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Risk Intelligence
Learning to Manage What We Don’t Know
Three Ages of Risk
From seeing risks as …and risk avoidance as …business has returned to the darker
generally matching rewards… little safer than risk taking… pre-war view that what can go wrong
will do so
Circa 1950 Circa 1975 Back to the Future
“There is no security on this earth.
Only opportunity.”
Douglas
MacArthur
“People who don’t take risks
generally make about two big
mistakes a year. People who do
take risks generally make about
two big mistakes a year.”
Peter Drucker
“We took risks. We knew we took
them. Things have come out
against us. We have no cause for
complaint.”
Robert Frost
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
1
Not Breaking Even
And it’s no surprise, considering what we expect …versus what we so often get
from well-diversified portfolios of projects…
Expected Project Results Actual Project Results
Illustrative Illustrative
12
While break-out
successes would
offset disasters in
a portfolio of truly
random risks…
2 2
1
(1) (1) (1) (1)
(3) (3)
…executives report
them much more
(9) rarely in nature. (9)
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
2
Business Risks Learnable Not Random
The trouble is that most business risks …so we may well extract below-expected returns on projects
are not random but learnable… with learnable risks we have no advantage in assessing
Return Probabilities from a Project with Random Risks
Types of Business Risks
Illustrative
Production, or supply-side, risks Marketing, or demand-side, risks
We can expect average
• Operating risks such as: • Security or political risk such as:
returns no worse than
• Control and compliance failures • Market-disrupting events
others on projects with
• Partner coordination failure • Geopolitical volatility
a given random risk since
• Supply chain risks such as: • End-market or customer risks such as:
no one has an advantage in
• Supplier failure or political rupture • Brand or reputation erosion
assessing it.
• Key cost volatility • Customer consolidation
• Technology risks such as: • Competitive risks such as:
• Infrastructure breakdown • Disruptive technologies
• Information security breaches • New entrants to the market
• Workforce risks such as: • Regulatory and legal risks such as: Returns
• Capacity loss or disruption • Legislation and litigation
• Key staff loss or defection • Official corruption
• Asset risks such as: • Financial or economic risks such as:
• Fraud or theft • Financial market volatility Return Probabilities from a Project with Learnable Risks
• Counterparty credit losses • Recession Illustrative
To extract average returns
• Learnable risks reflect lack of no worse than others
knowledge not unpredictability extract from projects with a
given learnable risk, we must
assess it as well as they do.
• Only business risks based on market
prices are completely unpredictable
Returns
Expected Return for a Expected Return for a
Disadvantaged Risk Taker Well-Informed Risk Taker
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
3
Learning to Manage the Unknown
How should the kind of risks underlying a project affect our decision to pursue it, avoid it, or manage it with partners?
Discretionary Risks Nondiscretionary Risks
Determining Your Pursuing a Deliberate Building Networks
Challenge
Risk Intelligence Risk Strategy That can Adapt to Risks
Risk Intelligence Score Risk Strategy Audit Risk-Role Matrix
0-10 score measuring your Map of projects and plans Map of projects and plans
Solutions relative ability to learn what comparing risk intelligence and comparing risk diversity and
drives a kind of risk risk diversity market intensity
Uses • Selecting risky projects • Clarifying risk tradeoffs • Deciding how to allocate risks
• Diagnosing learning gaps • Building a risk pipeline • Finding good risk partners
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
4
Scoring Your Risk Intelligence
You can score your relative ability to learn about what drives a risk
Risk Intelligence Score Relevance Versus Surprise
Key elements of relevance and surprise capture
For each project, put 0 if less than competitors, value of any piece of information for avoiding
1 if same, and 2 if more mistakes about what’s really driving a risk.
• How often do you acquire information related
to the main project risk? 1
Definitions and Examples
• How surprising does the information tend to be? 0
Surprise = Improbability or memorableness of typical
• How relevant is the information to the possible experience
causes of the risk? 2 • High: Toyota’s just-in-time system confronts production line
with constant surprises
• How diverse are your sources of information? 0 • Low: AT&T’s lack of a galvanizing recent technology success
in the 1990s kept it out of Internet businesses it might have
• How easy is it for others to use this information? 1 managed well
Total 4 Relevance = Dependence of surprise on truth or falsity
of risk assumptions
• High: Pfizer’s experience with Lipitor highly relevant
to good cholesterol booster torcetrapib
• Low: Low relevance of AT&T’s long-lines experience
to risky prospects for new portability market delayed
McCaw acquisition too long
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
5
Three Types of Risk Intelligence
Knowing the risk intelligence …lets you put together better
patterns of staff and colleagues… balanced and higher performing teams
Risk Intelligence Patterns
Three Characteristic Gaps
Strength
• Impressionists are decisive, drawing on
Weaknesses
formative experiences, but apply them
Impressionist where they’re not relevant.
