Risk in good times and bad
In general, as human beings, we seek to avoid uncertainty. We prefer the security that knowing what is going to happen gives us, we choose certainties over ambiguities. However, in business contexts, this attitude is extremely dangerous. How can we manage in advance the variables that affect us the most?
Risk is related to a situation in which we do not know for sure what is going to happen, and in some cases, it is specifically related to the probable unintended consequences. It is very common for risk to be confused with danger, and hence, in the face of fear, we remain paralyzed. Paradoxically, this paralysis is the greatest danger since it does not allow us to explicitly recognize the most relevant risks.
Risk also includes the likely positive consequences for our business. Undoubtedly, the only ones who can take advantage at times when others don’t dare are those who may be monitoring these opportunities that the context offers them. Let us not forget that without risk there is no return.
The uncomfortable uncertainty
Usually, entrepreneurs do not tend to make an analysis of their critical risks, but projections of their business variables, biased by optimism or pessimism at the time of making them. The problem is that we generally overestimate our prediction abilities and underestimate what can go wrong.
It is often believed that an analysis of the past will help us manage future risk, and history has proven that this is not the case. It is very common to see managers who run their companies looking backwards, as if we could drive a car using only our rearview mirror. In other cases, we look ahead detecting the most critical sources of uncertainty, but underestimating events due to their low probability of occurrence. The problem is that sometimes these events could cause incalculable losses (because they are not calculated either!) and not paying attention to this can put the business at risk.
It is time to start valuing, “winning”, in the same way we do, “avoid losing”: a dollar lost is worth the same as a dollar gained.
Risk management, a source of profit
Risk management helps us understand uncertainty in order to reduce the impact of threats and capture the opportunities that are always present in troubled waters. There are today a large number of tools to permanently analyze risks; so, what only remains is to have the will to do so.
Influence diagrams make it possible to generate an understanding of the variables that impact the business and how they relate. Stochastic modeling makes it possible to include even low-probability risks and evaluate the effect they have on our business. The generation of uncertainty dashboards help us periodically monitor the most critical uncertainties. These tools, among others, can help us to robustly manage risks.
At Tandem, we routinely work in three steps to help organizations manage uncertainty.
1. Identify the critical variables that affect the area or the business throughout the different stages of the value chain. It is crucial to detect which are essential decisions (those that add the most value to the company) and to distinguish their related uncertainties, whether external (price of inputs, consumer behavior), or internal (operational or management risks).
2. Prioritize these variables, conducting an impact analysis. It is crucial to know the degree to which each variable affects our business (sensitivity analysis) and to be able to assess whether we are willing to take those risks. In some cases, the occurrence of certain events could turn the company upside down and that is where we need to act in advance. Uncertainty management does not end once the variables are listed, because there are events that are very difficult to predict, even of low probability, but that could have very high impacts if they occur. In these cases, the recommendation is to focus on the consequences. Through contingency plans, companies can prepare for eventualities, instead of trying to guess when they will occur.
3. Monitor the most sensitive variables in a continuous and unbiased manner. When there is a regular practice of checking the critical variables, we can encourage ourselves to decide by taking advantage of the risk in our favor, knowing that we will have early signals which help us to act in advance, to preserve the strengths of the business, or to capture situations that can make a difference in uncertain contexts.
The reports that, as an obligation, are made to present to shareholders or to comply with internal regulations, are no longer enough; executives today need to become aware of the risks to which they are exposed and manage them advantageously.
To do so, companies need to work on creating a space in their agendas that links them to uncertainty. In some cases, they will have to do it internally, consciously incorporating it into their business plans. In others, by assigning executives specialized in “risk management”, or by outsourcing the analysis and committing to its management. Today, it is necessary to invest resources in managing risks properly, because we never know whether there is a threat waiting just around the corner that takes us out of the market, or a great opportunity to capture.
Partner at Tandem.