Improving Risk Management, Finance & Operations Alignment

In their book, Surviving And Thriving In Uncertainty: Creating The Risk Intelligent Enterprise Funston and Wagner shed to light how a conventional approach to risk management has failed many businesses.

In the book, the authors exhibit a situation where businesses have failed to identify the differences between conventional wisdom and unconventional realities when it comes to managing business risks.

They go on further to argue that, a traditional approach to risk management is misguided as it assumes that:

  • Factors affecting events will remain equal.
  • Events are mildly random.
  • Extreme events are rare and should be treated as anomalies.
  • Forecasts are accurate and reliable.
  • Events are independent of one another.
  • Markets are efficient and rational.

Instead, Funston and Wagner believe organizations should take an unconventional approach to risk management which takes into consideration unconventional realities based on a random walk with hops, skips and jumps.

By taking this approach, the authors believe managers will be able to learn that:

  • Factors affecting events will change.
  • Events can be wildly random.
  • Extreme events are more common than we think and should be treated as such.
  • Forecasts can be misleading and unreliable.
  • Events interact.
  • Markets are neither efficient nor rational.

The events of the past decade such as: the 1997 Asian Financial Crisis, 1998 Russian Financial Crisis, September 11 attacks, 2004 Asian Tsunami, 2010 Haiti Earthquake and the 2007 Global Financial Crisis all prove that we live and work in a world full of uncertainty.

A number of organizations were completely caught unaware and unprepared by these events and suffered huge loses.

As no one person or business can accurately predict the future, planning for the worst case scenario in advance and developing early warning systems will reduce the severity of an extreme event.

A number of causes have been levelled on the 2007 Global Financial Crisis, chief among them being lack of information to guide decision making and poor risk management by financial institutions.

In pursuit of higher salaries and bonuses, managers and their employees became very much innovative and risk-taking.

They developed complex financial products carrying a lot of risk too difficult to understand for the layman and the developers themselves.

What started as a housing bubble in the US economy ended up crippling the entire global economy.

Those managers who followed the conventional thinking of risk management, misguided by the notion that events are independent of one another, were never alerted by what was happening in the US and how this could have an impact on their bottom-line.

As the events unfolded, reality that events interact, hit home. By then it was too late to react as much damage had been done.

Events in one function of the organization can have a crippling effect on the entire organization.

For example, a breakdown in IT infrastructure will not only affect IT operations, but will also affect the operations of the marketing, finance, human resources , production and other functions that rely on the infrastructure functioning to achieve their goals and targets.

A product recall due to wrong design and poor quality will affect the reputation and sales revenue of the entire business and not only the production department.

Supply of incorrect customer information by the sales and marketing functions will have a huge impact on the cash flow forecasts prepared by the finance function.

Improving alignment among risk management, finance and operations is key to achieving organizational strategic objectives.

Organizations wanting to improve their competitive position should therefore move away from the narrow approach of viewing functions as silos with own goals and targets to achieve, and embrace the fact that they are part of an ecosystem.

Improving alignment among risk management, finance and operations involves:

1. Collaboration: In some organizations, the internal audit function and the finance function are independent. The internal audit function is tasked with monitoring and managing risks that affect the business.

Managers should promote collaboration through regular meetings among the finance, risk management and other business units to discuss business trends.

This collaboration and close communication among finance, risk management, and the business units is critical to striking the appropriate balance between risk and reward.

2. Integrating the financial planning process with risk management: During the budgeting and business planning process, questions should be asked, even if they sound basic and silly, about the risk appetite of the organization.

If one of the goals is to create future growth, you must talk about the risks that must be undertaken and managed to successfully create and sustain growth.

The discussion of value creation and risk should not be separated. If the goal is to protect existing assets, you must also talk about risks to those existing assets.

You should be able to identify where and how you are overexposed to risk.

3. Top management participating: Participation, commitment and leadership of senior personnel is critical to embedding a risk management culture across functional areas and other business units.

