Shutting down a children’s lemonade stand: All in a day’s work for those in downside risk protection

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

As an entrepreneurial company, RSD Solutions Inc. takes risks all the time so that we may move the company forward.  With each risk or strategy we look at the potential cost of the downside and potential benefits of the upside; one wonders whether Casity Dixon (age 14) fully considered the downside risk of establishing a lemonade stand in Midway, Georgia so to self-finance her trip to a water park.  While I doubt she did some thorough cost/benefit analysis, the local police did it for her and shut Casity's entrepreneurial business operation down because as they said:

 

“(the consumer,...) didn't know how the lemonade was made, who made it or what was in it.”

 

On the surface the police’s logic is sound, but is their action of preventing potential downside risk warranted?  Have children’s lemonade stands been red flagged as causing undue harm to consumers across GA?  When your firm or organization decides to reduce or eliminate downside risk, is it based on founded and proven principles (experience? statistics?) or on some broader undefined concept?  Reducing the downside is important but it is double-edge for the more you reduce downside the more you reduce upside.  

 

For more on this story, click on the link to the Winston-Salem Journal:  http://tinyurl.com/6b2ku7t

 

 

Downside risk protection: A bargain (?) at $278,000 USD per job

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The so-called Great Recession is an excellent case study in the failure of financial risk management caused by group think and the “perfect” algorithm.  The handling of the Great Recession is an excellent case study in political risk management.  In one instance we have the failure of developing good downside risk management with too few resources and in the later – perhaps caused by realizing the former – dedicating (possibly) too many resources to mitigate downside risk.  In a recent report released by President Obama’s own appointed White House Council of Economic Advisors it was revealed that the US government spent around $278,000 per saved job during the recent recession.  What is feared now is that with over $600 billion in additional debt the US economy will now move forward with restricted upside risk potential.

 

The knee-jerk reaction is atypical of business management when things go wrong (or right) hence the case for an independent voice of reason (?) gained through risk management staff.  Better still, from external sources (but that is another story).  The other point I wish to make is that downside risk has benefits and costs, and while those benefits are desirable is management aware of the costs both today and tomorrow of reducing the pain of downside risk too much? 

 

For more on the US government’s economic downside risk protection and the thoughts of the WH Council of Economic Advisors, follow the link:

http://tinyurl.com/3bf62xc

 

 

Canada Day: A celebration of up-side risk

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Today (July 1^st) is Canada’s 144^th birthday and I like many other Canadian’s and those who endorse what Canada represents will be celebrating across the world.  We celebrate a great country that is currently and for the foreseeable future in a “sweet spot”; Canada has a stable government, banking and legal system which immigrants and investors love.  As a country we are also lucky to have food, energy and fresh water all in quantities greater than our 33 million or so people can consume. 

 

While we celebrate all those benefits; we are also celebrating up-side risk.  John A MacDonald and his contemporaries, who created Canada, surely saw downside risk in creating a country as vast and under-populated as Canada was in the agrarian nineteenth century but they didn’t let this over-ride their belief in the benefits of one Dominion.  By clinging to their convictions of the up-side risk, Canada was born and happily their vision continues to live on, grow and prosper.

 

Happy Birthday Canada and to our readers in Canada – have a great long weekend.

“Medicine approvals slump to lowest in decade”: It’s pay-up time for downside risk protection

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

A while ago a tech oriented friend (jeffroach.ca) commented on the effect of the bursting of the dot-com bubble between March 2000 and 2001: his observation was that tech advancements from Silicon Valley were pushed back by 3 or so years.  On a related note, in a Globe and Mail article today, it was pointed out that new medicine approvals have slumped to the lowest level in a decade.  How is this related?  When the tech bubble burst, the flow of angel, private and corporate venture capital dried up in all sectors, including the search for new medicines.  With the lead time from inception to commercial launch of pharmaceuticals for human use being an average of 7 to 10 years, we are now witnessing the demise of that new venture funding 10 years ago.

 

So what does this have to do with risk management?  The collapse of the tech bubble caused a sweeping focus on downside risk (understandably as USD $1 trillion was wiped from the US equity markets) with perhaps little thought to the cost this would have on reducing upside risk – especially in the longer term.  Limiting all corporate activities to reduce downside expose does have a cost; in this particular instance pharmaceutical firms and the greater human populace are about to begin paying for it now.  Firms must be more selective in deciding which downside risk to address and at what cost now and in the future. 