Frequency Surprise Relevance Diversity
Knowledge • Encyclopedists have widely relevant
Sharing knowledge but it tends not to be
“hard won” from experience and
provides a weak basis for decision.
Encyclopedist • Amnesiacs have lots of memorable,
widely relevant experiences but tend
to have trouble prioritizing and
Knowledge
Frequency Surprise Relevance Diversity
Sharing communicating them.
• Teams of all three are formidable.
Amnesiac
Knowledge
Frequency Surprise Relevance Diversity
Sharing
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
6
Making Your Risk Strategy Visible
You can chart your projects on a risk strategy matrix to see what learning challenges their risks pose for your organization
Risk Strategy Matrix • Major risks of each activity, project or division represented by circles
• Your risk intelligence for each risk captured along horizontal
High risk intelligence and • Diversifiability of each risk or its lack of correlation with the firm’s
Project Size
diversifiability make this other risks captured along vertical
project’s risk a great fit.
• So risks that you assess well and that your other risks diversify appear
in upper right
• Complements BCG “growth-share matrix”
High XYZ Ventures Partnership Circa 2000
Nice growth… …pity about the risk
Risk
Diversifiability
High High
Market Risk
Low
Growth Diversifiability
Low Low
Low High Low High Low High
Low risk intelligence and Risk Intelligence Market Share Risk Intelligence
diversifiability make this
project’s risk a bad fit.
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
7
Building a Risk Pipeline
Risk strategy matrices illustrate risk pipelines… …that reveal learning gaps
and bottlenecks in the firm’s plans
• Experiments with new, unfamiliar risks start in the upper left Lehman Brothers Circa 1990
• The ones on which we focus move right
Fixed Mergers and
High Income Acquisitions
High Risk Diversifiability
Fixed income
becomes dominant
Low Equity product in 5 years
Risk
Diversifiability
Low High
Risk Intelligence
Low
Pfizer Circa 2004
Diversified
Low High High Torcetrapib
Projects
Risk Intelligence
Risk Diversifiability
• The ones that succeed move down as their risks become harder Torcetrapib fills gap
for us to diversify in risk pipeline
Low Lipitor
• Those we harvest under cheaply financed attacks from challengers
move left
Low High
Risk Intelligence
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
8
Risk Intelligence at AT&T
Different information disadvantages delayed AT&T’s …to leave the firm highly exposed
entry into wireless, discouraged it from promising Internet to the risks of the long-lines business
opportunities, and hurt its ability to penetrate cable…
Estimated AT&T Risk Intelligence Scores Hypothetical AT&T Risk Strategy Audit
Decent Internet risk intelligence gave AT&T Business Size
an opportunity to diversify its business risks
Wireless Internet Cable
(1984) (1995) (1999)
High
Frequency 1 2 0
Surprise 1 0 2
Relevance 0 1 1 Risk
Diversifiability
Diversity 0 1 1
Record Keeping 2 1 0
Low
Total 4 5 4
AT&T’s shifting risk Low High
intelligence disadvantages Risk Intelligence
Low risk intelligence and Long-lines focus exposed
diversification made cable AT&T to concentrated risks
unpromising for AT&T
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
9
Putting Your Risk Network to Work
The nature of your risks determines …and their risk-role evolution shows
the role you should play in your risk network… which you’re best suited to pursue
Risk-Role Matrix
Hypothetical AT&T Risk Strategy Audit
Low-road risks more
concentrated than
Customer Shock widespread—like
High
Umbrella Absorber wireless and cable
at AT&T—so most
suitable for lone wolf
Risk organizations geared—
Diversifiability unlike AT&T—for focus
Low Classic Risk
Borrower Distributor
High-road risks more
widespread than
concentrated—like
Low High AT&T’s Internet
options—so most
Market
Intensity
suitable for dabbler
firms able, like AT&T,
to innovate widely
Protect customers from risks with low Protect suppliers from risks with high market
market intensity you can diversify and intensity you can diversify and distribute those
transfer those you can’t diversify to lenders you can’t diversify to any partner with capacity
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
10
Next Steps
1 List your major recurring project or initiative risks Risk List Example
2 Score your organization’s risk intelligence for each Assessing customer needs
3 Estimate whether each one is highly, somewhat, Assessing innovation complexity
or not at all correlated with the others
4 List your major project or new business alternatives Assessing new technology feasibility
5 Assess the major risks for each alternative Assessing competitor capabilities
6 Audit your risk strategy Assessing counterparty intentions
7 Make a risk-based selection of alternatives Forecasting talent needs
Source: Apgar, David, Risk Intelligence, Harvard Business School Press, 2006.
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