The message of change (creating a risk management focused workforce) should start from the top and communicated down the hierarchy.

Information about risk exposure should also be clearly, accurately and transparently communicated to business stakeholders.

This will give a coherent picture of what risk management plans the organization has implemented or plans to implement, thereby help calm and reassure nervous stakeholders.

4. Focusing on the future: Traditional risk management looks at historical events as the basis of sound decision making. There is nothing wrong in learning from the past.

However, managers should spend much time and resources trying to anticipate the future and developing early warning systems. Thus, it is essential that you understand the lagging and leading indicators critical for driving business success.

This not only involves assessing the internal environment, but also the external environment.

5. Focusing on processes, information content, communication and technology: The recent Global Financial Crisis has shown us how reliance on quantitative risk models alone is not enough for strategic risk management.

Managers should improve both quantitative and qualitative analyses. Where information is lacking, judgement informed by experience can make a difference between riches and ruin.

In some organizations, there is a tendency of making information accessible via different IT platforms. This can be very costly and sometimes causes misalignment in data.

A better approach would be to have an integrated platform which has the advantages of efficiency, improved data quality and promotes visibility of what’s happening across the entire organization.

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Leading in Uncertain Times

One of the biggest challenges facing business leaders today is making the right decisions that will ensure their organizations succeed, survive, and remain competitive in an increasingly uncertain and complex environment.

A recent post, The best way to lead in uncertain times may be to throw out the playbook, by Strategy+Business has several good points.

The article is about the COVID-19 pandemic, how global companies navigated through the crisis, and how best to prepare for future disruptions. Here are some key points and my comments.

