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Optimism without grounded reality is a dream. Grounded reality without optimism is boring. People who are emotionally tough are always saying, "There's got to be a way." Business is not life-threatening; it's ego-threatening. And the people who are willing to risk their ego are emotionally tough.

Take a chance! All life is a chance. The man who goes furthest is generally the one who is willing to do and dare. The 'sure thing' boat never gets far from shore.

There are risks and costs to a program of action, but they are far less than the long-range risks and costs of comfortable inaction.

That risk and uncertainty are important stimulants for life has been trumpeted by wiser observers than me. ". . . Uncertainty, far from being a symptom of imperfection, is in fact a natural property of economics, indeed, probably of all life systems. . . . Uncertainty is the name of the game in the service economy." That's from Orio Giarini, of the Geneva Association. Richard Feynman, the Nobel Laureate physicist adds: ". . . it is in the admission of ignorance and the admission of uncertainty that there is hope for the continuous motion of human beings in some direction that doesn't get confined, permanently blocked, as it has so many times before in various periods in the history of man."

A venture capitalist is happy if two out of every 10 tries work. Everyone gets rewarded-even those who made the eight investments that failed. But big companies are unhappy if two of 10 tries fail. Those involved in the failures are demoted or sidelined when it comes to promotions. That means big companies focus on small, low-risk, incremental improvements and miss the big, but risky, opportunities.

Men involved in technical innovation in a corporation confront a situation in which the need for action is clear but the action itself is not.... So long as this situation exists, the corporation cannot function effectively, because it is not designed for uncertainty - a situation in which there are no clear objectives to reach, no measures of accomplishment, and no proper concept of control. A corporation cannot operate in uncertainty, but it is beautifully equipped to handle risk. It is precisely an organization designed to uncover, analyze, evaluate, and operate on risks. Accordingly, the innovative work of a corporation consists in converting uncertainty to risk.

Risk has its place in a calculus of probabilities. It lends itself to quantitative expression - as when we say that the chances of finding a defective part in a batch are two out of 100. In the framework of benefit-cost analysis, the risk of an innovation is how much we stand to lose if we fail, multiplied by the probability of failure.

Uncertainty is quite another matter: a situation is uncertain when it requires action but resists analysis of risks. For example, a gambler takes a risk in an honest game of blackjack when, knowing the odds, he calls for another card. But the same gambler, unsure of the odds or unsure of the honesty of the game, is in a situation of uncertainty.

What is often overlooked is that if one person can single-handedly save the ship, that one person can probably single-handedly sink the ship, too.

We know a lot about the conditions under which groups work well and work poorly. It's really clear that groups are superior to individuals in recognizing an answer as correct when it comes up. But when everybody in a group is susceptible to similar biases, groups are inferior to individuals, because groups tend to be more extreme than individuals. One of the major biases in risky decision making is optimism. Optimism is a source of high-risk thinking. Groups tend to be quite optimistic. Furthermore, doubts are suppressed by groupsÂ… But remember that the internal incentives that shape how the group perceives risks and rewards may be very different from the reality of the risks and rewards in the external marketplace. Those incentives can distort risk perception.

The flip side of rewards is risk. A commitment to delegation and empowerment raises a host of thorny questions. For example: How do you strike a balance between trust and security? Senior managers want people to be bold enough to do "what's right" for the company - but what if what's right for the company means shutting down their project or cutting back research dollars for their operation? If top management doesn't give people the security to make the right decisions, can they expect people to act against their own interests? On the other hand, if teamwork eliminates all personal risk ("just be a good team player and don't worry"), will people be motivated to perform?

"The most powerful factors in how people perceive risk," Professor Wildavsky wrote in his essay "Riskless Society," "apparently are 'trust in institutions' and 'self-rated liberal and conservative identification.'" According to the professor, left-leaning individuals are more likely to perceive true risk as potential injustice and perceive technology as exploitative, harming the poor and nature, while those who lean to the right are more likely to perceive true risk as opportunity and perceive technology as a solution.