 

For more on medicine approvals click on the link to a Globe and Mail article:

http://tinyurl.com/6aajlyu

Olympic Swimming Gold medalist? Bring your flotation device to Kings County, WA

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

From time to time, I like to look at the “far-side” of downside risk management.  Sadly, most of my examples tend to come from litigation prone America, in this case Kings County in the State of Washington. 

 

As the temperatures on the thermometers increase, the call of “Everybody into the pool” is sending shivers down the spines of local government councilors.  In 5 years there have been 17 drownings in a county of 1.9 million people (about 1 per 650,000 residents per year); to reduce this number further the Council has passed a by-law making flotation devices mandatory for all swimmers.  This is another fine example of a governing body focusing on reducing the cost of downside risk (drowning) while ignoring the far greater reduction in the benefits of upside risk (fun, health, exercise, socialization, future Olympic gold medalist).

 

Unfortunately such folly is not restricted to elected government officials.  When your company or organization looks at risk is only the downside focused on with the exclusion of the upside?  The answer may be telling and hold the key to moving your organization forward by freeing up resources.     

 

For more on this story click on the link to the Seattle PI story: http://tinyurl.com/3qjd3yx

Boeing’s 7-Late-7: Upside risk takes flight,… finally?

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Nicknamed the 7-Late-7, Boeing’s 787 Dreamliner is scheduled for delivery to its first owner, All Nippon Airways Co. in the next few months.  The project to develop a truly revolutionary passenger aircraft is now three years behind its original May 2008 launch date.  The aircraft is revolutionary on innumerable fronts from studying human psychology to assist in interior design, having no rivets on the outside plastic skin and having engines that are 25% more fuel efficient and with less noise.  Boeing further pushing the envelope in letting go of its intellectual property, allowing vendors to speak directly to each other rather than through Boeing and developing the most comprehensive integrated design software on earth. 

 

For managers, senior executives and shareholders the downside risk for this project were huge from a safety perspective and just plain bad press; and Boeing has certainly experienced its share of problems.  While I do not have access to the Boardroom at Boeing, I can imagine numerous heated debates between the risk adverse (who only see downside risk) and the dreamers (the upside crowd).  In the end, I believe the company realized that despite downside costs, the upside potential of their new form of operations and their aircraft would easily compensate those cost.  In your firm is risk looked at from both sides and with equal “weight” or is the fear (?) of downside risk either exaggerated or considered a more likely event despite the potential magnitude of the upside? 

 

For more information on Boeing’s 787 click on this Bloomberg link:

http://tinyurl.com/3nbngs2

Revisiting Definitions

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Early in this blog series several years ago I wrote a lot about defining risk.  My definition of risk was (and still is) that risk is the possibility that bad or good things may happen.  Not everyone agrees with my “two-sided” definition of risk, but I believe not only that it is mathematically accurate (are you using semi-variance or variance in your risk calculations – be honest) but also conceptually accurate. 

Perhaps the best reason to adopt this two-sided definition of risk is the need for the risk management department to be seen as a valuable strategic function within the firm.  If the definition of risk is focused only on the downside, then the risk function is limiting themselves to being the “Department of NO!”, and a wonderful opportunity to show the true value of risk management techniques is wasted.  That is a terrible downside risk to take.

We need an Anti-Von Restorff Effect

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

You don’t recall the Von Restorff effect from your studies?  Neither do I.  Likely my students don’t either.  However my students do recall (and they have the cell phone photos to prove it) the day that I showed up to teach my class in a bathrobe and slippers (normally I teach in a suit and wearing a dress shirt and bow-tie). 

The Von Restorff effect is our tendency to remember the highly unusual.  The common place we casually ignore or process without thinking.  For example you likely cannot recall many details about your commute to work today – assuming it was a commuting day like any other day.  If something significant happens – like you meet your favorite celebrity on the subway and start a conversation, then you are likely to remember many details from that encounter.

