A new study finds that underestimating strategic risks is the number one cause of shareholders value destruction. But it doesn’t have to be. (An excerpt from an article in Strategy+Business by Christopher Dann, Matthew Le Merle & Christopher Pencavel).
Many benchmarks of corporate practice start by looking at successful companies. But a recent Booz & Company survey took the opposite tack. Contrary to prevailing wisdom, it was not compliance issues that were most responsible for destroying shareholder value. That distinction went to the mismanagement of strategic risks — those risks embedded in the top-level decisions made by the executive team, such as what products and services to offer, whether to outsource manufacturing, or what acquisitions to make.
Making matters worse, the sources of strategic risk have increased. Accelerating technology development is forcing the rapid adoption of new products, services, and business models; digital information is making organizations more vulnerable to theft and loss; supply chain disruptions quickly ripple around the globe, affecting both companies and customers; consumer connectivity via social networks can broadcast missteps instantaneously to millions of people worldwide; and natural, political, or regulatory shocks can reverberate widely. Companies must learn how to effectively anticipate and hedge against these and other risks in order to survive.
Studying the Biggest Losers
The results are unambiguous. Among the 103 companies studied, strategic blunders were the primary culprit a remarkable 81 percent of the time.
About half the time, the loss of value occurred gradually — over many months, or even years if the company took too long to grasp a changed strategic environment or lacked the agility to react. The other half of the time, the lost value occurred in a matter of months, weeks, or even days. Sometimes these sharp shocks were caused by strategic failure (for example, being caught by surprise when a competitor introduced a superior product), and sometimes they resulted from an operational issue, compliance problem, or external event that overwhelmed the company.
Often, it is a confluence of events that leads to value destruction. Strategic failure caused more than 60 percent of shareholder value destruction.
The Resilient Company
How should management respond to the threat posed by strategic risks? Senior leaders can’t rely on their enterprise risk management (ERM) teams to make the enterprise more strategically resilient, because ERM teams do not have the scope to question the strategic decisions that set the company’s course and undergird its operations. Make no mistake, the ERM function is vital: Once handed a strategic plan, these teams identify and quantify risks and then assign people to build continuity plans. Thus, ERM groups play an essential role in addressing frequently encountered risks in areas such as compliance, ethics, finance, and accounting, as well as safety. However, ERM groups can’t be the only source of protection, especially when it comes to the most potentially disruptive issues.
Instead, what senior executives need is a more balanced approach to strategic decision making, augmenting traditional cost and value considerations. They need to adopt an element of ensuring resiliency that is critical, yet currently missing in most companies: a top-down view of risk. To improve their risk management capabilities, executives should add the following three steps to their decision-making process — all of which are outside the scope of most ERM teams.
1. Broaden awareness about uncertainty and risk. We expect change to continue accelerating and uncertainties to increase. Extreme events with extreme consequences cannot be accurately predicted, but they can be anticipated. Management teams need to think broadly about what could occur and constantly layer new risks into their calculations as these risks emerge.
2. Integrate risk awareness directly into strategic decision making. By conducting more conversations about risk at the top levels of the company, looping in key individuals as needed, management acquires a full understanding of the uncertainties — both upside and downside — inherent in strategic decision making.
3. Focus on strategic resiliency. Managers need to consider how strategic decisions can affect resiliency, incorporate resiliency into all decision making, and always be on the lookout for more strategically resilient alternatives in order to build greater corporate agility.
Just as managers can make use of advanced tools to analyze cost, revenue, profits, and value, they also need sophisticated tools — such as scenario planning, wargaming, and trend analysis — to judge the potential risks of the decisions they are making before turning the strategy over to the ERM team. Ultimately, companies need both a robust ERM function and leaders willing to evaluate risk at the highest level of strategic thinking. This combination will bridge the gap, enabling executives to preserve and grow shareholder value.
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