May 19, 2010

The Risk-Return Effects of Strategic Responsiveness: A Simulation Analysis

Torben Juul Andersen and Richard A. Bettis

Summary:

Companies in turbulent dynamic markets experience volatility in their performance. The turbulence described here is not only a case of going back and forth, or cyclical changes, but a case of structural changes.   Companies need to undergo learning about the new changes, devise new strategies to adapt to the changed market and implement those strategies.  This is called strategic responsiveness.

The paper creates a simulation model to determine the risk and return effects of being strategically responsive.

Organisations learn in at least three ways. One, they gain new knowledge (perhaps a better mental model) and notice that current peformance can be improved.

First order learning involves improving current processes. Second order learning creates new knowledge which changes practices.  Continuous improvement may lead to very efficient processes that are no longer required.

Competitive advantage arises from knowledge creation which increases range of strategy options.  Market learning which is about acquiring insights about market conditions prepares the way to taking steps to capitalise on the market condition.

The simulation model finds that strategic responsiveness does play a part in improving performance in a dynamic environment.  It does not require perfect learning since perfect learning costs more and the extra cost offsets the improvement in cashflow.  Strategic responsiveness is a way to achieve higher performance at lower risk.

May 17, 2010

When to trust your gut

Alden Hayashi, Harvard Business Review

Summary:

Many decision situations do not lend themselves to quantitative analysis.  For one thing, the situation may be so complex that quantitative analysis simply cannot be applied. Examples include areas in public relations, which person to hire, research, marketing, and strategy.

In other cases there just is not enough data to perform quantitative analysis.

Even if data could eventually become available, there are times when decisions have to be made quickly, or else the opportunity is gone. There is no time to gather and analyse data in a systematic and rational manner. Situations like this can be expected to become more common in today’s increasingly turbulent and globalized economy, where things can change at the drop of a hat.

Executives in the strategic positions of organisations often face these types of situations.  They have to rely on gut instinct to make their decisions.  Although in some cases they are provided the results of quantitative analysis, the numbers are often biased to show why something is a good thing.  For example, mergers and acquisitions often show why the merger would succeed (from a quantitative point of view).  The executives have to rely on their instinct to tell them why it might not work.

The question for a decision maker then is how to tune in to your inner instincts and how to tune your inner instincts.

Executives and researchers discover that you need to have your subconscious knowledge emerge and connect with your conscious knowledge.  This can be done through meditative activities such as driving, day-dreaming, showering, and so on – it all depends on what works for you.

Our emotions assist in the decision making process by filtering out patterns that do not apply and by emphasising patterns that apply. In a sense, our emotions sort out and shortlist the considerations that our rational part of the brain can work with. When making decisions, be aware of your emotions and take them into consideration.

Gut instinct is simply based on rules and patterns we have within our subconscious. Some patterns may be built-in (true instincts).  Some are acquired through experience.

The quality of our gut instinct depends on the number of patterns our subconscious stores, the variety of patterns, and how it is able to interconnect those patterns.  The number of patterns come from our experiences, the variety comes the variety of experiences.

Instincts do not guarantee correct decisions. We need to continually self-assess our decisions and ‘train’ our instincts.  We can do this be reviewing our past decisions, reviewing why they were wrong, or why they were right.

Finally, it is important not to fall in love with your original decisions, but to keep flexible and adjust it as new information becomes available.

Contemporary Enterprise-Wide Risk Management Frameworks: A Comparative Analysis in a Strategic Perspective

Per Henriksen and Thomas Uhlenfeldt

Summary:

Many risk management frameworks claim to be holistic and ‘enterprise-wide’.  Henriksen and Uhlenfeldt argue that for a risk management framework to be truly holistic and strategic, it must address the strategy creation process and not just the strategy implementation arena.  It is in the area of strategy process where many strategic risks are created. Hence, an enterprise-wide risk management system that does not lend itself to be used in the strategy creation process falls short of the mark. 

The authors investigate 4 ERM frameworks that claim to be holistic: DeLoach EWRM, COSO ERM, FERMA (a precursor to the current IRM Risk Management Standard), and AS/NZS 4360:2004.  Their study reveals that while these frameworks claim to be applicable at the strategic level, they fall short of providing actionable guidance on how risk management can be performed concurrently with the strategic processes.

A key weakness lies in the frameworks’ treatment of consolidating, prioritizing, and communicating key risks.  The very point of ERM is to consolidate the key risks faced by the organisation so that it can allocate scarce resources most effectively. The frameworks provide little, if any, guidance on how this consolidation, prioritisation, and organisational communication can be done.

The frameworks also acknowledge that risks can result in positive opportunities for the organisation but provide little guidance on how to take advantage of this.  Since the frameworks are not integrated with the strategy creation process - where the biggest opportunities to identify and seize opportunities exists - the frameworks’ take on positive risks are not that helpful.  The authors recognise that in the real world, preventing losses is the focus of management and identifying opportunities is generally the remit of strategy. 

Hence, while risk management in theory helps in identification and grabbing of opportunities, this is seldom done in practice.  The orientation of the frameworks in the process steps is still heavily slanted toward negative risks.

The frameworks add some value in that they pave the way for common risk language and processes across an organisation.