Extreme competition means more volatile earnings - something that worries equity markets obsessed by predictable earnings per share. Most businesses monitor and control operational risks but pay too little attention to the more complex range of strategic ones. Four in particular merit attention: the value proposition risk (will a cheaper product knock the company out of the water?), the cost curve risk (will a low-cost competitor steal the company's market share?), the bad-conduct risk (will a price war destroy the company's profitability?), and the bad-bet risk (will the company's assumptions prove too optimistic?). Companies should assess the source, extent, and timing of all these risks, communicate them appropriately to investors, and define the activities that will help mitigate them. Two things are fundamental to making such an assessment: a dispassionate view of businesses whose trajectory indicates that they will never generate satisfactory returns and a willingness to close or divest them.

Crisis management is only as strong as its most distant parts. The best crisis management plans have a consistent process across all an organization's sites. A crisis manager from head office should be able to walk onto any site in that organization and play a part of the crisis response team anywhere; similarly, a member of the most distant site of that organization should be able to walk into head office and join the team there.

Currently, in some industries, the difference in the cost of labor is such that they have no choice but to outsource to, say, China. But in other industries, the choice is not always so clear. My feeling is that in many cases not all costs in terms of increased risks are taken into account. One of the problems is that we don't have good metrics for operational risks. If a company engages a supplier in China to do something, there's no way to quantify that this company went from 0.71 to 0.73 on some sort of risk index or operational risk ratio. The appropriate metrics don't exist yet.

Some managers have a general awareness of risk. Clearly they know that taking a supplier in Indonesia is not like taking a supplier in Kansas City. It's easier to keep tabs on what's going on in Kansas City than in Indonesia. But there's no way to quantify the difference. So people make the decisions based on what they can quantify, and what they can quantify are labor costs, landed costs, or whatever the knowable cost might be. And since financial analysts also lack the tools to quantify the increased risk, this is not reflected in the stock price. My feeling is that much of the offshoring is done without proper comprehensive analysis of the consequences.

Risk tolerance is a kind of index of confidence and courage: the willingness to go forward into uncertainty and operate there at length. When decisions are made collectively, the risk tolerance of the group is a measure of mutual trust. It shows what the members believe they can accomplish as a group if conditions become turbulent during, say, a difficult merger or acquisition. But it's also a test of leaders and what they can elicit from their colleagues - whose tolerance and capabilities may be sharply different from the leader's own. Can the members of a team be motivated past their own resistance and fears, to results they might not be able to achieve otherwise?

The reliance on open borders, transnational alliances, and global markets for capital, goods, and services has generated a "just in time" economy, which, although remarkably cost-efficient, leaves companies open to a range of discontinuities that can affect operations, reputation, customer habits, legal standing, regulatory compliance, earnings performance, and ultimately shareholder value. We call these new vulnerabilities, collectively, interdependence risk, and define it as unanticipated risk exposure across the extended enterprise that is beyond an individual organization's direct control.

A ship in harbor is safe -- but that is not what ships are built for.

Unfortunately, in many companies, the CFO is handling financial risk, the CEO is handling strategic risk, and the COO is handling operational risk, but no one is looking at all those risks as one.

Start-ups tend to be enormously resource constrained. Typically they are not able to devote money and time to the problems of strategic uncertainty. As a result, start-ups tend to be "bet the farm" propositions: high risk, with the potential of high reward. Such firms don't manage strategic risk, they accept it.

The degree to which you manage risk will be a function of your ability to bear risk and recover from setbacks. On the continuum from the archetypal "two people in a garage" to Johnson & Johnson, I take the counter-intuitive view that start-ups are much better able to bear risk: if the venture fails, the people and other resources involved are typically far more easily redeployed than is the case with large corporations.

A flipside of risk is trust. Trust is implicit in any dialogue between a company and its shareholders or any of its stakeholders. Trust is implicit in any discussion about the future in conditions of uncertainty...Any increased understanding of risk will tend to increase trust; while a dialogue that is risk-blind will tend to decrease trust especially over time as the unexpected inevitably occurs. By focusing on the issue of trust, we can also emphasise that anything which acts to increase Trust in the shareholder and indeed stakeholder dialogue will tend to both reduce shareholders' overall required return (and hence companies' cost of capital) and increase stakeholders' confidence in looking to the longer term in the face of any unexpected fluctuation. Increased openness and transparency in the stakeholder dialogue is thus a significant element in improving the management of Shareholder Value and sustainable growth.

