When leaders think about risk management in business
they are too often talking about legal compliance. This is a common
misunderstanding of risk by leaders, not seeing risk as primarily a
strategic issue in business. This view of risk misses the strategic
elements of risk, which leaders need to consider in defining
their business model and in making strategic decisions.
From start-up to exit risk is a strategic issue, which should underpin all
strategic thinking.
Developing leadership risk skills is an important
element for leaders to understand that their approach to risk defines how
the lead and what they lead. Strategic risk defines the type of
business model that leaders develop through to which markets and where in
them they choose to operate.
Drawing up lots of rules and making sure that all
employees follow them on the other hand can solve operational risk. Many such
rules, of course, are sensible and do reduce some risks
that could severely damage a company. But rules-based risk management focuses
on legal requirements, not complete risk management.
Understanding strategic risk and learning to how to
manage key business risks throughout your business is an important skill set
for leaders to develop in establishing their judgment in risk considerations
and ensure they are integrated into strategic thinking. There are
two parts to risk, firstly identifying your strategic risk and then secondly
how to actively manage the identified risks, which this article covers. If you
would like to know more about strategic
business planning then click this link here.
Here are some key questions to consider in identifying strategic
risk:
1. Risk Appetite
The first stage in managing risk is to look at the
leadership team and its surrounding stakeholders, both formal (Board, NED,
shareholders) and informal (employees, advisors, channel partners) to
map out the appetite to risk. The leaderships' risk appetite determines the
overall approach the business will take to risk. Risk is always directly linked
to reward, take no risk and you take no reward. Conversely take high
risk and you could achieve high reward, but equally high failure. The more
the leadership diversifies from its core skill sets it also increases the
risk it takes. So risk is linked to the sector you are operating in,
established and known is lower risk than emerging and unknown.
2. How well is your strategy defined?
Without a strategy your business is at high risk. If the leadership does
not have a clear and articulated strategy, which is shared and owned, then the
business is vulnerable to strategic drift, living in a dream and is without
clarity and purpose. Having a strategy in place, provides the context of the
business, with strategic goals, intent in positioning and outcomes defined
which enable the business to drive forward. To learn more about strategy click
here.
3. Strategic Risk Analysis
A business strategy must define the risk environment within which it
operates. Strategic risk starts by looking at the risk of entering a market
compared to the risk of not entering a market. Strategic risk management should
compare not only the risks of the strategy but the reverse risks of not doing
the strategy, the gap risk of
missing the opportunity.
Strategic risk also covers risk analysis of the leadership and its
approach to risk, how comfortable it is with risk reflects in how leadership
teams actively manage risk which reflects its established risk skill set and
appetite to risk across the board.
4. Strategic Risk Assessment
Risk, any risk is defined by the
potential impact of the consequences from it. The manifestation of its
likelihood of occurring is the assessment which must be undertaken, this is
often scrutinized by undertaking scenario analysis (driven by board, NED and
expert support and advisors) will encourage the leadership to consider a range
of scenarios that can result in significant adverse consequences for the
business and assist the leadership to make sure full width and depth analysis
of strategic risk is undertaken.
This assessment provides the basis of mapping the risk
and determining the investment in mitigation required to reduce or remove that
risk.
5. Strategic Risk Mapping
The
leaders must see risk in the context of how shareholders or
stakeholders measure value in the organization. This essential mapping of risk
enables the leadership to articulate to stakeholders how the risks they are
taking or the risks the business is exposed to may affect the organization’s
ability to realize its strategic goals. By identifying common metrics for risk
and performance also allows the leadership to define the priorities of risk
management activities and focus on the mitigation of relevant and important and
decision defining risks the board.
The second step, in creating an effective strategic risk management
system is to understand the qualitative distinctions among the types of risks
that a business could face and determining how to actively manage those risk. Risks typically fall into one of three categories and here's how leaders should be managing them:
1. Managing: Strategic risks.
The leadership having determined the level of risk it is willing to take
in order to generate the returns from its strategy, its risk and reward
profile, leaders must then develop appropriate channel partners to achieve that
strategy. From its bankers credit risk, its strategy of launching new products
through to its channel partner selection, all these decisions impact upon the strategic
risk strategy.
