Managing Strategic Risk

Managing Strategic Risk

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CHAPTER 13

Managing Strategic Risk

In the previous chapter we identified various types of risk, their linkage with business strategy, and the pressure points that aggravate exposure to risk or increase the possibility of loss. In this chapter, we discuss how managers can proactively manage these risks as they work to achieve profit goals and strategies.

Much of the risk that we have described is created by management's use of aggressive performance goals and incentives to get the organization up to speed, just like a driver who steps hard on the gas pedal. In this chapter we look at another set of systems—the brakes that managers employ to control businesses operating at high speeds. High-performing businesses need good brakes, just like high-performing cars. Cars have brakes for two reasons. First, and most obvious, they allow the driver to slow the car down and stop safely. However, cars have brakes for another reason. They give the driver the confidence to go very fast. Imagine a high-performance racing car on a speedway. The driver can operate at top speeds only if he knows that he can rely on excellent brakes to control the car on tight turns. Like the fastest cars, managers of high-performing businesses need the best brakes to control strategic risks that are an inevitable consequence of driving their businesses to their maximum potentials.

Strategic risks are managed primarily by communicating effective boundaries —both business conduct and strategic— and installing good internal control systems. Boundary systems are designed to communicate risks to be avoided and to remove any ability to rationalize actions that could expose the firm to undesirable levels of risk. Internal control systems are designed to protect assets and to remove the opportunity for inadvertent error or willful wrongdoing in transaction processing and performance measurement. Together, these two systems supply the necessary control to ensure that accidental or willful error does not harm the ability of the firm to create value for customers, stockholders, and employees:

BELIEFS AND BOUNDARIES

Empowered employees —those who are asked to make decisions and assume responsibility for their work—must make choices every day about how to create value. They must balance tensions between profit, growth, and control, tensions between short-term and long-term goals, and tensions between self-interest and the desire to contribute to organizational success. If properly managed, these tensions can result in innovation that enhances the value and strategy of the firm. Think back over the past 10 years to all the innovations that businesses have brought to market and the new markets that individuals have created: cellular telephones, global-positioning satellite systems, derivative financial products, the Internet, and geographical expansion in China and eastern Europe. The list goes on and on. The potential for people to identify and create opportunities in changing markets is virtually limitless.

Sometimes, however, as we discussed in the previous chapter, people may pursue opportunities in a way that actually harms the firm. They may pursue opportunities that do not align with the intended strategy of the business. They may attempt to take advantage of a loophole in the law that causes the firm embarrassment when reported in the press; they may engage in insider trading to personally benefit from knowledge of an upcoming business transaction; or they may decide to ship substandard products in the mistaken belief that no one will be hurt by their actions. Whenever employees are asked to make choices, good brakes are needed to ensure that a business does not crash and burn.

To ensure that employees engage in the right type of activities, managers must first inspire commitment to a clear set of core values. Core values are the beliefs that define basic principles, purpose, and direction. Often rooted in the personal values of the founders, core values provide guidance about responsibilities to customers, employees, local communities, and stockholders. They explicitly define top management's views on trade-offs such as short-term performance versus long-term responsibilities. Core values provide guidance to employees where rules and standard operating procedures alone cannot suffice.

We know from work in organizational behavior that inspirational leaders (1) articulate a vision that addresses the values of the participants, (2) allow each individual to appreciate how he or she can contribute to the achievement of that vision, (3) provide enthusiastic support for effort, and (4) encourage public recognition and reward for all successes.' Employees will go the extra mile and work diligently for the best interest of organizations to which they are committed and proud. For example, commitment to mission and purpose allows successful nonprofit and charitable organizations to attract talented individuals at little or no cost. Without commitment to organizational purpose, people will not be able to fully participate in the decisions that affect growth and profitability.

In small companies, communication of core values can be accomplished informally. As organizations become larger, however, managers must formalize this process by articulating and communicating formal beliefs systems. Beliefs systems are the explicit set of organizational definitions that senior managers communicate formally and reinforce systematically to provide basic values, purpose, and direction for the organization.2 Using the mission statements and credos discussed in Chapter 2, managers attempt to give all employees who work for the business a sense of pride and purpose. Core values and statements of purpose are actively communicated to provide a compass for action. This is strategy as perspective—one of the four Ps of strategy.

Managers should never delegate the preparation of missions and credos. Managers should take every opportunity—both written and verbal—to personally reinforce core values and their importance. To increase ROME, however, the work of distributing documents, designing educational programs, and conducting organizational surveys to test awareness can, and should, be delegated to staff groups.

Because missions and credos are designed to appeal to all levels of the organization —from truck drivers to company presidents—they must be written at high levels of abstraction and generality. Therefore, they can never be specific enough to tell people facing difficult choices how to compete or how to choose appropriate actions in novel situations. These inspirational beliefs are typically too vague to