June 22, 2007
News & Opinion: An essay from Adrian Slywotzky
What Your Boss Means By "Risk" Is Changing: Opportunities Created by the New Risk Management By Adrian J. Slywotzky With Karl Weber Authors of The Upside We have some good news and some better news for corporate risk managers. The good news is that risk--once a mere afterthought in the world of corporate management--is moving toward center stage. More and more business leaders are coming to understand the vital role that risk management plays in shaping the future of their companies...which means that the opportunities for risk managers to influence thinking at the C-suite and boardroom level are greater than ever before. The better news? What board members, CEOs, CFOs, directors of operations, and other top-level executives mean by "risk" goes beyond the traditional definition. Today's "risk" is a bigger topic than in the past, carrying with it bigger challenges, new sets of skills, and a new way of thinking that you can master to elevate and expand the conversation. If you're a traditional risk manager, you're expert at coping with the three familiar categories of business risk: hazard risks (fire, flood, earthquake), financial risks (bad loans, currency and interest rate swings), and operating risks (the computer system goes down, the supply chain gets interrupted, an employee steals). You've probably been working with insurance companies, finance and security experts, and other specialists to reduce the levels of risk your business faces in each of these areas and to develop hedging strategies to minimize potential losses. These traditional kinds of risks remain extremely important. But today, more and more company leaders are beginning to focus on a different set of risks that can be even more dangerous. These are the strategic risks your business faces. Strategic risks target one or more of the crucial elements in the design of your company's business model. In some cases, they shatter the bond between you and your customers. In other cases, they undermine the unique value proposition that is the basis of your revenue stream. In still other cases, they siphon away the profits you depend on. And sometimes, they destroy the strategic control that helps your company fend off competition. In the worst case, a major strategic risk can threaten all these pillars of your business. Not all businesses face every form of strategic risk (technology risk, competitor risk, customer risk, brand erosion, industry risk, project failure, etc.). But every business faces some. In fact, strategic risk comprises most of the total risk most companies face. Here are a few examples of the kinds of strategic risks that most companies today are grappling with: Project risk. Think back to the last major project your company initiated (R&D project, new product launch, market expansion, acquisition, IT project). What were the odds of success at the outset? What is the true success rate of all your company's projects in the past five to ten years? If you assess them honestly, the true odds of success at the outset of most major projects are less than 20%--which means the risk of failure is greater than 80%. The new risk management asks: Can those odds be changed? How? What specific moves have other companies made to radically alter the odds in their favor? Which of these moves can you use to dramatically change the odds on your next project, or even on your entire portfolio of projects? Customer risk. Has your business ever been surprised by its customers--by sudden, unforeseen shifts in their preferences, priorities, and tastes? When this happens, the revenue base on which your company is built can erode very quickly. But there are companies that have found specific ways to beat customer risk. How have they learned to get inside the minds of their customers, anticipating surprises before they happen? What growth breakthroughs did they create? Can you adopt their methods successfully? The new risk management is focusing on answering questions like these. Transition risk. When technology or business design shifts transform an industry, as many as 80% of incumbent firms fail to survive the transition. But a handful of companies have not only beaten transition risk, but also turned it into an enormous growth opportunity--and a few have done it successfully more than once. What lessons do these survivors have to teach the rest of us? Here is another area where the new risk management is deeply involved. These three examples just skim the surface of the kinds of challenges posed by strategic risk. (Our new book, The Upside, delves into the seven chief forms of strategic risk in significant detail.) But they'll suffice to illustrate the range of new problems risk managers can learn to think about in order to help their companies better navigate the new age of volatility that all of us are living through. Of course, strategic risk has always existed. But it has not always been high on the list of leadership challenges. In more stable periods, everyone knew there were dangers that could threaten the viability of their companies' business model, somewhere out in the indefinite future. But they usually weren't considered big enough or likely enough to worry much about. Today risk has moved to the top of the agenda. As everyone intuitively senses, our world is becoming a riskier place, featuring greater risks, more frequent risks, and more kinds of risks. The explosion of risk is particularly obvious in certain fields, such as geopolitics, weather systems, and financial markets (although shrewd analysts like mathematician Benoit Mandelbrot have argued that the risk in markets has always been greater than generally recognized). It is becoming especially obvious in business. Companies that once owned seemingly invulnerable strategic niches have been reeling under assaults from quarters no one predicted. As a result, one great name after another appears in scare heads on the business pages. General Motors and Ford are working hard to reestablish their market positions; once-powerful brands from Sony, Levi's, and Reader's Digest to Polaroid, are eroding or disappearing before the onslaught of new competitors; U.S. manufacturers are losing tens of thousands of jobs to overseas competitors; airlines are facing challenges in the wake of deregulation and geopolitical developments; and the PC, TV, and stereo businesses are becoming no-profit zones as once-exclusive technologies become commodities. No wonder business leaders from the boardroom to the executive suite are becoming increasingly nervous about the risks their companies face. All they need to do is switch on the TV news or open their newspapers to get an inkling of the looming threats. The evidence that risk is increasing isn't just anecdotal. It's quantitative as well. As an example, let's look at the stock performance of electrical utility companies. (Yes, we know you probably don't work at or even invest in a utility, but bear with us--it's an unusually clear example of a trend with broad implications.) The utility business was historically regarded as an industry with an extraordinarily low risk profile--the classic "widows and orphans" stock holding. But in the 1990s, something happened. For a host of economic and political reasons, the electric energy industry was rapidly deregulated. As a result, the volatility of earnings (EBITDA) for the average electrical utility roughly doubled during the nineties. And volatility means large, unpredictable changes--in revenues, earnings growth, dividends, stock prices. In other words, risk. And stock market analysts have found that the same is true in other industries. Why is risk so much more threatening in today's business world than ever before? There are many reasons, but several stand out:
- In today's wired world, customers have instant access to more information about products and services than ever before--and can switch brands at the click of a button.
- The multiplication of sales channels (from direct mail to QVC to big-box discounters to the Internet) is opening up more avenues for competition and transforming once-unique product offerings into commodities.
- Deregulation is forcing businesses that once enjoyed the security of near-monopoly markets and guaranteed profits to struggle for survival.
- Globalization has opened every market to competitors from around the world, exerting powerful downward pressures on prices and further damaging brand loyalty.
- Worldwide capital in search of investment opportunities is driving an ever-accelerating pace of technological change, creating upheavals in more and more industries, including ones not normally thought of as technology-driven.
Adrian J. Slywotzky -- cited by Industry Week as promising "to be what Peter Drucker was to much of the 20th century, the management guru against whom all others are measured"--is a director of Oliver Wyman. He is the author of the bestselling The Profit Zone (selected by BusinessWeek as one of the ten best books of 1998), Value Migration, and How to Grow When Markets Don't. He has also been published in the Harvard Business Review and the Wall Street Journal and has been a featured speaker at the Davos World Economic Forum, the Microsoft CEO Summit, the Forbes CEO Forum, and the Fortune CEO Conference. Karl Weber is a freelance writer and editor who has collaborated with Adrian Slywotzky on several books and worked with such authors as former president Jimmy Carter, Loews Hotels CEO Jonathan Tisch, UN ambassador Richard Butler, and representative Richard Gephardt. See www.crownbusiness.com or www.mercermc.com for more info.