03 November 2011

Dear Investor,

Risks and Success

What is it that makes an entrepreneur successful? Why do some business people and investors achieve their goals, whilst others fail to get off the ground? Is it, as is commonly thought, a willingness to take the risks from which others shrink? Does the 'gambler's instinct', coupled with good fortune, make the difference? This was one of the questions posed to delegates at the 2011 Australian Chambers Business Conference held at the Gold Coast.

The speaker who took the topic head on was Malcolm Gladwell, the New York-based Canadian writer known for his books The Tipping Point, Blink, Outliers and What the Dog Saw: And Other Adventures. Gladwell has made a name for himself over the years for his fascinating presentations of the unexpected and counter-intuitive implications of social science research.

At the Gold Coast conference, Gladwell turned his considerable powers of presentation to the question of why some entrepreneurs succeed when others fail. In doing so, he drew on his own earlier writings for the New Yorker magazine and the writings of economist Scott Shane, the author of the book The Illusions of Entrepreneurship.

Gladwell's argument was that the conventional wisdom is completely wrong. It is commonly thought that successful entrepreneurs are big risk-takers. They make big stakes gambles and, either through good luck or uncannily good judgment, win more than they lose.

Gladwell argued that this is a myth. It is easy to point to many entrepreneurs who indeed take plenty of risks. However, these are often the failed entrepreneurs, not the success stories. The failures break all normal principles of good business practice. They are undercapitalised; they do not write business plans; they ignore established operations and prefer to start from scratch; they chase the same people as their competitors; they underemphasise marketing; they ignore the importance of financial controls; they try to compete on price.

We can immediately concede that, depending on industries, some of these risks are unavoidable. In such cases, entrepreneurs take them on because they have no choice. But others are the result of plain bad management, failure to prepare or a lack of foresight.

In stark contrast, according to Gladwell, the successful entrepreneurs seek to minimise risks in all situations. They are inherently conservative. They prefer small, certain gains to low chance, high pay-off opportunities. They plan and prepare and are forever seeking to reduce and control the risks that they face.

In some ways, on deeper reflection this insight makes sense. The research on entrepreneurship holds that people who work for themselves are, on average, happier. The average person would have to earn two and a half times as much to be as happy working for someone else as they would be working for themself. And people who like what they do are profoundly conservative. They are not dazzled by the chance of making big money. Instead, they are drawn to getting to do what they love doing.

However, Gladwell points out that this risk aversion has one exception: social risk. Successful entrepreneurs do not care what others think of them. They are doing what they love to do and are prepared to risk the bad opinion of others to do it in the way that they think works.

It was this contradictory approach to risk that led to the success of Professor Emil Freireich, who undertook pioneering research into childhood leukaemia. Freireich was the medical innovator who risked his reputation and future as a doctor by proposing a toxic cocktail of drugs to treat a disease which was at the time (1950s) 100% fatal. Many in the medical professional considered the approach he took to be unethical, so toxic were the drugs. But, noting that childhood leukaemia was 100% fatal, Freireich believed that the greatest risk was to do nothing and so ignored the opinion of his peers. History records that Freireich's approach turned out to be one of the most outstanding treatment innovations in medical history.

So what can we learn from this?

First, that the conventional wisdom is not always right. The greatest innovations frequently occur because someone has seen through the conventional wisdom and risked the social ostracism that this can cause.

Secondly, contrary to their public image, successful entrepreneurs are frequently not big risk takers. They are living the life that they love, doing what they want to do and do not want to risk what they have. They prefer smaller, more certain gains against the roller coaster rides of high stakes gambles.

This sounds a lot like one of La Trobe's immutable laws of investing: getting rich slowly never goes out of fashion.


Best regards,
Chris Andrews

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Chris Andrews
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