Risk vs. Return

I pick up sharp things when I see them.  I’m talking about nails, screws and wire – not glass.  Whether I’m on my bike riding around town or walking down the street, I always take the time to stop and pluck any sort of sharp thing up off the ground.  Having had my share of flat tires, I know how disruptive they can be.  So I gladly do my small part in trying to prevent them before they happen.

But does it actually make that much of a difference, other than allowing me the opportunity to feel sanctimonious in the moment?  In a recent conversation, I heard (second hand) “Why would you attempt to solve a problem when it’s unlikely ever to happen again?”  At first, I thought that sounded pretty dim, but that was because it was encroaching on my bias that it’s always worthwhile to investigate.  But it’s a fair question – one I thought I should be able to answer without a reflexive dismissal.

Investigations aren’t free – there are costs associated with them, mostly in the form of opportunity cost (investigating instead of doing something else) and sometimes direct costs in the form of outside analysts, labs, etc.  If it’s true that there are no “expenses” in business, only investments, then I should be able to calculate my expected return for investing in an RCA.  

In calculating ROI, we compare the impact of the problem to the cost of solving the problem.  But it’s not like you actually earn money directly by investigating and solving problems.  What you get for an investment of this type is a reduction in risk.

Take the sharp things I pick up, for instance.  If it takes me on average 15 seconds to stop and pick up the object, that investment provides a reduction in risk to near zero (depending on where I ultimately deposit it) that the nail or screw will be involved in a future flat tire incident.  But what was the baseline risk of a flat in the first place?  If my investment buys down the risk effectively to zero, I need to know what the baseline level risk was so I can see how much my efforts (miniscule as they were) moved the needle.  In order to estimate risk, I’ll use the simple risk formula of Probability multiplied by Consequence.

I’ll need a model to assess probability.  And I’ll also need to make some assumptions because I’m not going to sit out on the street counting cars!

• How many cars pass the spot where the nail was over an average month? Assumption = 1,000 cars/month, or 12,000/year
• How many of them drive over the nail?
• Assumption = 30% of cars drive over the nail
• What are the chances that when a tire makes contact with a nail in the road, the universe aligns so that it actually pierces the tire?  Assumption = 10%

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