Risk & Reward: A Healthy Relationship

June 25, 2024

I got several comments on my blog last month, Maybe Go the Extra Mile, mostly by email but also a friendly text and in-person mentions - all along the lines of “I read your WHOLE blog about your trip to Utah, and it was pretty fun”!  It did get long, and I even left out some stories and ideas along the way, but for those of you who read the whole thing and were annoyed by its length - I’ll do better this time!  

In this month’s blog, I’m going to muse on the relationship between risk and reward - or risk and profit from a microeconomic perspective, or risk and benefit from the macro.  But - I am going to start off with another quick travelog - because it ties into the topic, and it’s from a perspective that very few of my readers are familiar with - high-speed motorcycle touring!  

On June 5, only a week after returning from our Utah camping trip, I took off with four friends on what would become a 6-day, 5-night tour of some of the finest riding roads in Colorado, encompassing 1,625 total miles.  Three motorcycles, plus my pal Tony from college days at NDSU in his fancy pants Ferrari 488 Spider, and his roommate Zach from back in the day flew out from Seattle to co-pilot.  The Minnesotans all trailered out to Fort Collins - slabbing it stinks on a cycle, and hate to put those expensive miles on the Ferrari going down the freeway!

The image that was in my mind when I came up with this month’s title is that of a fawn deer on McClure Pass, not too far outside Paonia.  She had just decided to make a dash across the road in front of me, but realized too late that I was coming pretty fast.  I braked and dove right, aiming for the part of the road right behind her tail - and that where I went - and she was still staring at me from about 2 feet away when I went by still going about 60 mph - I swear I saw a look of relief in her eyes - and I’m sure I had one in mine!  

And then, I scanned the road ahead looking for any obstacles, and took it back up to the appropriate speed for this wide open road full of sweepers, and led the other cycle riders through Carbondale to Aspen for a very late lunch.  The Ferrari was still ahead of us - he’d come upon the habit of leaving early by this point, because he just couldn’t comfortably keep up.  Mostly, this is due to the ability of a sporty motorcycle to pass slower traffic safely on the double yellows more easily than the Ferrari.

“This sounds like a lot of risk to me! - and not much reward!” many of you are thinking to yourselves right now - and that’s why you don’t ride.  For me though, and my riding friends, the reward of swiftly moving through a scenic and curvy road is among the highest there are, and so we planned this trip and we enjoyed it very much.  Our routes took us down the Peak-to-Peak Highway, through Winter Park and Steamboat Springs and Telluride and Durango and Breckenridge and Glenwood Springs and along the North Rim of the Black Canyon of the Gunnison and many points between and around.  

OK - one more paragraph and I’m done with the travelog!  For those of you who are not riders, but do or have ridden bicycles - I want you to imagine with me if you will, coming in a little warm on a downhill curve on a road bike - it’s a right-hander so you’re at the left edge of your lane - and you trim some speed by braking coming in so that you can keep your line.  As you round the curve, the hill flattens out and you see the apex, so you know you’re on a good line.  Keeping your head up, and looking ahead to the slow uphill S-curves unfolding before you - you roll on the throttle, and soon your 50 mph corner speed is up to 80, before braking again do get down to 60 before the S-curves marked 35 begin, but soon realize the sign was a little conservative, and 70 mph - double the recommended speed - is a comfortable pace to lead your friends through.  

Of course, safely is a relative term, and there are many who would disagree - and the same is true of risk in business. During my banking tenure, lenders were encouraged to build a portfolio with diversity in both industry and loan types, but also diversity in risk profile.  Class A loan customers get Class A loan rates - and there isn’t a lot of margin in Class A loan rates - but they don’t fail often.  Banks can make a stronger profit when they take on some Class B and Class C clients, because they pay higher interest rates, and thus earn stronger margins.  And - they are riskier clients - and sometimes they don’t pay their loans back in full and the bank takes a loss.  Some of the trick in being a good banker is in finding Class C clients that are on the rise, headed for Class B.  Most banks won’t even take on those clients - but if you do - and it works - there’s a relationship forged that will keep that client loyal even after they’re Class A - and they won’t leave you for a ¼% interest rate reduction at the competitor bank.  

Entrepreneurs have a reputation for being risk-takers, but more typically, and supported by this article in Inc Magazine they are risk-managers.  Any business capable of making a significant profit will have some risk involved - but there are so many different flavors and it’s all about managing risk along the journey - because it changes! 

One of the riskiest businesses to start is a financial planning or investment practice.  A startup financial representative faces significant training and licensing hurdles before they can even serve clients - and they have to get clients, with no experience and nominal expertise.  Most begin through a training program with Edward Jones or New York Life or similar, but the house takes a good cut of the revenue for all the support and services they offer.  If a candidate is smart, and perseverent, and dedicated to learning and meeting with LOTS of people, usually they can reach a sustainable income within 5 years or so.  

Then, if they keep after it, after 10 years they can be well into 6-figure income, and for the next 10-20 years depending on career length - it’s pretty easy living.  You meet with clients, and do some paperwork, and in most cases change affiliations at least a couple times - but after 20 years the good ones are making $250K working 32 hours a week, and taking lots of golf trips and family vacations.  The reward is strong, but the risk on the front end is an obstacle. And - some people are just made for this kind of business - my recent podcast with Joseph Vander Linde is one such example. 

