There can be no doubt that the world has changed dramatically in the last two months.
Catch phrases like “the new normal” seem ironic when any shred of normalcy evaporated weeks ago. Navigating what seems like an endless stream of bad news and new challenges can be hard even just as a human, much less as a business owner. When emotions are running high, it is of utmost importance to have a decision-making framework that relies upon clear, data-driven analysis.
Seeking Asymmetric Returns
When thinking about decision-making and risk management as investors, we look for opportunities that yield asymmetric returns. Put simply, this is when the upside return greatly outweighs the downside risk. Stock options are a common example of an investment that can yield asymmetric returns. For instance, with a call option you can only lose the initial capital invested, but if the underlying equity moves in the right direction, a return of 5 or 10x is possible.
Seeking asymmetric returns can also be applied to business and even life decisions. When we analyze the current pandemic, in order to simplify, let’s say we have two choices: we can either follow physical distancing guidelines, or we can choose to go about normal life. After we have made this decision, there are two possible outcomes - either the virus is worse than we expected, or it’s not as bad as initially thought. This simplified thought exercise creates four possible scenarios:
We do not observe guidelines and the virus is a lower threat than projected.
We observe guidelines and the virus is a lower threat than projected.
We do not observe guidelines and the virus is a higher threat than anticipated.
We observe physical distancing guidelines, and the virus is a higher threat than anticipated.
When considering each of these scenarios, we must consider the opportunity cost of observing physical distancing guidelines. My family has the ability to buy a month’s worth of groceries and work from home fairly easily. It is important to note that we must consider our position of privilege and recognize that many others may not have this luxury, but for us, stocking up on groceries and staying home costs us very little.
Once we have determined the cost (or investment), we can now evaluate outcomes. In scenario 1 and 2, where the virus is a lower threat than initially thought, if we apply a cost benefit we see that we have lost very little. In scenario 1, we are no better or worse off than before. In scenario 2, we are very slightly worse off because we may have missed out on a family trip or missed a few fun experiences, but very generally have lost almost nothing.
However, in scenarios 3 and 4, we observe a quite different value curve. If the virus is a significant threat, and we choose not to observe guidelines, the cost to both our immediate family could be devastating. In the case of scenario 4, we see a real world example of an asymmetric return. Observing the practice of physical distancing has a very low opportunity cost, but the upside is overwhelmingly positive.
Don’t Be Attached to An Outcome
Once we have identified a decision-making framework, one of the worst mistakes we can make is deciding which outcome we think will happen and then acting on that information. In the example above, you will notice that no prediction was made about whether or not the virus would be a higher or lower threat. One of the most innate and self-sabotaging behaviors we exhibit as humans is confirmation bias.
Research (such as that written about by Daniel Kahneman and Jonathan Haidt) shows that we tend to first make a decision, and only then do we start to gather facts and evidence to support the decision we have already made. We are doomed from the outset if we allow our own personal biases to cloud our judgement when it comes to scenarios like the current pandemic.
When making decisions, what we think will happen is almost irrelevant if we want to create the best outcome for our families and businesses. The better approach is to try and remain as neutral as possible when it comes to prediction, and continually seek out and assess the best data available. This has the added benefit of allowing us to quickly and easily change our mind. In my own case, in the weeks leading up to the lockdown, I did not take the COVID-19 threat as seriously as perhaps I should have. However, when evidence began to mount of its seriousness, I was able to quickly and unapologetically change my mind. Once I recognized that we could be on a path that led to the current lockdown situation, I was able to make preparations well ahead of most others. I make this point not to gloat about how brilliant I am-- remember, I was dismissive at the beginning-- but to illustrate how not being attached to my opinion allowed me to act decisively and end up in a much better situation than if I had let stubbornness cloud my judgement.
Moving Forward in the Face of Uncertainty
In the world of military aviation, we always like to say “Don’t fall in love with the plan.” Tactical decision making requires constant, unbiased threat assessment and refinement in order to succeed. No matter how brilliant our initial gameplan might be, we must observe real time complications that could change the efficacy of the current plan. We continually modify the plan to accommodate the newest data, and in some cases, we must throw out the old plan completely in order to honor new, unanticipated information.
So how do we apply this framework to the current situation? As of now, most of us are observing physical distancing protocols (whether we want to or not), so the next set of decisions we must make as business owners is around how to navigate the economic fallout.
Once again, we can look at costs vs. outcomes in order to determine our next best steps.
Consider the case of two business owners, one who begins rapidly preparing for a recession, and the other who operates full speed ahead. The first business owner is proactively cutting costs, asking to renegotiate rates with vendors and contractors, and stockpiling cash to weather the coming storm. The second owner continues with business as usual, hoping that things don’t get as bad as the media is predicting. Again, we can look at opportunity cost vs. reward. Even if the economic impact is much lighter than expected, the first owner still has put her business in a more advantageous position moving forward. However, with a potential downside case of 30% unemployment fueling a sustained recession, those who prepare early and aggressively stand a much better chance of survival.
Taking precautionary measures in the face of a potential disaster does not make the disaster more likely to occur. To create the best outcomes for our businesses and employees, using this time to think through likely scenarios and creating gameplans for each does not make us pessimists, but could allow us to survive. True to my own advice, I have no opinion on how bad the economic situation will get, but I can consider how bad it might get, which is the key difference that could very well save my business in the face of an unprecedented and unpredictable situation. While it may be difficult, I would urge you to ask yourself, “Am I willing to have the hard conversations that could save mine?
About the Author
Mike Brown is an entrepreneur, investor and guerrilla philosopher. Prior to founding, managing and exiting an 8-figure oil and gas company, Mike flew F/A-18 Super Hornets for the Navy and brings the fighter pilot spirit to entrepreneurship. When he isn’t dreaming up his next business or telling Navy stories, you can usually find him riding mountain bikes in the foothills of Golden, CO.