Understanding Risk and Uncertainty: Making Wise Decisions As An Entrepreneur

 

I was listening to a Freakonomics podcast this week about the major difference between risk and uncertainty. Like most people, I previously assumed risk and uncertainty were essentially the same thing. But after listening to the researchers on this podcast it became blaringly apparent how different the two are.

Webster defines risk as the “possibility of loss or injury” or “someone or something that creates a hazard.” Using this definition of risk, you could classify nearly everything as risky because it’s such a broad definition. For example, there’s a risk the battery inside the computer I’m using right now could spontaneously combust and blow up in my face. Although this has actually happened, the probability of that happening right now is low and the impact that would have on my life is also low. This is obviously not a great example, but the point is there is risk in everything we do, whether the risk is large or small in nature.

Uncertainty is different. Following the theme of the above paragraph, Webster defines uncertainty as “not known beyond doubt” or “not having certain knowledge.” Saying it another way, uncertainty can also be defined as “incalculable or unquantifiable risk” because it cannot be measured. Generally speaking, people have a propensity to try quantifying or classifying every perceived risk primarily in an effort to understand how to manage it. But it’s different with uncertainty because uncertainty cannot be quantified. Henceforth, most people, right or wrong, avoid it.

The example given on the Freakonomics podcast to help underline the difference between risk and uncertainty was as follows:  Suppose you have a jar with 50 red and 50 black marbles inside and you are asked to reach in and grab a red marble while blindfolded. If you grab a red marble, you’ll win a cash prize of $5000. However, in order to play the game, you have to pay a certain amount of money. At this point in the experiment, the majority of those tested agreed to pay a reasonable amount of money for the chance to win $5000. Now, suppose you have a jar with the same number of marbles, but you don’t know how many are red or black. If you grab a red marble, you’ll win a cash prize of $5,000. At this point in the experiment, nearly all of those tested did not agree to pay to play the game for obvious reasons. When it was easy to calculate the probability of winning or losing more people were inclined to pay for the chance to win a much larger prize. However, the opposite occurred when the risk of winning or losing could not be quantified.

In the context of our daily lives, Stephen Dubner and his guest on this particular podcast argued that those who invest time in doing things which are not only risky but uncertain, tend to be the ones who are either wildly successful or complete failures. They pointed to Bill Gates who was building Microsoft at a point in history when it was completely uncertain whether or not computers would be as ubiquitous in our society as they are now. Or Henry Ford who started building Model-T’s at point in history when nearly all prominent business leaders were convinced there would never be anything better than the horse-and-buggy. In fact, this makes me think of Jamie Dimon’s recent comments about Bitcoin stating that

“Right now these crypto things are kind of a novelty. People think they’re kind of neat. But the bigger they get, the more governments are going to close them down.”

Jamie goes on to say,

“It’s creating something out of nothing that to me is worth nothing,” he said. “It will end badly.”

Having spent a fair amount of time myself researching and talking to professionals in venture capital about cryptocurrency and blockchain, there’s strong evidence to suggest Mr. Dimon could be wrong. No one can say with absolute certainty what will happen with cryptocurrencies. But the broader message here is as a society, we’ve seen this happen before where a prominent individual (or individuals) speaks negatively of something they do not like, understand, or are able to quantify, and it ends up radically changing society. I have no way of knowing whether blockchains or cryptocurrencies will do that, but it’s interesting to think about nonetheless.

When I think about risk and uncertainty in regard to entrepreneurship, it seems entrepreneurs who are wildly successful make a lot of uncertain bets that are either wildly successful or complete failures. My colleague recently sent me a link about Elon Musk titled “The Many Failings of Elon Musk Captured in One Giant Infographic.” People invest in Elon because he’s building things that are in every aspect uncertain, but have the possibility of changing the world as we know it (Tesla, Hyperloop, SpaceX, etc.). Not every entrepreneur will be or needs to be like Elon to be successful. But at a basic level, it seems the difference between great entrepreneurs and good entrepreneurs lies primarily in the level of uncertainty they are willing to endure.

Uncertainty in this sense is the complete absence of quantifying the outcome of an endeavor. I’m certainly not saying the rewards (financial or otherwise) of taking quantifiable risks aren’t generous. I’m just underscoring the difference between risk and uncertainty as it pertains to entrepreneurs who’ve accomplished incredible feats and have completely flipped the paradigm of how society does and thinks about things. Throughout history there are countless examples of people who have done this (Thomas Edison, George Washington Carver, Leonardo da Vinci, Steve Jobs, etc).

In summary, the discussion on risk versus uncertainty is an interesting one and goes many levels deep. As a means of human instinct and survival, all of us unconsciously think about risk and uncertainty every day. To a certain extent, it seems like we have to obey our basic human instincts to survive, otherwise I the world would be filled with even more chaos, panic and confusion. But for those who buck the norm and seek to do good while embarking on uncertain endeavors that positively benefit mankind, more power to you! Cheers -KM


2 thoughts on “Understanding Risk and Uncertainty: Making Wise Decisions As An Entrepreneur

  1. Great topic and spot on examples Kevin! (Keep that laptop at a safe distance please😜) There are only two things we can be certain about – death and taxes. It is common for Fear to drive the views of most detractors. Mr Dimon likely sees the threat to his world in the success of cryptocurrencies and/or blockchain technology. Doesn’t mean these innovations will or won’t happen. Chances are, it shows the need for disruption in a industry that is falling behind. If not crypto or block chain then it will be something else. Good news is entrepreneurs are the heros of our time. So many out there with big visions, ready to fail, learn, reset, and keep moving forward. We live in extraordinary times.

    Like

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