  • Rather than follow a rigid blueprint, executives must help organizations focus on sensing and responding to unpredictable market conditions.
    • Comment: Senior leaders play a vital role in providing clarity about the organization’s strategic direction, creating alignment on key priorities to ensure the achievement of enterprise objectives, and ensuring the business model is continuously evolving to create and capture value in the face of uncertainty. They must not rest on their laurels and stick to the beliefs and paradigms that got them to where they are today and hope they will carry them through tomorrow. Regulatory changes, new products, competition, markets, technologies, and shifts in customer behavior are upending many outdated assumptions about business success. Thus, the businesses you have today are different from the ones you will need in the future hence the importance of continuously sensing changes in the global economy. Employees and teams often feed off the energy of their leaders and tend to focus their attention where the leader focuses attention. If the leader is comfortable with current business practices and rarely embraces the future or challenges the status quo, then the team is highly likely to follow suit.
  • When it became clear that supply chains and other operations would fracture, organizations began scenario planning to shift production sources, relocate employees, and secure key supplies.
    • Comment: Instead of using scenario planning to anticipate the future and prepare for different outcomes, it seems most of the surveyed organizations used scenario planning as a reactionary tool. Don’t wait for a crisis or a shift in the market to start thinking about the future. The world is always changing. As I wrote in The Resilient Organization, acknowledge that the future is a range of possible outcomes, learn and develop capabilities to map out multiple future scenarios, develop an optimal strategy for each of those scenarios, then continually test the effectiveness of these strategies. This does not necessarily mean that every change in the market will impact your business. Identify early warnings of what might be important and pay closer attention to those signals. In other words, learn to separate the signals from the noise.
  • The pandemic forced the organization’s senior management team to re-examine how all decisions were made.
    • Comment: Bureaucracy has for a very long time stood in the way of innovation and agility. To remain innovative and adapt quickly in a fast-changing world, the organization must have nimble leadership and an empowered workforce where employees at all levels can dream up new ideas and bring them to life. Identifying and acting on emerging threats and potential opportunities is not the job of the leader alone but every team member. To quote Rita McGrath, in her book Seeing Around Corners, she writes, “Being able to detect weak signals that things are changing requires more eyes and ears throughout the organization. The critical information that informs decision-making is often locked in individual brains.” In addition to the internal environment, the leader must also connect with the external environment (customers, competitors, regulators, and other stakeholders), looking for what is changing and how.
  • It’s worthwhile for leaders of any team to absorb the lessons of sense-respond-adapt, even if there is no emergency at hand.
  • Sensing: Treat the far-flung parts of your enterprise as listening stations. The question leaders must ask is, “What are we learning from our interactions beyond the usual information about costs and sales?” Train your people to listen for potentially significant anomalies and ensure that important information is not trapped in organizational silos.
    • Comment: Cost and sales data are lagging indicators that reveal the consequences or outcomes of past activities and decisions. Although this information can help leaders spot trends by looking at patterns over time, it doesn’t help understand the future and inform what needs to be done for the numbers to tell a different story. In addition to lagging indicators, pay attention to current and leading indicators and understand the relationship between these indicators and outcomes.
  • Responding: Improve communication across intra- and inter-organizational boundaries. Leaders should view business continuity as an essential function that acts as connective tissue for the enterprise.
    • Comment: In addition to creating mechanisms that allow the free flow of information both inside and outside the organization, decision-makers should also be comfortable receiving information that challenges their personal view of the world, even if it’s not what they want to hear. Create a culture of psychological safety where people are not afraid to share bad news for fear of getting punished, but rather are acknowledged and rewarded for speaking up. Leveraging the diversity of thought enables leaders to anticipate the future as an organization, decide what to do about it collectively, and then mobilize the organization to do what’s necessary.
  • Adapting: Challenge assumptions, and question orthodoxies. There’s always the temptation to mitigate threats simply by applying existing practices harder and faster. One way to get at those deeper issues and encourage double-loop learning is to ask, “What needs to be true for this to be the right approach?”
    • Comment: In an increasingly uncertain environment, it’s difficult to survive and thrive with an old business model or outdated technologies. Many businesses fail because they continue doing the same thing for too long, and they don’t respond quickly enough and effectively when conditions change. As a leader, stay curious and connected to the external environment, look for market shifts, understand what needs to be regularly refreshed and reimagined, adopt new technologies and capabilities, and adapt in ordinary times but also during times of transition. Unfortunately for many leaders, it’s just more convenient for them to continually downplay the fact that conditions are changing than take the appropriate course of action that drives business success.

How are you preparing your organization for potential future disruptions?

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The Collaborative Organization

These days the term collaboration has become synonymous with organizational culture, creativity, innovation, increased productivity, and success.

Let’s look at the COVID-19 pandemic as an example. At the peak of the crisis, several companies instructed their workers to adopt remote working as a health and safety precautionary measure.

Two years into the pandemic, they are now asking their employees back to the office full time or are planning to adopt a hybrid model.

The need to preserve our collaborative culture and accelerate innovation are two of the top benefits being cited by organizational and team leaders for bringing workers back.

Collaboration is indeed essential for the achievement of team goals, functional objectives, and the overall success of the organization.

Today’s breakthrough innovations are emerging from many interacting teams and collaborative relationships.

When teams, functions, and organizations collaborate, the whole is greater than the sum of its parts; group genius emerges, and creativity unfolds.

But, what makes a successful collaboration? What are the key enabling conditions?

