When I was part of a management team acquiring and divesting businesses, evaluating capital projects, setting pricing strategy, and exploring investments in new technology, risks were an integral part of each decision. I may have addressed the risks poorly or well, but I was still doing “risk management” as an integral part of making the decision. RM may be best thought of as a mindset and discipline – supported by tools, expertise, and process.
The question is not whether to manage risk, but how to manage risk. Will it be through ad hoc, inconsistent, or poorly-executed actions? Or, through disciplined thinking and structure to make sure it is managed correctly?
Many examples exist to show the need for improvement in RM ranging from large catastrophic failures (e.g., Lehman Brothers) to small, but impactful, decisions made in companies every day. While central ERM functions, consultants, and technology can be great tools to improve RM, it seems all too many resort to using disconnected ERM functions, RM consultants who leave, and mindless implementation of sophisticated technology. Each of these can be valuable steps to mature RM efforts, but they are too often seen as standalone answers to improving RM. Instead, I would suggest a holistic approach that encompasses the following:
This means implementing RM improvements at the place and time that decisions are being made. When I was the finance director for a global billion-dollar business, we had plants across the world. We used a centralized expertise center to continuously improve how the plants ran. Local management still ran the plants, but leaned on the central group for help. The same approach could be used for RM, where RM experts do not take ownership over the “risk aspect” of decisions, but come alongside decision makers and help them use RM expertise to make better decisions.
Some risks require a lot of attention, some require little. For example, I was approached by a business leader to help on a licensing agreement he was negotiating. The two parties had a significant difference of opinion on the variability of the future effectiveness of the technology to improve our business’s products. We could have spent hours drawing up diagrams, collecting data for Monte Carlo simulations, rating risks, etc — but that was unnecessary. Instead, we developed a stage gate process whereby payments for the technology were paid only upon proven performance. We effectively shifted the risk to the other party with very little effort. By thinking through the nature of the risk and potential responses, we got to the right answer without much effort. We deployed RM in the form needed to improve the decision.
Early in my internal audit career I set out to improve a very antiquated risk identification and assessment process for the CAE. I incorporated some sophisticated modeling tools and was able to generate numbers representing quantifiable risks. However, no one in my group believed them. I had generated numbers, but they failed to incorporate the critical quantitative and qualitative factors needed for risk assessment. I later came to learn that many CAEs “tweak” the output of their model-based quantitative risk assessment in finalizing audit plans. This was a case of blindly relying on the output of an automated system when certain aspects of risk are not fully understood or able to be incorporated into the model. Use the tools properly, but inject the necessary qualitative assessment in analyzing risk.
There are many specific ways to improve RM, but all start with a proper understanding. I challenge you to rethink how you view RM – a centralized, formal process that has no substantive impact on your organization or a functional discipline that improves decision making. Don’t immediately start with lists of risks, mathematical models, charts, and endless meetings. Instead start with understanding your business, the decisions to be made, and how the risks that are an integral part of your decisions will impact your business’ success.