True, strategic change is something that's played out over a longer time period.

This means that folks who are responsible for shorter time periods actually don't need to worry much about "strategic uncertainty" and in fact should not worry much about strategic uncertainty. Why? Because somebody needs to actually deliver on the strategy that's in place.

The problem I think in a lot of organizations is that the need to manage both delivering on the present and thinking about the future is something that has historically sort of been in the same place organizationally - people who make decisions with respect to one of those things have also been making decisions with respect to the other.

Financial theory would say that companies diversify to reduce risk, but in the business world diversification is done not to hedge risk but to sustain top-line growth. The riskiest companies-the start-ups and early-stage companies-are intensely focused. Companies begin thinking about diversification only when their growth has plateaued and opportunities for expansion in the original business have been depleted.

We pride ourselves on being the only species that understands the concept of risk, yet we have a confounding habit of worrying about mere possibilities while ignoring probabilities, building barricades against perceived dangers while leaving ourselves exposed to real ones.

Highly differentiated strategies, either low cost or product leadership, offer the promise of high returns, but only because they run higher strategic risk. Staking a defensible claim to a unique competitive position demands bold commitments over long periods of time to assets and capabilities that few others feel will be valuable in the future. In other words, greatness requires that companies make a significant, and largely irreversible, strategic bet. And like all bets, even when the odds are with you, you can end up losing (nearly) everything.

It is this kinship between success and failure that defines the "strategy paradox": precisely the same behaviors that maximize an organization's possibility of great success also maximize its likelihood of total catastrophe.

A plan is only a scenario, and almost by definition, it is optimistic. Any complex undertaking is subject to myriad problems – from technology failures to shifts in exchange rates to bad weather – and it is beyond the reach of the human imagination to foresee all of them at the outset. Although the probability of any one of these events could be low, the aggregate probability of something going awry can be high. As a result, scenario planning can lead to a serious underestimate of the risk of failure.

In many cases, what looks like risk-taking doesn't take courage at all; it's just unrealistic optimism. Courage is a willingness to take the risk once you know the odds; optimistic overconfidence means you are taking the risk because you don't know the odds. There's a big difference.

How should we think about risk vs. uncertainty? A logical starting place is Frank Knight’s distinction: risk has an unknown outcome, but we know what the underlying outcome distribution looks like. Uncertainty also implies an unknown outcome, but we don’t know what the underlying distribution looks like. So games of chance like roulette or blackjack are risky, while the outcome of a war is uncertain. Knight said that objective probability is the basis for risk, while subjective probability underlies uncertainty.

To see another distinction between risk and uncertainty, we consult the dictionary: risk is “the possibility of suffering harm or loss.” Uncertainty is “the condition of being uncertain,” and uncertain is “not known or established.” So risk always includes the notion of loss, while something can be uncertain but might not include the chance of loss.

Cost-benefit analysis can be an effective tool to analyze simple, one-dimensional problems, such as whether to install dividers on dangerous stretches of highway, where relatively unambiguous data is in abundant supply and there is little controversy. It also is a good way to elucidate the trade-offs for a given policy or regulation, or to produce a summary statistic about its economic efficiency.

But the cost-benefit method loses its authority when it’s used to assess more complex decisions. It is inadequate for evaluations of interventions that will affect many different dimensions, such as markets, economies, health, the environment, and endangered species. Cost-benefit analysis is also inappropriate for products or processes over which there are disagreements about benefits or about which outcomes are important. And it should never be used as the basis for regulation in the presence of scientific uncertainty or value conflicts, or in an area where there are no authorities one can trust to know all the answers. Decisions like these require a more expansive methodology — one that isn’t dependent on the affectation of translating all value into economic terms, that is more transparent and responsive to outside criticism, and that pragmatically represents the interests of everyone involved: industry, government, and the public.

There is a tendency in our planning to confuse the unfamiliar with the improbable. The contingency we have not considered seriously looks strange; what looks strange is thought improbable; what is improbable need not be considered seriously.

The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world.

All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that.

That’s why portfolio theory simply doesn’t work. It uses metrics like variance to describe risk, while most real risk comes from a single observation, so variance is a volatility that doesn’t really describe the risk. It’s very foolish to use variance.