Damage Control

The scientific study of risk management probably began in the 13th century, when mathematicians studying gambling odds built the foundations of modern probability theory, according to Bryan. However, risk management has only flowered during the 20th century, as financial institutions have employed increasingly complex strategies in order to enhance investment returns without adding too much risk. "That," says Bryan, "is where it's become quite a sophisticated art."

Many of the risk management techniques used by large financial institutions, such as options pricing and portfolio management theory, are built around complex mathematical formulas. These may be used to do such tasks as manage pension fund investments, set prices for government bonds and so on. However, you don't have to be a mathematician to manage the risk and reward of such common business activities as starting a company, entering a market, developing a new product, signing up a strategic partner or embarking on a marketing campaign.

One basic risk management strategy is to disaggregate risk. That may sound complicated, but, in essence, it simply means breaking down a large, unwieldy risk into smaller, more manageable pieces. Typically, a company might, as X.com did, break a risky initiative down into areas defined by corporate departments: marketing, finance, operations, human resources, legal and so forth. With the problem thus separated, entrepreneurs are better equipped to recognize, analyze and manage the separate risks.

At X.com, for instance, Musk dealt with the financial risk by raising more money than the firm was likely to need. "If things don't work out exactly as planned," he says, "we've got plenty of capital." In fact, raising money was relatively simple; the public is well aware of the enormous gains early investors have made in numerous Internet start-ups, including Musk's earlier firm, Zip2 Corp., which he sold to AltaVista for more than $300 million earlier this year.

Another way to manage risk is through the leveraging of what Bryan calls familiarity advantages. This is similar to concepts such as relying on core competencies, focusing on niches and simply doing what you know best. In a sense, leveraging familiarity advantages means avoiding or minimizing the risk of the unknown. It's common sense: When you know what you're doing, you're less likely to make a mistake than when you're trying something for the first time.

Musk did this, first by leveraging his own expertise at starting Internet businesses. "It's important to have expertise in what you're going to do," he says.

However, there's more to X.com than simple e-commerce. Musk had only minimal knowledge of the financial services industry; he dealt with this issue by bringing in people who could provide the familiarity advantage that he lacked. That meant Musk had to hire people with experience at starting banks and mutual funds from scratch. "They know what steps need to be taken," he says. "They don't have to figure it out along the way." It also meant retaining the most experienced legal advice he could find, sometimes from several different law firms, to mitigate the possibility of legal and regulatory problems.

In essence, there's nothing complicated about making the most of familiarity advantages. As Bryan puts it, "Leverage what you're already good at, and figure out how to do more of it."

This article was originally published in the November 1999 print edition of Entrepreneur with the headline: Damage Control.