Millennium Marketing Research®
Tom Schori DBA Millennium Marketing Research®, 808 Ironwood, Normal IL 61761, 309-532-8466

The risk of not taking risks.

By Thomas R. Schori, Ph.D., and Michael L. Garee, Principals,  Millennium Marketing Research, 808 E. Ironwood, Normal, IL 61761-5239. 

Every business that’s in existence today started out as a "risky" venture, at least to some extent. Someone had an idea for a unique or necessary product or service and they bet at least something (in many cases, everything) that their assessment of market potential was correct. It is nothing short of amazing, then, that some of those charged with shepherding our most successful businesses into the 21st Century have taken such a risk-averse posture.

As there is indeed a cost for taking wild, ill-advised business risks, there also is a cost for taking no risks at all in business. That cost, many times, includes such things as failing to capitalize on opportunities as they present themselves, creation of a culture that not only avoids taking any calculated risks but also rewards those who assiduously avoid taking calculated risks, and eventual stagnation (and ultimate "death") of the organization itself, to name but just a few of the more important and pressing.

Ask students of virtually any university marketing class today which type of product manager they would prefer if they were a Chief Executive Office, i.e., one who launched a lot of new products with a success rate of about one-third, or one who launched just a few new products and had success on about one-half, and you may well be surprised at the answer. Most students will respond that the "right" answer is the product manager who has the higher new product success rate. That answer, by the way, is not correct!

At the risk of belaboring the point, consider a sports analogy. We all know that Babe Ruth is considered to be one of the most successful batters in baseball history. Yet, when we stop to think about it, Ruth failed considerably more times than he succeeded. In fact, a full 70% of the time he was at-bat he struck out! Now, some of his fellow players who were at-bat far fewer times than he undoubtedly boasted a better batting average than he at various stages in the season. But it certainly isn’t those players we remember, is it? It’s Ruth we remember because he made things happen in the long-run by taking a lot of swings at the ball!

How does all of this relate to business and taking calculated risks? Let’s illustrate the value to a business of taking calculated risks, by "getting up to bat" a lot of times and ending up with an impressive "batting average" in the long-run.

Assume that we have two companies in the same product category and serving the same target market. Let’s call these two companies the ABC Company and the XYZ Company. Here are some additional assumptions:

  • At the start of year one, each company offers 10 products.
  • Each year one product is dropped from the line because of obsolescence, poor sales performance, etc.
  • Each product produces $10 million in annual revenue.
  • Each company has fixed expenses of $50 million, plus variable costs of 30% of revenue.
  • It costs $5 million to launch a new product.
  • For each company, one out of three new products becomes successful.
  • For purposes of this illustration, let’s assume there is no increase in the Consumer Price Index from one year to the next.
  • The two companies differ only in the rate at which they introduce new products, i.e., the ABC Company rolls out just one new product each year, and the XYZ Company rolls out four new products each year.

Now, let’s look at how each company can be expected to fare over a ten-year period:

ABC Company

Year

Net income (000)

Cumulative income (000)

1

$15,000

$15,000

2

$12,450

$27,450

3

$9,900

$37,350

4

$7,350

$44,700

5

$4,800

$49,500

6

$2,250

$51,750

7

-$300

$51,450

8

-$2,850

$48,600

9

-$5,400

$43,200

10

-$7,950

$35,250

XYZ Company

Year

Net income (000)

Cumulative income (000)

1

$5,000

$5,000

2

$7,400

$12,400

3

$9,800

$22,200

4

$12,200

$34,400

5

$14,600

$49,000

6

$17,000

$66,000

7

$19,400

$85,400

8

$21,800

$107,200

9

$24,200

$131,400

10

$26,600

$158,000

Remember, the only difference between these two companies is that XYZ Company introduces far more new products each year. It isn’t that the company is more successful in their introductions, it’s that the company simply has more "at-bats" than the ABC Company.

From a financial performance standpoint, the results are startling. Initially, it looks as though ABC Company has the edge. For the first three years of the ten-year period depicted, they have the higher net income. The company also has a higher cumulative income for the first five years. But from year six on, it’s all XYZ Company’s "ballgame"!

By the end of the ten-year period, cumulative income for XYZ Company is nearly five times greater than that of the ABC Company. And, it’s significant to note, from year seven on, the ABC Company experiences negative net income.

The point? Simply this: companies that are more innovative, more willing to take calculated risks, generally are considerably more likely to prosper in the long-run than those that don’t. Or, to return to our baseball analogy, the more times one gets "up to bat," the more likely it is that one will have an opportunity to hit "home runs." And, in business, "hitting home runs" definitely is what it’s all about!