Incredible as it might seem, companies fail because they underestimate strategic risks – yes, strategic blunders instead of common sense – according to an authoritative study.
Instead of studying the successes of companies, Booz & Company consultants took the opposite approach in a 2012 study. In “The Lesson of Lost Value,” Christopher Dann, Matthew Le Merle and Christopher Pencavel looked at the biggest losers.
“To be sure, during the past decade, companies have steadily dialed up their focus on risk, in part as a reaction to the requirements of the U.S. Sarbanes-Oxley Act of 2002,” acknowledged the authors. “Individual functions such as accounting, finance, and compliance have improved risk controls.”
However, companies drop the ball.
The consultants concluded that compliance issues weren’t the reasons for corporate failures.
Senior management has often been misdirected.
“…they have usually done so with a bottom-up approach that has proven flawed,” they wrote.
Such companies have enterprise risk management (ERM) teams. ERM specialists are responsible for identifying and evaluating risks, and they start with an assumption – that senior executives are on the right track.
However, executives bypassed ERM in “what products and services to offer, whether to outsource manufacturing, or what acquisitions to make.” And the ERM folks aren’t apprised of the big picture.
Meantime, Messrs. Dann, Le Merle and Pencavel indicate the reasons for strategic risk have multiplied.
“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,” they explained.
“For example, an ERM team can call attention to risks associated with doing business with manufacturers in Southeast Asia, but it can’t evaluate whether the company should be outsourcing to the region in the first place. This responsibility gap can be costly,” they offered.
What about shareholder value? Underestimating risk by CEOs also means too much risk for investors.
The consultants’ recommendations:
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.
See the report.
Good stuff. The study makes a lot of sense.
In the past, I’ve questioned the approach by Carly Fioria at Hewlett-Packard (Leadership, HR, Marketing Lessons from HP’s Executive Turmoil).
You might also want to consider an aerospace example (Boeing, Airbus Rivalry – Lessons in Strategic Planning).
From the Coach’s Corner, regarding the mistake executives usually make in mergers: They must consult HR pros first.
“Chains of habit are too light to be felt until they are too heavy to be broken.”