Two rival, illustrative companies: same type of product and market, and similar number of employees, asset size and revenue. Yet, one has a market value three times larger than the other . . . Why? The less-valuable company concluded: “We are too risk averse.”
Recent economic turbulence has forced many companies to challenge their propensity for risk-taking. Questions being asked by management include, “Are we too risk averse? Do we have the right investment in new product development? Should we expand? Are we daring enough in product design?”
Some companies are able to seize competitive advantage through early adoption of technology. For instance, a well-known airline uses Google Glass to check-in customers, while a hotel group encourages customers to check-in through a smartphone app – which also serves as their room key.
There is an increasing trend in corporates to use risk appetite and risk-taking techniques for shaping strategy and business plans.
The winning outcome is achieved when executives, assisted as necessary, convert signals of change into opportunities.
Signals of change
Any change in society can present opportunities – or risks. Fail to seize the opportunity to innovate and your competitors will almost inevitably win.
Surveying the landscape of change is a considerable challenge – yet there are notable benefits to systematically identifying relevant and valuable signals of change for business planning and strategy formulation. This may reveal early warning signs of specific threats to market dynamics such as industry capacity, pricing and earnings. Other identified trends may trigger risk-taking opportunities for existing business processes; reveal opportunities for entering new markets, improving products and services or shaping an investment strategy.
Taking calculated risks
Receiving information about trends and potential opportunities will not necessarily cause management to act. Formal academic research by Kahneman & Lovallo shows that management generally neglects future opportunities. The reasons are complex and need to be put under the spotlight.
A company’s risk-taking propensity becomes clear from how it views innovation, investment initiatives and commitments to research and development. These clearly differ from one organisation to the next but can be quite easily compared – a certain company, for example, may not invest in new manufacturing assets until it has covered the cost through secured customer contracts. Another company, may invest in new assets speculatively, and betting on itself to secure the required income.
Some companies are more confident in taking calculated risks when the potential downside risk is protected. However, protecting the possibility of loss and taking calculated risks are part of the same risk return continuum, which provides the context for using risk appetite methods to optimise exposure.
A risk-based strategy
The most successful risk-taking strategies are those which are disciplined and empirical. In a world of constant change, a company would do well to incorporate a systematic framework of trend identification, opportunity management, risk appetite and risk-taking into its strategic and business planning processes.
Steven Briers is Director of Internal Audit & Risk Consulting Services at KPMG