Let’s play a game. It costs you $1 to play. We then roll a dice once. If it comes up 6, I pay you $10 otherwise you lose. Do you want to play? Most likely you will agree to play. You have a one in six chance of winning $10 for a $1 bet.
Now let’s make it $1 million to play. Once again we roll the dice just once. If it comes up 6, I pay you $10 million. Do you want to play? The probabilities are exactly the same and so it should be an easy decision. But most people would decline. Would you risk your home and life savings for a one in six chance of winning $10 million?
Now let’s imagine you are the CEO of a business which turns over $50 million and makes $2 million profit every year. You have say $2 million cash in the bank. Joe, your VP of Marketing, comes to you with a proposition. He wants to enter an exciting new market with an innovative product. It will cost $1 million to develop and launch the product. There are many imponderables but if it is successful he estimates it will add $50 million in turnover and $10 million in profit over the next three years.
You cannot forecast what the competition will do but taking a cautious approach your conservative estimate of the chances of success are 1 in 6. Should you go ahead? Let’s assume that you have no better uses for your cash and there is no cheaper way of testing the market. What would you do?
Most CEOs would make the decision based on how they felt about the product idea and how much they trusted Joe. Let’s say you go ahead and after one year the product has failed. Some unforeseen difficulties with the technology or marketing or distribution or competition meant that you could not make it a success. You learn what lessons you can and move on.
Now Joe comes to you with a different idea. Strangely the figures are exactly the same as before – $1m investment gives a 1 in 6 chance of a $10 million return in profits. You examine all the assumptions and they check out. Would you agree to Joe’s request? The probabilities are exactly the same so you should make the same decision but most CEOs would hesitate. You decide to go ahead and unfortunately the product flops.
What happens when Joe comes to you a third time or a fourth time? In theory you should expect failure 5 times out of 6 and keep faith with Joe. However, in human and emotional terms it becomes very difficult to keep placing bets after a string of losses. Most likely you would say to Joe, “Sorry, but your track record on these projects is poor. We cannot keep risking that kind of money.”
You might find that Joe quits and starts his own business. You focus on your current business and the company enters a long period of decline because it lacks new sources of revenue growth. Eventually you sell the company to a larger competitor for a disappointing price.
What are the lessons here? Innovation is a risky business and often involves many failures. Even with the best market intelligence and research it is impossible to forecast exactly how things will turn out. Should you roll the dice, risk your scarce resources and face the pain of failure?
Wherever possible you should test prototypes in small experiments so that you can learn lessons quickly and cut your losses on failures – but that is not always possible. It is important to recognise that you cannot avoid risk. Doing nothing is risky; you will get left behind. Courageous leaders keep taking calculated risks even after a string of setbacks. Eventually you will roll a 6.