Risk in the Strategic Planning Process
The uncertainties of planning are well-documented in prose and poetry. "The best-laid plans of mice and men often go awry," wrote Robert Burns (in translation). "When men speak of the future, the gods laugh," says a Chinese proverb. "Prediction is very difficult, especially if it's about the future," declared Niels Bohr. But you don't have to be a philosopher to know that strategic planning is simultaneously important and daunting -- and that planning for the future is no guarantee you'll get the future you expect. It's not unusual, in life or business, to invest a great deal of energy into a desired future state that simply doesn't pan out.
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While strategic planning has always been hard, it has been getting harder. According to Geoffrey Colvin's October 2, 2006, Fortune article, "Managing in Chaos," a recent study of S&P 500 companies showed that overall risk levels -- risk to a company's ability to achieve stable long-term earnings growth -- has more than doubled since 1985. In that year, only 35 percent of the S&P 500 faced high risk and highly volatile long-term earnings growth. By 2006, that number had risen to 71 percent. During the same period, the number of companies enjoying low risk and volatility fell from 41 percent to 13 percent.
This rise of risk and uncertainty appears to be fueled by two major factors: speed and connectedness. In today's technology-enabled business environment, conditions change rapidly, and organizations that don't anticipate or respond in time can easily find themselves losing their competitive edge, market share, or worse. Furthermore, in a global, connected economy, changes or trends that occur in one industry or region can have a nearly instantaneous impact on companies in other industries and regions. In this environment, no company's future is assured.
Failure: A Taboo Topic
Talk of failure is traditionally shunned in executive suites. The focus, instead, is placed on the upside of a company's strategy and on the perceived need for unwavering commitment to execute that strategy. All too frequently, the brave (or foolhardy) individuals who question the viability of plans or raise the specter of risks are perceived as not being "on the same page," or not being "team players."
It's high time that more organizations put failure on the table. Only by acknowledging and better understanding risks and uncertainties, as well as the key assumptions underlying their planning, can companies take the steps to manage their risks more effectively. And only by acknowledging the potential for failure can they understand and manage it. Consider, for example, a hedge fund that lacked adequate controls and bet heavily on its assumptions about low-probability risks. It did not monitor the effectiveness of its policies -- or changes in its risk environment -- and consequently went bankrupt. Similarly, domestic manufacturers that did not anticipate a change in consumer preferences lost billions when foreign competition filled the void. In both of these cases, enterprises with historically strong performance failed to imagine the prospect of failure and paid the price for that mistake.
For businesses, the most common failure of imagination lies in not understanding or considering how the enterprise itself could fail to achieve and sustain revenue growth, how it could fail to improve its operating margins and the efficiency of its assets, or how it could fail to meet the expectations of its key stakeholders. Decision-makers who understand how the enterprise could fail can then decide whether to accept the risk of failure and figure out how best to prevent it, more readily detect it, and possibly correct it. A capacity to imagine and then prevent failure must be built into the strategic planning process. Organizations need to be intelligent about the risks they must take to gain and sustain competitive advantage (rewarded risks), as well as the risks they must avoid (unrewarded risks) to protect their existing assets (see Understanding Unrewarded vs. Rewarded Risk).
On Risk Intelligence
While most companies employ some form of enterprise risk management, only a minority are what we at Deloitte & Touche LLP would call Risk Intelligent Enterprises. Risk intelligence is the ability to think and learn about outcomes. It is how an organization gathers, analyzes, applies, and learns from information. Risk intelligence requires effective systems, accurate data, and timely reporting, but it enables organizations both to exploit strategic opportunities and to protect their existing assets.
Consider, for example, a company about to expand overseas. While emerging markets are brimming with opportunities, they are also fraught with risk. In many locations, these can include weak intellectual property (IP) protections, uncertain political environments, rampant corruption, and complex legal and regulatory regimes, to name but a few. Success in emerging markets requires an intelligent approach to managing the risks necessary for future growth while avoiding risks that have no upside potential. Based on a recently released Deloitte Touche Tohmatsu Global Manufacturing study, "Innovation in Emerging Markets," Risk Intelligent Enterprises keep their highest-value activities in more developed markets with better IP protections, while sourcing components and distributing production and data centers across multiple emerging markets. They also conduct rigorous and integrated risk assessments of supply chain, legal and regulatory tax, business continuity, intellectual property, security, and geopolitical risks before entering an emerging market. After entering a market, Risk Intelligent Enterprises perform risk assessments on a regular basis to catch early warnings of risk factors that may affect ongoing operations. As a result, Risk Intelligent Enterprises have higher confidence in their ability to manage risks.
Success demands excellent risk management as a core competency. Risk intelligence enables an organization to respond to rapidly changing circumstances with greater agility and resilience. Risk handled well becomes a source of competitive advantage; handled poorly, it can severely hamper a company's prospects. The greater the risk, the less complacent an organization can afford to be.
