In recent years, entrepreneurship has been on the rise as a career choice. There are different approaches to this choice. More and more people test the water by combining self-employment with a part-time job, thus generating income from a variety of activities and sources and refusing to place all bets on a single horse. Others quit their job altogether to do what they already did, but for themselves, working on an hourly or per diem basis, with clients they already know. This is slightly riskier, but still a relatively safe choice. Venturing into something that is completely new – whether it be shifting from a paid job to a career in innovation leadership or working on a product or service that needs substantial time and capital investment in order to fly – is in a league of risk of its own.
According to some statisticians, more than half of all startups fail within their first five years of existence; figures on innovative startups are even bleaker. A first round of investment is no guarantee for success, either- the generally accepted figure is that roughly three-quarters of venture-backed firms won’t ever return their money. There may be a different kind of return as seasoned entrepreneurs often reveal that the basis for their current success lies in the lessons they learned by failing and starting over, one, if not, multiple times.
One of the inherent virtues of innovation leadership is that the excitement of the opportunity outweighs the perceived risks of loss and failure.
So you don’t need to look far to see risk in innovation leadership. Yet many entrepreneurs lack a sufficient understanding of how to judge and deal with risks. In this article we introduce a model for classifying risks in innovation leadership. In turn, we discuss how some of these risks can be reduced or averted, and in some cases even embraced and reframed to mean something positive.
Not every risk has the same severity, or has the same probability of occurrence. Where some risks can easily disrupt an organization and are a cause for real concern, others should not keep you awake at night. In order to distinguish between different types of risks we propose the following framework:
Risks that have a low likeliness to occur and low potential impact are not worth spending much, if any, time on. Examples of this risk are the risk of a running a flat tire on your way to a client meeting, or missing a flight due to an unexpected strike of airport staff. Apart from taking standard precautions like regular maintenance on your car, or checking the airline website for any cancellations in advance, there is nothing one should do. Though a pain when they do occur, consequences can be avoided through simple apologies or rescheduling.
Risks that have a high potential impact but a low probability can often be averted through insurance. This is desirable when the benefits of insurance are likely to outweigh the costs. Insurance roughly covers risks in three categories: assets and property insurance (e.g., damage due to natural hazards, fire, theft or vandalism), human capital insurance (risks of incapacitation/injury or death of staff), and liability insurance (mitigating the risk of legal claims arising from the usage of your product or services). As said, the essence of insurance is that the likeliness of occurrence of the insured event is low, as risks with a high probability usually command an unattractively high premium from the insurer. We notice many entrepreneurs feel too busy or too optimistic to insure against this category of risks.
These risks, due to their low severity, are as inconvenient as they are avertable. Examples of risk in this category are: a key team member becomes ill just before an important deadline; a computer crashes with all the customer data information. These risks are often the result of what some people refer to as ‘Murphy’s law’: that which can go wrong, will go wrong. The root cause for these inconveniences is often lack of foresight or preparation. If your margin for error is small or null, problems will occur. If you build in safety margins and back-up capacities, things don’t boil down to the last moment, and your flexibility to resolve an unforeseen situation improves drastically.
The risks in Quadrant 4 are of key concern for innovation leadership (and any existing business), as they are too costly to insure and cannot simply be ignored or averted due to their severity. These risks are the real company killers, often tapping into the core beliefs and (informed or non-informed) assumptions that businesses have built their product or services on. All elements of the enterprise (market, competition, leadership, operations, legal, finance) are exposed to such risks.
Businesses engaging in innovation leadership move into unknown markets, whether it concerns products, services or business models. They have to deal with a great uncertainty: whether a substantial number of customers is willing to spend actual money on their offerings quickly. As the market may be in continuous flux, this requires a strong degree of adaptability and the capacity to pivot quickly to become and stay relevant.
Many innovation entrepreneurs overlook the risk of competition, sometimes by downplaying or even ignoring competitors, both vested, and up-and-coming. In any competitive market there is no such thing as a real comfort zone. A real sense of competitive paranoia and keeping a high pace are your best bets to make it through.
Destructive team dynamics can have a catastrophic impact on the progress of any innovative venture. Internal orientation, confusion, distrust, loss of motivation – can all result from destructive team dynamics and were never foreseen when the team started. Also many startups fall apart over internal struggles about the direction and ambition level of the collective endeavor. Legal arrangements at an early stage often are quickly outdated as the venture evolves. It is the leader’s responsibility to quickly step up and resolve the issue or to step down and let someone else lead. VCs classify the lack of willingness to do so as one of the largest causes of start-up failure.
Operations need to be organized to be a competitive strength, rather than a risk factor.
