Risky Business

"The world is much riskier today," argues risk-management expert Ron Dembo, "Because everything is much more interconnected." Here's his advice on how to manage the new risks of the new economy.

Record-high stock prices. Record numbers of Internet millionaires. Has there ever been a more rewarding time to be in business?

The Y2K problem. Wild gyrations on Wall Street. Has there ever been a riskier time to be in business?

Ron Dembo, 50, president and CEO of Algorithmics Inc., is a leading authority on the risks of modern business life. He and his 400 colleagues (30 of whom hold PhDs) sell powerful software -- applications with names like RiskWatch and RiskMapper -- to banks, insurers, and big corporations that need help measuring and managing their financial risks. Dembo himself is no stranger to risk: He gave up a professorship at Yale University to launch his company.

"The world is much riskier today," says Dembo, "because everything is much more interconnected. You can sit in Lima, Peru, pick up a phone, and borrow U.S. dollars from Citibank in Germany. You can sit in a jungle in Brazil and trade stocks over the Internet. If you're not managing risk, you can't claim to be managing your business." In an interview with Fast Company, Dembo offered insights on navigating the risky new world of business.

The Past Isn't Always Prologue

Managing risk means thinking about the future, not about the past. Some of the best minds in business misunderstand this point. We all get comfortable basing our strategies for the future on the past. That's why risks that we didn't anticipate can take us by surprise -- and why it's so hard to reckon with events for which there is no precedent. The euro debuted last January. There's never been a euro before: How will it affect how we think about risk? Y2K has never happened before: How do we plan for it?

Different Futures, Different Risks

There's no such thing as "the future." When it comes to risk, the most common error that people make is to think about the future in terms of a single scenario. Why? Well, look at the newspapers; listen to the analysts. They're full of predictions: "Interest rates will be lower." "Internet stocks will crash." "The Dow will go down." These so-called experts have no idea what's going to happen. Never confuse a forecast with a scenario.

For example, I might look at a scenario for my company in which every customer defaults tomorrow. I'm not predicting that this worst-case scenario will happen, but I want to be prepared for it. And early on in the history of this company, there was a nearly worst-case development that could have done us in -- if we hadn't managed against that risk. Most businesspeople have a hard time thinking about bad scenarios.

Regrets -- Too Few to Mention?

Lots of people think about risk in terms of "probabilities." But probability is a way of analyzing events that occur many times. Most business decisions are one-time events. Thinking about probability doesn't help much with those decisions. Instead, you should think about what I call "regret."

Regret isn't the same as disappointment. Regret is sensitive to specific circumstances, and it adds a psychological factor to your choices. We've all heard stories about entrepreneurs who mortgage their homes. The risk of losing your home makes sense for some people. But for others, losing a house might be a tragedy from which they would never recover.

Regret works the other way too. Why do smart people buy lottery tickets? To insure themselves against regret. If you play the same numbers all the time, spending a dollar a week offers cheap insurance against the regret that you'd feel if your numbers won -- and you hadn't purchased a ticket.

Visit Algorithmics inc. on the Web (www.algorithmics.com) or contact Ron Dembo by email (dembo@algorithmics.com).

Sidebar: No Risk, Big Reward

Ron Dembo has built a thriving software company that helps banks, insurance companies, and other clients manage their risks. Here Dembo explains how he has managed the risks that his own company has faced.

"I'm an entrepreneur, and I take big risks. But this company is funded entirely out of its own cash flow. It doesn't have any debt. It didn't use venture capital. As we were growing the company, I always kept enough cash in the bank to cover everyone's salary for six months.

"That cushion came in handy. In the early days, we had one big client, a major commercial bank, that bought into our idea and helped us to fund product development. Something like 80% of our revenue came from this bank. But I kept our head count low enough to ensure that if this client dropped dead, we could survive for another six months, using that time to find new clients.

"One day, this bank changed its mind about what it wanted to do with us. It insisted that we make major revisions in our business model. Its executives figured that because they represented 80% of our revenue, we would do as they asked. But because we had managed our risk, we didn't need them as badly as they thought we did. So we parted ways with them.

"They predicted that Algorithmics would go under. Today we're probably the world's largest risk-management software company. It all comes back to regret. I manage regret to make sure that if something big goes wrong, I'm still covered. That's what all good entrepreneurs do. You think they're out there in the middle of the desert, guns blazing, with nothing protecting them. With the smart ones, that's not the case. They always have a Plan B."

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