# Risk-Reward Ratio

## Risk-Reward Ratio

Risk-Reward Ratio Jonathan Poland

The risk-reward ratio is a measure that compares the potential for losses to the potential for gains for a particular action. Risk management aims to optimize this ratio, taking into account an organization’s risk tolerance, rather than necessarily eliminating all risk. The goal is often to minimize the risk relative to the potential reward. The following are a few examples of a risk/reward ratio.

Investing

Based on a proprietary estimation, an investor guesses that the S&P 500 has equal chance of going up 20% or going down 5% in the next year. The investor sees the risk/reward of 1:4 as attractive and buys into the index.

Product Development

An electronics company is considering launching a line of 3D printers. The development costs are significant and the company estimates there is an equal change of net income of \$3 billion or a net loss of \$2 billion from the product within the first 5 years. The company views the risk reward of 2:3 as unattractive and decides not to develop 3d printers.

Marketing

A luxury hotel is considering changing their pricing strategy to add a resort fee of \$33 a day. They know that such fees are unpopular and the hotel has recently experienced declining ratings on popular travel review sites. They calculate that the price change will generate revenues of \$1 million dollars but that there is a 50% chance of a customer backlash that will cost \$12 million dollars in lost revenue due to a lower occupancy rate. The resulting risk/reward ratio is 6:1 meaning that the price increase is a risky proposition that’s unlikely to payback.

Types of Risk/Reward Ratio

The risk-reward ratio is a simple mathematical equation: risk / reward that can be used to evaluate strategies, tactical actions and processes for their potential payback. For simplicity, the ratio is often expressed as gains and losses that are estimated to have equal probability. More accurate methods model risk as a risk matrix or probability distribution.

Market Environment Jonathan Poland

# Market Environment

The market environment refers to all of the factors that can impact a company’s strategy, decision making, and tactics. This…

Market Risk Jonathan Poland

# Market Risk

Market risk is the possibility that the value of an investment will decline due to changes in market conditions. This…

Budget Risk Jonathan Poland

# Budget Risk

Budget risk refers to the potential negative consequences that a business may face as a result of budgeting errors or…

Brand Metrics Jonathan Poland

# Brand Metrics

Brand metrics are used to assess the effectiveness of branding efforts and marketing strategies in terms of brand identity, positioning,…

Pre-Sales Jonathan Poland

# Pre-Sales

The term “pre-sales” can refer to a range of different things depending on the industry in which it is used.…

First-mover advantage refers to the competitive advantage that a company can gain by being the first to enter a new…

Over Planning Jonathan Poland

# Over Planning

Over planning refers to the practice of spending excessive amounts of time planning without implementing any of the plans. This…

Lobbying Jonathan Poland

# Lobbying

Vertical integration is when a single company owns multiple levels or all of its supply chain.

Market Saturation Jonathan Poland

# Market Saturation

Market saturation refers to a state in which a particular market is filled with a high number of similar products…