  • It extends beyond the boundaries of the organization. Business success is a function of internal and external relationships. Instead of viewing your business in vacuo, understand that you are part of an ecosystem. External to your organization, who do you need to partner with to enhance your value creation processes, achieve/exceed your objectives, or successfully execute your strategy?
  • Ensure the objectives are clear and there is shared understanding by everyone. Unclear objectives are one of the topmost barriers to team and organizational performance.
  • Foster a culture that encourages opinions and ideas that challenge the consensus. People should feel free to share their ideas and not hold back for fear of others penalizing them or thinking less of them. Collaboration is hindered when one or two people dominate the discussion, are arrogant, or don’t think they can learn anything from others.
  • Groups perform more effective under certain circumstances, and less effective under others. There is a tendency to fixate on certain topics of discussion amongst groups which often leaves members distracted from their ideas. To reduce the negative effects of topic fixation, members of the group should be given periods to work alone and switch constantly between individual activity and group interaction.
  • Effective collaboration can happen if the people involved come from diverse backgrounds and possess complementary skills to prevent conformity. The best collective decisions or creative ideas are often a product of different bodies of knowledge, multiple opinions, disagreement, and divergent thought processes, not consensus or compromise.
  • New technologies are making collaboration easier than ever, enabling us to increase our reach and broaden our network. Although new technology helps, it will not make your organization collaborative without the right culture and values in place. First, define what you want to achieve through collaboration then use these tools to promote creative collaboration.

How else are you championing collaboration within your organization to create value and succeed?

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Preparing for Geopolitical Shocks

Geopolitical instability has steadily increased over the past years, and uncertainty in the global economy is at an all-time high. Thanks to globalization and advances in technologies, we now live and work in a tightly interconnected world, one in which the boundaries that previously separated domestic from global issues have disappeared.

Threats are no longer confined to traditional political borders, social structures, and geographic boundaries. Geopolitical shifts have dramatically altered the global economic landscape and brought politics and business together.

The rise of China as an economic and politically influential power has threatened the dominance of the United States as the world’s largest economy. Although the opening of China and a market of 1.4 billion people have benefited both countries, it has also intensified competition and sparked U.S. economic and technological espionage accusations against China, leading to strained relations between the two giants.

U.S. companies operating from China have felt the impact of this tense relationship. The opposite is true for Chinese companies in the U.S.

Across Europe, national populism is on the rise and now a serious force. In 2016, the United Kingdom shocked the world when it voted to leave the European Union, generating reverberating effects across markets.

Banks and financial services companies that once benefited from the EU passporting system have had their cross-border banking and investment services to customers and counterparties in the many EU Member States impacted, causing them to reimagine their value proposition models.

The recent invasion of Ukraine by Russia is another example of a geopolitical event that has had devastating effects on human livelihood and businesses. Although the conflict between the two countries has risen over the years, I think it’s fair to say that few political analysts, governments, and businesses predicted a war to happen.

The war has created a humanitarian crisis, rattled global commodity and energy markets, caused prices to soar, and forced many international companies to temporarily suspend their Russian activities or completely cut ties with the country.

Global supply chains which are already fragile and sensitive due to the COVID-19 pandemic are now facing new challenges in the aftermath of the Russia-Ukraine crisis. Multilateral economic sanctions have been imposed on Russia. A state of affairs that was unthinkable months ago and is now threatening to derail the nascent global economic recovery from the COVID-19 pandemic.

Given the global domino effect of geopolitical events and the shrinking of the distance between markets and politics, the need to better understand and more effectively mitigate geopolitical risk has become more urgent. The business impacts, whether direct or indirect, vary by company type and industry sector.

Your company may not be able to prevent wars between nations, but you can anticipate and better prepare for geopolitical shocks:

  • Integrate strategy, risk, and performance decision-making. Consideration of risks to business success is an important part of the strategy selection and execution process, not an afterthought.
  • Develop a better understanding of geopolitical trends and how they are changing. For example, what are the megatrends in business, politics, and technology that are making geopolitical risks more diverse, prevalent, and consequential?
  • Assess the links between these geopolitical events and business performance. What are the events that matter most to your business? For example, how might current global political trends pose physical, business, and reputational risks to your parent organization?
  • Anticipate how these trends are likely to play out in the short, medium, and long terms, and develop mitigation strategies for each geopolitical scenario. Proactively anticipate and plan for radically different worlds, instead of reacting to problems as they arise
  • Review your mitigation strategies as the world changes. Are they effective enough in case of a major shock?
  • Develop capabilities for continuous learning to anticipate, address, and recover from geopolitical crises.

What do you think?

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