09 May 2005  Research & Ideas

Hold or Fold? Sizing Up Business Risk

According to Eileen C. Shapiro and HBS professor Howard H. Stevenson, three key elements help you size up an option: your satisfaction to date, predictions about likely results, and future intentions. A book excerpt from Make Your Own Luck.

 

Every bet—large or small, corporate or personal—puts you into a game. And whatever the game, at some point your participation ends. Sometimes it ends because the game is over for all the players, sometimes because your participation is terminated by others, and sometimes because you've chosen to exit the game.

Once you've placed the bet, though, you always have to choose one of three broad options, which we'll call Option A, Option B, and Option C. Option A is to stay in the game as an active player until some later time or until someone or something boots you out. Option B is to quit this game and then enter another game that will allow you to go after the same kinds of results you've been aiming for in the current game. And Option C is to quit this game and go to a different kind of game that produces a different type of results.

If you invested $10,000 in Microsoft in March 1986 and have held onto it since, or held on and added to your stake, you were making Option A–type choices. If you made the same investment in Microsoft at the same time but sold your stake in December 1999 and then reinvested your $6 million or so of proceeds into other publicly traded equities or into a venture fund, you made an Option B choice at the time of the sale. And if you sold your stake in December 1999 and then sailed around the world or began work on a series of nonprofit ventures, you made an Option C choice at the time you sold your stock.

The final skill of the Gambler's Dozen, and the one this step is based on, is figuring out how you will know when to go for Options B or C and call it quits on the current game. To do this, we first assess what our best option seems to be based on: our satisfaction to date with the current game, our predictions about future results, and our intent going forward. And then we go back for another heart check, just as we did in step 1, the Big Goals, to make sure that we don't have hidden emotion loops pulling us toward an option that is less likely to help us reach the goals we say we want to achieve.

Estimate forward to assess whether to stay or quit

When we think about whether we want to stay and play, quit and play again, or quit and start a different kind of game, we try to figure out three things: current satisfaction, prediction about next results of staying in the current game, and our going-forward intent. Then we combine these three into a simple "estimator" that we use to assess which of the options—A, B, or C—looks like the best for us.

The most minimal form of this "estimator" uses only two alternatives for each of the three variables, and that's the one we show here. Though obviously you can make these assessments more complex and add more classifications, we limit the first run-through to just two alternatives per dimension which then generate eight distinct profiles that we can use to help us assess what we want to do. Even if you prefer more shades of gray, we recommend that you try it the simple way before you add more alternatives. (The math behind this is that two alternatives for three dimensions gives 23 or 8 profiles. Three alternatives for three dimensions gives 33 or 27 profiles.)

Satisfaction is the first dimension we look at, focusing on how satisfied we are with the results to date of the current game. We define the results to date in terms of the desired currency of the return for whatever kind of bet we are looking at—money for investments, for example; love and support for marriages; money, challenge, and new opportunities for jobs. Then we assess our satisfaction as "high" or "low," with "high" being anything from pretty satisfied to very satisfied and "low" being anything from deeply unsatisfied to marginally satisfied.

Prediction is the second dimension we look at, and here we concentrate on our prediction of the results we are likely to get if we stick with Option A and stay in the current game as active players. We use the same definition for the currency of the future results as we did with the Satisfaction dimension, and again we use a very simple measure with only two alternatives. One alternative is that when we think about the future upside, future downside, and future rules and rulemasters, we predict that we have more to gain than to lose by staying in the game. The other is that we predict that we have more to lose than to gain.

Intent is the third dimension and for this one we ask what kinds of results we want to achieve in the next round—more of the same, or more of other kinds of results. An investor may say that she wishes to continue to build her financial assets, so she would check the column for "want more of the same kind." An executive who is looking at whether to divest a recent acquisition or buy other assets to build this business area would check the same column. The law partner who is thinking about retirement from a lucrative law practice and who really wants to go into teaching and shape minds or become a missionary and save souls would check the last column, "want other things."

When you put these three dimensions together, you get a simple matrix that looks like this. We've included a line for you to add your rationale or thinking for the initial ratings you make on each of the three dimensions:

Time-to-Quit/Time-to-Stay Matrix

SATISFACTION with results to date PREDICTIONS about results of next round INTENT for next round/kind of results
HighLowMore to gain than to loseMore to lose than to gainWant more of same kindWant other things
Rationale:Rationale:Rationale:

To use this matrix, take a bet you are currently in, and make your assessments on each of the three dimensions. Then match your profile to one of the eight on the following Time-to-Quit/Time-to-Stay Estimator. The last column on the Estimator tells you which of the three options—A, B, or C—fits this profile the best.