 In risk management we are similar in our thinking.  For example, as I write this the world is concerned about the consequences of the earthquake in Japan, and just to make it specific about the consequences on the safety of the nuclear power plants in Japan.  The media in particular tries to draw parallels with Chernobyl and Three Mile Island.  This is the Von Restorff effect taking place in which we recall (and by inference try to draw parallels) from other unusual events happening. 

Understanding, recalling and interpreting history is undoubtedly a useful exercise.  We all recall and appreciate the well worn statement that those who forget history are doomed to repeat it.  The issue is what parts of history do we tend to recall the most and to put the most emphasis on? 

In risk management, we tend to deal with the unusual, or the potential of the unusual happening.  This is particularly true for those who take the view that risk management is dealing with downside risk.  However we need to ask the question of whether we focus too much on the unusual, and let the usual run its course without sufficient attention to detail.  In making our risk management plans are we too focused on the outlier effects and their potential to occur again, without appropriate planning for the usual?  Do we need to make sure that we do not subconsciously submit to the Von Restorff effect?  Do we need an anti-Von Restorff effect?

The (Forgetful) Dismal Scientists or “Yesterday’s logic is illogical today”

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

 

As the US Federal Reserve Chairman’s own version of the QE2 sets sail, commodity prices continue their upward move. The upward march in oil was initially caused by the increase in demand for product as world oil consumption moved from about 88 million barrels/day last year towards an expected 90 million this year. More recently, Brent crude has been pushed above $100 because of increased uncertainty of continued delivery from the Middle East.

Now those of us with long memories, say 12 months, will recall that the dismal scientists as economists are affectionately (?) known, predicting that the next recession would start when oil trades above $100 USD/bbl. Interestingly, the Street has not renewed their talking of this outcome but rather they focus on the renewed and continued strength of the US economy. It is strange that all the arguments Street economist gave about the effects of triple digit oil and $4.00/gallon gasoline 12 short months ago are no longer gain attention.

This blog raises 2 points:

1. It takes a paradigm shift for yesterday’s logic to be illogical or have reduced impact. Effective risk management must be dynamic but not at the expenses of forgetting the past.

1. It looks like price volatility will continue in 2011 and downside risk is starting to appear.For corporate risk managers: what are you doing now that the likelihood of downside economic risk is increasing or are you seeking safety in the crowd?

In fairness.  I caught the following (taken from the Globe and Mail) just prior to posting:

"The International Energy Agency’s (IEA) executive director Nobuo Tanaka said prices above $100 per barrel for the rest of the year could drag the global economy back into a repeat of the 2008 economic crisis."

Domestic Risk Management - Our Valentine's Blog

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

Valentines Day is an appropriate time to ponder on some aspects of personal risk management, especially for those of us who have spouses or partners.  Actually, if some thought had not gone into Valentines Day before now, the risks of arguments, domestic splits, divorce or even being told that your partner has a headache increases dramatically. 

A basic domestic risk hedging program could include ordering flowers.  The addition of a present adds extra cost to the program but can provide a better hedge.  Booking a table at an expensive restaurant is again more expensive but can provide the most effective protection against domestic risk.  Each of these provides a progressively more expensive risk management program and the one chosen would depend upon a number of factors including risk appetite, past experience, etc. 

Of course, the risk management program can be poorly conceived or implemented.  If, for example, the present is a book entitled “How to Stop Snoring” or “10 Steps To A Cleaner House” or the dinner is not at a romantic venue with subdued lighting, but at the local sports bar when an important game is on, then the risk management program can significantly increase risk.  Of course, the same risk program can work for good or bad depending on the circumstances.  So in our sports bar example, if it is a female taking her boyfriend there she could gain a whole lot of brownie points, whereas the other way round, the boyfriend may well end up wearing a pitcher of beer and going home alone. 

Looking at the downside, a hedge may also include an escape plan.  I am told that France is a much friendlier jurisdiction then England for the male side of a relationship in a divorce.  (There are some people I am hoping won’t be reading this!!!)  You only have to spend a night in France to claim residence and give the courts jurisdiction … and assuming you file first! 

All the above considerations are completely applicable in a corporate context and show that a risk management program is individual to every company and should be developed and implemented according to specific circumstances. 

How do you handle your domestic risk management? 

For my part, I intend to rush out to the store immediately I stop typing.