What is Strategic Risk Management? Description
Although Adrian J. Slywotzky and John Drzik of Mercer did not conceive
the terminology Strategic Risk Management (SRM), they deserve credit
for their excellent description of it in an article in the Harvard Business
Review of April 2005. SRM is a technique that can be used for devising and
deploying a systematic approach for managing strategic risk, the array of
external events and trends that can devastate a company's growth trajectory
and shareholder value.
The authors distinguish 7 Classes of Strategic Risk, with underlying
subcategories. (some typical countermeasures in italic):
- Industry
- Margin Squeeze - shift the compete / collaboration ratio
- Rising R&D / capital expenditure costs
- Overcapacity
- Commoditization
- Deregulation
- Increased power among suppliers
- Extreme business-cycle volatility
- Technology
- Shift in technology - double bet
- Patent expiration
- Process becomes obsolete
- Brand
- Erosion - redefine the scope of brand investment, reallocate your
brand investment
- Collapse
- Competitor
- Emerging global rivals
- Gradual market-share gainer
- One-of-a-kind competitor - create a new, non overlapping business
design
- Customer
- Customer priority shift - create and analyze proprietary information,
conduct quick and cheap market experiments
- Increasing customer power
- Over-reliance on a few customers
- Project - smart sequencing, developing excess options, employing
the stepping-stone method
- R&D failure
- IT failure
- Business development failure
- Merger or acquisition failure
- Stagnation
- Flat or declining volume - generate "demand innovation"
- Volume up, price down
- Weak pipeline
Note: Certain financial-, operational-, and hazardous risks can
potentially also be of strategic significance.
Origin of Strategic Risk Management. History
The first notion we could find of the term "Strategic Risk Management"
is in a paper called "A framework for integrated risk management in international
business", By: Miller, Kent D., Journal of International Business Studies,
00472506, 1992, Vol. 23, Issue 2.
Miller describes five "generic" responses to strategic environmental
uncertainties, being avoidance, control, cooperation, imitation, and flexibility:
- Uncertainty avoidance occurs when management considers the risk
associated with operating in a given product or geographic market to be
unacceptable. For a firm already active in a highly uncertain market, uncertainty
avoidance involves exiting, through divesting the specialized assets committed
to serving the market. For firms not yet participating in a market, uncertainty
avoidance implies postponement of market entry until the industry uncertainties
decrease to acceptable levels.
- Firms may seek to control important environmental contingencies
to reduce uncertainties. Managers are here predisposed to trying to control
uncertain variables rather than passively treat the uncertainties as constraints
within which they must operate. Examples of control strategies include:
- political activities (e.g., lobbying for or against laws, regulations,
or trade restraints),
- gaining market power, and
- undertaking strategic moves that threaten competitors into more predictable
(and advantageous) behavior patterns.
- Cooperative responses are different from control responses, because
they involve multilateral agreements, rather than unilateral control, as
the means for achieving uncertainty reduction. Uncertainty management through
coordination is resulting in increased behavioral interdependence and in
a reduction in the autonomy of the coordinating organizations. Cooperative
strategies for reducing uncertainty include:
- long-term contractual agreements with suppliers or buyers,
- voluntary restraint of competition,
- alliances or joint ventures,
- franchising agreements,
- technology licensing agreements, and
- participation in consortia.
- Firms may resort to imitation of rival organizations' strategies
to cope with uncertainty. This behavior can result in coordination among
industry rivals. But the basis of this coordination is clearly distinct
from that under control or cooperation strategies. In this case, no direct
control or cooperative mechanism is used. Rather, an industry leader is
able to predict the response of rivals because their responses are merely
lagged imitations of its own strategic moves. Imitation strategies ("follow-the-leader-behavior")
involve pricing and product strategies that follow those of an industry
leader.
Imitation of product and process technologies may be a viable low-cost strategy
in some industries [Mansfield, Schwartz & Wagner 1981]. But uncertainty
about the underlying technology of competing firms may preclude such a strategy
[Lippman & Rumelt 1982].
- A fifth general category of strategic responses to environmental uncertainties
involves managerial moves to increase organizational flexibility.
Unlike control and cooperation strategies which attempt to increase the
predictability of important environmental contingencies, flexibility responses
increase internal responsiveness. The predictability of external factors
is left unchanged. The most widely cited example of flexibility in the strategy
literature is product or geographic market diversification. Diversification
reduces company risk through involvement in various product lines and/or
geographic markets with returns that are less than perfectly correlated.
Usage of Strategic Risk Management. Applications
Steps in the Strategic Risk Management Process
- Identify and assess risks (severity, probability, timing, likelihood
over time).
- Map risks (create a strategic risk map).
- Quantify risks (in a common measurement currency - i.e. economic
capital at risk, market value at risk).
- Identify potential positive consequences of risks (if company
turns the risk into an opportunity).
- Develop risk mitigation action plans (by risk teams).
- Adjust capital decisions (capital allocation and capital structure).
Strengths of Strategic Risk Management. Benefits
- Preparation for a major risk enables mitigation of that risk and makes
sense to protect company stability.
- If you prepare better for risks than your competitors, who simply manage
risks in the "old" way, you have a source of competitive advantage.
- Tool for thinking systematically about the future and identifying opportunities.
- You can turn strategic threats into growth opportunities. Moving from
the defense into the offense.
- Probably the benefits of SRM outweigh those of other, less strategic
forms of managing risk.
- Avoiding insolvency risks or earnings volatility.
- If you can reduce your GAAP/IAS
volatility, this may mean you will have a better standing in the analyst
community.
- You can better utilize capital and reduce its costs.
- Organize systems and processes that increase the
Risk-Adjusted Return on Capital of the
firm.
- Protect corporate
reputation.
- Helps companies to fend off additional regulatory and legislative assaults
on how they run their businesses.
- Helps corporate executives to defend themselves against legal lawsuits
of the sort that have been filed against former Enron, Tyco and WorldCom
executives.
Limitations of Strategic Risk Management. Disadvantages
- Strategic risks are just one of four categories of risks (Others are:
financial-, hazard, and operational risk).
- Certain risks may occur and cause irreparable damage despite anticipation
and preparation ("Acts of God").
- No company can anticipate all risk events.
- SRM is not a box-checking exercise: there are substantial costs and
efforts involved to SRM.
- A major potential issue in accomplishing progress with regards to SRM
is that in light of Sarbanes-Oxley and other post-Enron developments, companies
may likely view SRM as simply another regulation being imposed on them rather
than new "ground rules" that, if followed enthusiastically, have the potential
to provide global competitive advantage and enhance shareholder value.
Assumptions of Strategic Risk Management. Conditions
- It is possible to prepare for major future risks.
- Preparing is useful.
- It is possible to turn risks into opportunities.
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