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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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