I’m certain that my own risk profile has been significantly impacted by my upbringing, and especially my father.  Dad worked as a motorcycle mechanic in town, but before he married my mom - at 20 years old! - he had built a garage across the street from our house - with a pit, and was repairing cars as a side business.  The modest earnings from his job kept the family fed, but the side-work income he saved in hopes of starting a farm.  And that he did - in the heart of the farm crisis, and today he’s one of he most successful farmers in our county in North Dakota.  And - he managed risk all along the way.  He kept his mechanic job for over 10 years, And, he worked an extra 40 hours a week and more during the farming season to ensure the seeds had the best possible chances to grow.  

That’s the thing about a healthy relationship between risk and reward - is that the reward requires - or should require - hard work!  For any business, hard work is the water and the sunshine for the idea seeds, and those ideas grow into clients who have more needs and serving them helps to sprout new ideas.  Hard work powers the engine, but focus and trust are the lubrication.

To serve new clients, however, it takes more resources.  As a business grows to a capacity limit, it tends to become very profitable - the machine is running full!  To double client capacity for example, the owner must expand to a larger facility, purchase more equipment, and hire more staff - risky business!  The challenge is that they only have enough clients now to keep the machine ½ full - which is often not profitable!  As a business grows, they often face capacity limits - and must either stagnate their growth - or take a calculated risk to expand.  

This is why macroeconomics matters so much to business leaders.  If the above business is a cabinet shop, for example, and the housing market is strong, they know they’ll have demand from clients for more cabinets - thus managing the risk of expansion.  More saws, more latthes and joiners, a larger paint booth for staining and surfacing, more space to house all those machines and more people to run them - and perhaps a whole new countertops division!  

Julian Assange made the news this week, as he was released from custody in the UK after a plea deal with the US Government, who’d charged him with espionage.  Assange is of course, the founder of WikiLeaks, and shared evidence of war crimes and corruption in Afghanistan - and more.  More condemning to Assange than the sharing of war crimes documentation, however, were his widely shared convictions on the nature of the international war machine.  

If my business were a defense contractor, how might I best manage risk?

Probably, I’d manage risk by hiring lobbyists to talk with politicians about all the dangers in the world, and how we must be prepared to defend democracy by building more jet planes and bombs.  I’d make donations to political candidates in states where defense contractors are located, to make sure we keep those jobs.  From my perspective, the war machine prospers less by hard work and managed risk than it does by influencing demand for services and transferring risk to our US taxpayers and to the lives of foreign nationals!  

Now, I’m not about to go dogging on the military heading into Independence Day season, but I do think it’s useful to observe and acknowledge that there are many industries that have inherent conflicts of interest - and an unhealthy relationship between risk and reward.  

The health care system and the insurance industry are great examples.  If everyone in America suddenly focused on diet and exercise and got healthy - the hospital and pharmaceutical systems would financially collapse!  And there’s a great quip from way back:  There are two things insurance companies hate - accepting risk and paying claims!  There’s an inherent conflict of interest between client and service provider, and it can lead to an unhealthy relationship.  If you’re a pharmaceutical company, for example, and you can lobby the government to mandate your gene therapy solution, that takes a lot of risk out of your product line, and frees up a lot of profit in the reduction of marketing expenses, and it’s at the cost of transferred risk.  

So - what are markers for a healthy relationship between risk and reward for the smart business leader?  

First, the risk has to make sense.  If I were to launch a new business, selling a little bit of everything online to compete head-to-head with Amazon - what is my likelihood for success?  Even if I could launch, Amazon has so much infrastructure, and so much market power, that I’d find myself scrounging for distribution partners and suppliers and every scrap of margin from my revenues would be eaten up by expenses, and my money and all my investors money would burn up in a big fire of red ink!  Push a pencil to the challenge before you throw your chips in!

Second, you must be able to afford the loss if it doesn’t work out.  I caught up recently with Kyle Archer, Partner and CFO at Elevated, Inc.  Elevated is the largest Cheba Hut franchisee by far, and operates all of the Colorado Cheba aside from the training location for the home office.  They recently shut down a second concept - Skinny Fats - which features a menu laden with both extra-healthy, and extra-not-healthy fare.  It was working ok, covering the bills and paying the rent, and making a small return, but it would be a while before the sunk costs of equipment and franchise fees were paid off.  And, it was a distraction.  It took away from the operations’ core purpose, which is running the best Cheba Huts in the nation.  So - they closed the location and turned it into a Cheba Hut - and it’s working great!  They took a risk, looking to diversify their revenues and have a new concept to expand upon.  Nothing ventured, nothing gained, but this time it didn’t work out.  

Third, make sure the reward is something you really want!  Back in June of 2015, I took the question of adding a second food trailer to my mobile food operation to my LoCo chapter.  By adding a second, smaller trailer I reasoned, I could enhance revenues in the summer months, and maintain some revenues in winter through sidewalk sales and similar.  Thus reaching, hopefully, a sustainable income level.  My chapter asked me pointed questions like “How do you like always working when your friends have time off, and always having time off when your friends are working?”, and ultimately helped me observe that I didn’t want to be where I was heading toward!  My reward for taking the risk of adding a second trailer and creating a sustainable mobile food business would be that I would be trapped managing a barely sustainable food business!  

I had a friend once who acquired a larger services company and merged it with his own small firm, jumping him from the responsibility of managing a staff of ~15 to upwards of 40.  His financials were strong, his business acumen sound, and the merger paid off financially.  And - he did not like running this larger firm!  Before 3 years had passed, he’d sold the combined operation and started a new boutique firm in an adjacent industry, and was much more content with a staff of 5.  Point at what you’re aiming for, but consider wisely what you’re aiming for!  

I could write about risk for hours, risk management, risk mitigation, risk transfer, risk the game - but I’ve written enough already for this month.  Appreciate your readership and attention, and I hope you have a wonderful Independence Day and start to your summer season! 

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