. Every decision we make involves some degree of risk, whether we are aware of it or not. Some risks are obvious, such as the risk of physical injury when engaging in a dangerous activity. Other risks may be less apparent, such as the risk of financial loss when investing in the stock market.
Understanding the different types of risk
There are several types of risk that we may encounter in our decision-making processes, and it's essential to understand them to make informed decisions. The following are the four main types of risk that can apply to both individuals and organisations:
Physical risk: Physical risk involves the risk of physical harm or injury. This type of risk is prevalent in activities such as extreme sports or manual labour.
Financial risk: Financial risk involves the potential loss of money. This type of risk is prevalent in investments and business ventures.
Reputational risk: Reputational risk involves the potential damage to a person or company's reputation. This type of risk is prevalent in social media and public relations.
Legal risk: Legal risk involves the potential for legal action or penalties. This type of risk is prevalent in business and financial transactions.
A good reference for a list of risk types can be found in the ISO 31000:2018 standard on risk management. This international standard provides a comprehensive and structured approach to managing risk, and includes a list of common risk types. The standard defines risk as the "effect of uncertainty on objectives," and identifies the following types of risks:
Financial risks
Operational risks
Legal risks
Reputational risks
Strategic risks
Hazard risks
Political risks
Technological risks
Environmental risks
Social risks
There are many other references when it comes to providing a taxonomy of risks; for example:
Project Management Institute's (PMI) Project Risk Management Practice Guide: This guide includes a list of risk categories that are commonly found in projects, such as schedule, cost, quality, and scope risks.
World Economic Forum's Global Risks Report: This report identifies and analyses the top global risks based on their likelihood and impact. The risks are grouped into categories such as economic, environmental, geopolitical, societal, and technological risks.
Making risk decisions
The process of making risk decisions involves identifying potential risks, evaluating the likelihood and impact of each risk, and deciding on a course of action. The following are the steps involved in making risk decisions:
Identify potential risks: The first step in making a risk decision is to identify potential risks. This may involve conducting research, consulting with experts, or analysing data.
Evaluate likelihood and impact: Once potential risks have been identified, the next step is to evaluate the likelihood and impact of each risk. This involves assessing the probability of each risk occurring and the potential impact it may have.
Develop a plan: Based on the likelihood and impact of each risk, a plan should be developed to mitigate or manage the risks. This may involve taking steps to minimise the risk or implementing a contingency plan in case the risk occurs.
Monitor and review: After the plan has been implemented, it's essential to monitor and review its effectiveness. This involves assessing whether the plan is achieving its objectives and making adjustments as necessary.
Making risk decisions can be challenging, and failure to do so effectively can have serious consequences. However, there are several strategies that decision makers can use to address common areas of failure. By increasing awareness of potential pitfalls, encouraging diverse viewpoints, seeking out all relevant information, conducting regular risk assessments, planning for contingencies, and using data-driven decision making, decision makers can improve their ability to make effective and informed decisions.
These strategies can help decision makers avoid common mistakes such as overconfidence, groupthink, confirmation bias, and anchoring, and ensure that all potential risks are identified and addressed. By implementing these strategies, decision makers can make more effective and informed decisions that lead to greater success.
History is riddled with examples of leaders, that have fallen victim to these biases, resulting in major failures. Let's take a look at some of the most notable real-world examples of how these common mistakes have contributed to some of the biggest failures in history:
The Space Shuttle Challenger disaster: NASA's decision to launch the Space Shuttle Challenger in 1986 despite warnings from engineers about potential failure was due to groupthink. NASA's leadership had a strong desire to continue the shuttle program and ignored dissenting opinions, leading to a catastrophic failure that resulted in the loss of all crew members.
The Bay of Pigs invasion: The Bay of Pigs invasion in 1961 was a failed attempt by the United States to overthrow the Cuban government. The plan was developed with confirmation bias, as the decision makers ignored dissenting opinions and only sought out information that supported their desired outcome. The result was a failure, with the invading force quickly defeated.
Sears: Sears, once a retail giant, failed due to a combination of groupthink, confirmation bias, and anchoring. The company's leadership ignored dissenting opinions and failed to adapt to changing consumer preferences and technology, instead relying on their traditional retail business model. This led to a decline in market share and ultimately the company's bankruptcy.
Outcome of risk decisions
The outcome of a risk decision can be either positive or negative. A positive outcome occurs when the expected results are achieved or exceeded, while a negative outcome occurs when the actual results fall short of expectations or lead to harm or loss. The following are some factors that can influence the outcome of a risk decision:
Risk tolerance: Risk tolerance refers to the level of risk that an individual or organisation is willing to take. High-risk decisions may lead to higher potential rewards, but they also come with a greater risk of failure.
Risk management: Effective risk management involves identifying, evaluating, and mitigating potential risks. Organisations that implement effective risk management strategies are more likely to achieve positive outcomes.
External factors: External factors such as economic conditions, market trends, and regulatory changes can also influence the outcome of a risk decision. It's essential to consider these factors when making risk decisions. Read more about Risk Mega-Trends.
Risk decision making is an integral part of our lives, and it's crucial to understand the potential risks and their potential impact. Effective risk management strategies can help mitigate risks and increase the chances of positive outcomes. However, even the best risk management strategies cannot eliminate all risks, and there is always a chance that the outcome may not be what we expect. It's essential to approach risk decision making with a clear understanding of the potential risks and the likelihood and impact of each risk. By doing so, we can make informed decisions that increase our chances of achieving positive outcomes while minimising the potential for harm or loss.