A Consultant's View

Prairie Trail Software, Inc. ............................................................. November 2010

What are the real risks?

Jeff Ma was one of the members of the MIT blackjack team that took millions from casinos. He is also a successful entrepreneur and has written an interesting book combining his experiences with business philosophy, The House Advantage. He is also training people for the gambling tables. One challenge he runs into is that most people do not understand the real risks they are taking and how risks change over time. This is true also for business.

In management, that lack of understanding of how risks change over time can be a critical or even fatal mistake. Recently, Pontiac rolled their last car off the line and the brand is now dead. At one time, it was one of the liveliest brands in America. What happened? While individual decisions may be criticized, the crucial aspect was when the brand was put in the hands of people who avoided many small risks. They avoided small risks but took the huge risk of turning off the customer. They didn't recognize the various risks they were taking.

Human beings discount the risks after we take the risk and win. Most times, we will not re-evaluate what the risks are since time has passed and simply follow the same path as before. However, often the risks change significantly over time.

Jeff Ma points to a case where someone dropped thousands on the roulette wheel. The person saw that the last eleven spins had returned red and thought that the probability was a sure thing to have a black. He didn't realize that the risks changed with each spin. Instead of a sure thing to win, he lost it all. (Technically, the probability was the same for each spin. The risks of a sequence start low, but change with every spin.)

Some people claim that taking on debt is taking on risk. Technically, that is incorrect. Taking on debt reduces how well you can react to risks happening in the future. For example, after the 1906 San Francisco earthquake, the Federal government pumped the equivalent of $100 Billion in today's money into recovery efforts. If a major earthquake hit Los Angeles today, it would take about $3 Trillion to give the same level of support per person. The US government would be hard pressed to provide that kind of money because of all the debt we have. Yet, every year, the probability of a major earthquake increases.

One point Jeff Ma makes is to look for the numbers. Walt Disney did that before opening his famous parks. Harrison Price, the person who evaluated the locations for Disneyland and Disneyworld, stated that "Guessing is dysfunctional. Ignoring prior experience is denial. Using valid numbers to project performance is rational."

Repeatedly, people use their impressions of what the numbers should be instead of researching the numbers. This causes all sorts of losses at the gambling tables as well as in industry.