Time-to-Quit/Time-to-Stay Estimator

Profile SATISFACTION with results to date PREDICTIONS about results of next round INTENT for next round/kind of results A?
B?
C?
HighLowMore to gain than to loseMore to lose than to gainWant more of same kindWant other things
1x x x A
2 xx x A
3x  xx B
4 x xx B
5 x x xC
6x  x xC
7 xx  xC
8x x  xC

This matrix doesn't tell you the answer, but it will give you a roughly correct estimate of which option is likely the best for you if your initial assessments in the dimensions of satisfaction, prediction, and intent were also roughly correct.

So, say you're an investor in a start-up, and so far you've been somewhat disappointed in the performance of the company. You think the technology is solid but the management team, and particularly the CEO, isn't very strong. The board has begun to take a more active role, the founder-CEO has been made the Chief Science Officer, and a terrific new management team has been brought in. You are now seeing budgets and deadlines being hit, and customer feedback is more enthusiastic. The kinds of results you want—financial returns—haven't changed. The next round of financing is coming up and you have been asked if you want to participate.

This situation fits profile 2. If you are feeling pretty good about your predictions, your best option would be A, to stay in the game as an active investor. If this round is a down round, which means that your prior investment has now been substantially diluted and reupping for this round would be the only way to see a real return on your investment, you will want to think hard about your predictions (and see who else is reinvesting this time around). If you still feel you put your X in the correct column, you are still in an Option A situation. A marriage that's gone through a rocky stage but now is beginning to work much better would fit this same profile.

Now say you are a top executive of IBM or AT&T in the late 1990s. IBM has been famous in the minds of consumers for its hardware, from the big 360s of the 1960s to its PCs of the 1980s, and all the storage media, including the hard disk drives, that go into its machines. Similarly AT&T has been almost synonymous with long-distance services to consumers. Both businesses have historically been great cash generators for the companies. Still, as you look forward, you see only mediocre returns or losses.

This situation is a good match for profile 3, and it's a common one for companies whose former core products are no longer the stars they once were. In both cases, your best option is B, to get out of this game—in these instances by divesting the businesses—and then enter another game where you think you can make more money. That's what IBM did in 2002 when it sold its HDD (hard disk drive) business to Hitachi and continued to build its position in consulting, where it had better odds of earning the kinds of returns it wanted. And that's also the point that AT&T got to in 2004, prior to its acquisition by SBC, when it finally decided to reduce its position in wireline residential services and focus on its commercial and business markets.1 People who decide to leave their spouses or change jobs often also have this same profile and similarly make an Option B decision.

Finally, let's go back to the buffet that started this chapter. Do you eat and drink as you normally would? Or do you splurge and consume a bit more? Or do you eat and drink until you feel like you could burst? Do you stay for one meal, or eat and then hang out for a while and then eat some more?

Or, to put the buffet example into a business context, say you're a senior executive, age sixty-something plus or minus, who has loved being at the top. You know that if you retire, you will never again have a position like this one in terms of financial compensation and business power. What do you do? When do you decide that you've had enough and are ready for playing a new type of game in which you can achieve different kinds of results?

For people who are ready to move on despite the pleasures of the table or the satisfactions of the job, these examples correspond to profile 8. In these cases, the most appropriate option is C, to quit this game and go to a different kind of game that produces results of a different type—if you are pretty certain that you're ready to change the intent of your bets, or at least that you are ready to modify or expand the kinds of results you are seeking. Businesses also face situations where Option C is the most appropriate option when they look at their financial returns and decide to share some of the wealth with their employees or their communities.

That's what John Tu and David Sun did when they sold 80 percent of their company, Kingston Technologies, to Softbank, the Japanese venture capital giant, in 1996 for $1.5 billion and then gave $100 million of their proceeds back to their employees.2 More typically, that's what fabulously successful entrepreneurs like Andrew Carnegie in the late 1800s or Bill Gates in the late 1900s do when they begin giving away big chunks of the wealth they have amassed. And it's what all of us do when we make major changes in our work and in our lives.

Of course, the recommended options for each of the three profiles we just looked at share one big caveat—you need to check your emotions as well as your analysis.

Footnotes:

1. "The point that AT&T got to in 2004..." Shawn Young, "AT&T Board May Pull Plug on Consumers," The Wall Street Journal, July 21, 2004, pp. B1, B8. CNNmoney, "AT&T 2Q Net Drops 80%; Confirms Consumer Exit Plans."

2. "what John Tu and David Sun did when they..." The best source on this is Kingston's own Web site, http://www.kingston.com

About the author

Eileen C. Shapiro (HBS MBA '81) followed her experience at McKinsey & Co., Inc., by founding the Hillcrest Group, Inc. She is the author of Fad Surfing in the Boardroom.

Excerpted by permission of the authors from Make Your Own Luck: 12 Practical Steps to Taking Smarter Risks in Business, Portfolio, 2005. Copyright 2005 Eileen C. Shapiro and Howard H. Stevenson. All rights reserved.

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