Ensuring the right skill sets are in place to ensure timely delivery at the right quality level represents a serious challenge and in turn a substantial risk as well. More often than not, innovation leaders set ambitious goals for the delivery, unaware of the real operational implications, underlying time constraints, unforeseen setbacks and complications in designing, selling, manufacturing, shipping and servicing a product or service. Some innovation leaders even falsely believe in “self-fulfilling operational prophecies”; they believe that impossible operational targets motivate the organization to do the impossible and surpass all expectations. In fact, operations need at least a similar amount of attention and quality of thinking as concept development. Therefore operations need to be organized to be a competitive strength, rather than a risk factor.
Issues about intellectual property rights, patents or brand names can lead to lawsuits and substantial claims that can kill any business or lead to costly delays in market penetration. In turn, the procedures of patenting or obtaining approval or certification can take precious amounts of time and resources. We recommend avoiding “declaration of war” strategies looking instead for cooperation and competition where possible and in case of real claims out-of-court settlement.
Getting funding at different growth phases and securing sustainable revenue streams can represent a substantial challenge and therefore an important risk. We would reframe this risk as market feedback: if no one is willing to fund the enterprise or pay for its products, its concept might need a redesign. Many inexperienced entrepreneurs are not focused on getting market feedback quickly, and keep ‘perfecting’ their products and services internally. This hampers adaptability, and severely reduces their chance of a timely and attractive market proposition.
One of the inherent virtues of innovation leadership is that the excitement of the opportunity outweighs the perceived risks of loss and failure. Without that zeal many innovations would never have seen the light of day. Identifying opportunity and spreading unbridled enthusiasm characterizes the innovative CEO or entrepreneur. Becoming over-cautious and risk-averse would take away the zeal and spirit of a company.
As such, risk mitigation is first of all a balancing act, a matter of balancing rationality and the excitement of opportunity. You are looking to have a constant awareness of potential risks and the basic precautions that often suffice to contain the risks that could cause major harm to a business, but without ‘killing’ the entrepreneur. Not everyone can perform both roles. So if managing risk is not your forte, find a skilled CFO. He or she can be your conscience when it comes to striking the right balance. As financial risks more or less underpin all the other risks, it is of crucial importance to have a professional guardian in place to safeguard these anyway. Now you can consciously use the thinking of your CFO to perform your balancing act.
Furthermore risks can be mitigated by reframing them, in essence embracing them, changing their meaning and allowing them to spur on your growth. We mentioned an example above. Here are some more:
If a venture is high risk but has a potentially high gain, it makes sense to design a portfolio.
In essence, risk mitigation is all about adaptability: bad surprises will happen so success is defined as the ability to adapt to these. In this respect it is relevant to spend some thought on portfolio thinking. If a venture is high risk but has a potentially high gain, it makes sense to design a portfolio. So instead of “putting all eggs in one basket”, the entrepreneur takes a stake in several opportunities and as long as some of these work out, she wins. Amsterdam’s Golden Age started when the traders, investing in ships to the Far East (a very high risk/high return enterprise), decided to pool risk and opportunity by taking shares in each other’s ships. The Amsterdam Stock Exchange – the oldest in the world – was started for this purpose. Even though a substantial amount of ships perished, all traders prospered.
Venture Capital firms think the same way; even if the majority of portfolio ventures fail, the odd success makes up for more than all the losses. However, we see only few innovation leaders take portfolio thinking on board in their own venture. Instead of having some costs covered with alternative streams of income and maintaining flexibility with regard to the bets they make, several seem to tend to a “my way or the high way” mentality. It seems all too easy to believe that only focus, focus, focus will lead to success. While experienced innovation leaders have mastered the balancing act of giving your all and keeping some options open. They usually have learned the hard way.
In conclusion, being able to distinguish between ignorable, insurable and real risks and then take appropriate action can improve your innovation leadership and also improve the potential for success of your venture. Apart from taking the necessary precautions and striking the right balance between zeal and rationality in your leadership team, risks can be embraced and reframed as opportunities for improving. This requires quick reflexes and a continuous drive to embrace market feedback to improve the product or service as quickly as possible. Risk cannot be eliminated altogether and even if it could, it shouldn’t be, as experience with failure is a real predictor of success in innovation leadership.
Leadership development has been at the core of my work around the globe as an independent consultant, facilitator, trainer and executive leadership coach. I thrive on empowering individual professionals and executive teams to perform and collaborate from personal strength, talent and ambition towards realizing full potential and tangible results. As THNK core faculty I was involved from the beginning to help shape the executive program as it is run to date. Witnessing participants develop themselves to the next level in their leadership journey is truly inspirational.
Auke Ferwerda has worked as founder of several startups, director of a new media incubator and co-owner of an innovative software company prior to joining THNK. He is passionate about technology and innovation in relation to society. Auke is co-responsible for the development and implementation of the THNK acceleration program.