Strategic risks are quite different from operational risks because they
are not inherently undesirable; they are quite the reverse they are
deliberately accepted as part of operating within that industry. A strategy
with high returns requires the business to take on higher risks, and actively managing
those risks is a key driver in achieving those potential gains.
Strategic risks cannot be managed through a rules-based control models,
such as compliance to legislation. Instead, the leadership must install a risk-management
system designed to reduce the probability that the assumed risks actually
materialize and to improve the company’s ability to manage or contain the risk events
should they occur. Such systems enable companies to take on higher-risk,
higher-reward ventures by identifying drivers of strategic risk, most
often these are identified through 5
Forces analysis within markets and systems usually include primary (and
secondary fallback) detailed objectives which must be achieved which underpin
the strategy to actively manage the strategic risks.
2. Managing: External risk factors
Certain strategic risks arise from events outside the company and are
beyond its influence or control, often identified through PESTLE analysis. These major
macroeconomic risks are outside the market but directly influence it. PESTLE identification and analysis
enable leaders to manage the external risks effectively, through proactive
identification and mitigation of their impact. For example changing economic
conditions may raise global interest rates, which put pressures on even
successful businesses, which impacts upon costs and profits.
Businesses need to build a defined risk management processes to these
different PESTLE categories. By
identifying key drivers of external change leaders can devise stress testing
through scenario planning and devise alternative strategic options should
external risk factors come into play.
3. Managing: Preventable internal risks.
Conversely internal risks, arising from within the organization, that
are controllable and ought to be eliminated or avoided. Businesses should have well
defined internal risk systems in place which includes a tolerance level, such
as 95% of all calls must be answered within 3 calls, in other areas health and
safety for example mandatory 100% requirements for the use of PPE and operating
systems must always be in place.
Businesses should seek to eliminate these risks since they get no
strategic benefits from taking them on. This risk category is managed through
active prevention by monitoring operational processes and guiding people’s
behaviors and decisions toward desired norms.
Identifying and managing preventable risks is
about good management of existing best practices within the legal and industry
best practice. Companies cannot
anticipate every circumstance or conflict of interest that an employee might
encounter, so ensuring that risk is talked about, reviewed and assessed against
best practice.
Managing Risk effectively
Risk is a difficult subject for leaders,
precisely because it is seen as an operational detail rather than strategic in
nature. Business planning sets over optimistic forecasts, from unrealistic
timescales to launch new products and services through over inflated revenue
streams. This form of linear
extrapolations, how leaders have done it before will be immediately repeatable
with something new is compounded by the use of conformation bias, selectively
picking supportive data and ignoring unsupportive data. This form of groupthink
often limits the risk discussion by narrowing the discussion down to it will
happen rather than taking a holistic approach to risk.
Other key drivers of strategic risk failure
come from leaders ignoring industry activity, how fast and quickly competitors
will react to any new strategic initiatives to minimize their impact upon the
status quo and how channel partners and customers will sound supportive but
will measure the risk to them and mitigate it by limiting their exposure to
risk. How industries react to change is one important consideration from an
effective 5 forces analysis of any market. How do they players react to change
is often analyzed by war-gaming with scenarios played out in theoretical games
to see the impact of industry competition.
By strategy mapping your business leaders can often assess
all risks linked to objective setting, looking at risk events associated with
each objective and generate a risk profile for each risk and associated
mitigation strategy.
Recently the adoption of the balanced scorecard has become
a major way of mitigating risk, by linking mitigation to performance driver
indicators of behavior within the organization. This highly effective risk
management tool enables companies to engineer risk out of departments through
positive mitigation strategies.
For areas of risk which cannot be mitigated from within
the company, such as natural disasters or acts of terrorism, then developing
contingency plans act as mitigation to unforeseeable external risks. Not
putting all leaders on the same plane is a simple example of contingency
planning as is having secondary operational site, should your primary site be
unusable from either natural causes such as flooding or from acts of terrorism.
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