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Don't Downplay Risk When Making Investment Decisions

February 24, 2011

Executives often downplay risk and uncertainty when making investment decisions.

One way to ensure better decision-making is to approach the process differently, according to McKinsey's Olivier Sibony in a recent Q&A from McKinsey Quarterly. In research, he asked executives to talk with him about their investment decisions – which ones worked and which didn't, and the practices that led to those decisions.

I found his results as described in the Q&A went beyond theory; he offered some practical advice that could help any company make smarter decisions. In a time when distributors and manufacturers are facing continued uncertainty in their markets, an additional dose of risk management should be welcome.

Sibony says having explicit discussions about the uncertainties involved in the decision is much more productive than what many often do – provide a slide that outlines the risk and what "risk-mitigating actions" will be taken. But, he says, "that's the way you frame it if you want to look like a confident presenter and want the meeting to go smoothly: You suppress the discussion of uncertainties."

How do you make the risk discussion more explicit? One way is to have your due-diligence team actively seek out information that might contradict support for your plans. Another is to assign a group to argue the other side of an investment. Another process he recommends in the article is to – before the deal – have people assume it has failed and write down three to five reasons why, which forces people to speak up about uncertainties they've kept to themselves in fear of appearing pessimistic or disloyal.

Another way to mitigate potential risks? Plan ahead. In Scenario Planning Basics for Distributors, Adam Fein writes that scenario planning is a management tool distributors can use to anticipate and profit from change.

In other words, rather than relying on a single most likely forecast, it allows you to compare and contrast alternative opinions on how your industry could evolve. Read that article.

With the volatility we're seeing today on many fronts – despite the bounceback in many sectors – it seems these tools would be necessary to prepare for growth in 2011 and 2012.

© 2019 Gale Media, Inc.

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