Trust as Risk Mitigation Strategy

Forget how you usually think of the word ‘trust.’ Think instead of ‘risk mitigation.’

“Risk mitigation” means reducing risk to an acceptable level. You’re familiar with it if you work in insurance, investment banking, natural resources, infrastructure, contracting, outsourcing, or deal internationally.

It usually comes packaged as high doses of things hard and practical: legal, financial, statistical. Here’s a typical example, this one from IASTA, a supply and spend management firm, lists seven strategies for risk mitigation. Seven ways, that is, to reduce the riskiness of your supply chain.

No surprise, it includes things like dual-sourcing, price hedging, performance-based contracts, and capacity assurance. Basically, ways to make sure your supplier does what you want them to do.

Risk Mitigation is Usually Based on Control

They are all based on the assumption that unless you control your supplier or the conditions surrounding the deal, you are at risk. And the solutions all involve controlling that risk: mainly controlling that supplier.

What’s surprising about that list—shocking, if you think about it–is the absence of trust. (I’m not picking on IASTA; it’s a good list for what it is—a list of controlling strategies). It generally beats the heck out of all the other seven.

What if you could trust your supplier? What if your supplier behaved toward you in a trustworthy manner? In general, your risk mitigation efforts will then cost a lot less, and will be more successful.

Agreement by legal negotiation, and enforcement by legal, process and accounting argumentation is costly. It causes bad blood. It reduces the felt moral obligation of each party to live up to an agreement. It causes delay. And it sure is expensive.

Risk Mitigation by Trust is Cheaper, and Creates Value

By contrast, trust creation costs less than lawyers and accountants. It can often be created more quickly. And it can be far more dependable.

More importantly: if a trustor-trustee relationship is developed, it doesn’t just cut risk mitigation costs, it positively creates whole new levels of value possibilities. Things you’d never do with an arms-length supplier suddenly become possible.

This is not crazy stuff. The truth is, it happens every day: we just don’t think of it as trust. Trust as risk mitigation happens whenever a customer and a supplier keep an informal rolling ‘tab’ of who owes whom. It happens when a client and a professional honor the spirit, rather than the letter, of an agreement. Warren Buffet did it on a grand scale when he bought McLane Distribution.

Simply put, trust is as hard-nosed a business strategy as any involving the usual suspects. There is no trust without risk: trust truly is at the heart of risk mitigation.

And it’s not that hard to do.

Trust-based Risk Mitigation Requires a Change in Belief

The main thing it requires is a belief in the massively predictable human phenomenon that people do as they are done unto. If one party behaves in a trustworthy manner, the other comes to trust. And if one party behaves in a trusting manner, the other party becomes trustworthy.

The predictability of that behavior is way better than any stock market algorithm. Yet it is astonishing how many businesses have been seduced into inherently untrusting relationships. At great cost to themselves, their supply chain, their customers, and even their shareholders.

It is far more profitable to depend on the rules of trust in human behavior, than to always rely on the rule of ‘do unto others before they do unto you.’ (Which, after all, produces an equally predictable negative counter-reaction). 

The amazing thing is that so many businesses, which claim they are focused on financial returns, continually miss this huge opportunity.  I think it’s because they are also bad at personal risk mitigation: the people who run those ‘hard-nosed’ businesses are personally fearful of constructively confronting other human beings, and of speaking the truth about themselves and others. 

People vastly overrate the risk of doing the wrong thing, while they underrate the risk of not doing the right thing.  In business, as in life.  Fear, to many, seems like the sensible attitude.  In reality, trust pays far higher returns.  In life, as in business.

3 replies
  1. Andrew Rudin
    Andrew Rudin says:

    Charlie:  your post helped me think of risk mitigation in a new way.  I hadn’t thought of trust as a risk mitigation strategy.  At the same time, you point out that "there is no trust without risk."  So trust carries risks of its own–that is, that trust will be broken–a real and sometimes-quantifiable chance.  Reagan’s admonishment "trust but verify" synthesizes this idea.

    Honoring the "spirit of an agreement" is valuable, and no doubt helps to seal cracks and holes that are not explicitly covered in contracts or enforced through law and regulations.  And although no party can eliminate the risk of failed trust, the risk can be reduced.  The job of senior executives is to recognize that risk, and then to manage it.  Toward that goal, I have found that a well-worded, unambiguous contract must accompany any meaningful business relationship.  

    Reply
  2. Claire Sutherland
    Claire Sutherland says:

    The balance of risk and trust is an interesting one, and I have enjoyed reading your post.  It seems to come from an ethos of unconditional positive regard for people, which is such a helpful belief basis for all human interaction.  I work with some major UK and international organisations to explore risk and trust as part of embedding culture change and managing wider organisational change programmes, and it seems to work on many parallels.  I often use the example of parents with children who have recently passed their driving test.  When your new-driver child cheerily asks if they can borrow the car, it is often with heavy and anxious heart that we part with the keys to what is usually the second most valuable asset we own.  But every time we take the risk of lending the car – and it comes back in its original showroom shape, so our trust in their driving competence increases, and before long, we are inviting them to take the car in order to run errands for us.  Trust is always the better position.  It expects the best from people, and sets them up to succeed.  If they make the wrong choice and betray the trust, then they have failed on the moral ground as well as perhaps the legal ground, and the duty of guilt may weigh much heavier.  Great article, Charlie – thanks!

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  3. Charlie (Green)
    Charlie (Green) says:

    Claire,

    Thanks for your kind comment on this older post; glad to see people are reading it.  I like your example of the teenager with the car; that certainly describes the dynamic well–the angst we feel, and the relief when trust turns out to have been well-placed.

    One minor correction, if I may.  At least for myself, I don’t intend to be coming from a place of "unconditional positive regard for people."  I do believe in idiots, and incompetents, and there are plenty of fear-based self-deluding people out there too.  I think the world is a very risky place, and so it’s not from positive regard that I come–well, at least not unconditionally–but rather from a place that says, what the hell, that’s all there is, no pain no gain, no risk no return.  Add to that the very clear dynamic, including in your example, that the act of trusting itself increases the trustworthiness of the one trusted, and it all becomes a bet worth placing, a risk worth taking.

    My general world view, for what it’s worth, is one of thinking, ‘ah well I’ll probably get screwed here, but it’s still the right thing to do; let’s see if they agree.’  And shockingly, they often do. 

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