The strategic process is fraught with uncertainty. Misunderstanding uncertainty and risk can undermine strategic efforts, but implementing risk literacy at all corporate levels can help mitigate the effects.
Strategic management involves making decisions using a process of formulating, implementing, and evaluating a series of actions designed to create and sustain a company’s competitive advantage, contributing to its success in the industry in which it operates.
But the strategic process leads to success only when it is ongoing and iterative. Strategic decision-making requires a continuous assessment of a corporation’s internal capabilities (or lack thereof), factors which it controls, to deploy them for its benefit against the external opportunities (and risks) present in its operating environment, factors which it does not control.
Risk, uncertainty and strategy
A student of strategy will recognize this as the company’s SWOT. A company’s strengths and weaknesses co-exist, one defining the other. There is bad in the good. Likewise, the opportunities and threats represented by the external environment are inseparable – two sides of the risk and reward coin, the good in the bad.
Strategy is complicated, and it is important to understand as a never-ending, simple iterative process. Strategy is complex because uncertainty attends its every step.
The continuous assessment of internal factors and their deployment against external factors follows a cycle of description, analysis, and action. For their decisions to lead to success, managers must know the situations they are dealing with, understand what needs to be done in each, and develop correct courses of action.
Managers cannot formulate effective strategies until they correctly describe the internal and external factors that characterize their company and its industry. The quality of their analysis depends on the thoroughness and accuracy of their description. Applying analysis to description leads to understanding.
Formulating good strategy depends on the quality of understanding managers possess.
But the cycle does not end with formulation. Implementation requires a thorough and accurate description of the strategies formulated. These are then analyzed so their implementation can be understood. A correct understanding of how strategies should work makes it possible to implement them with a maximum probability of success.
An important feedback loop exists in evaluation. After implementation, evaluation combines the description of how strategies are working out (or not) with an analysis of why this is so. This understanding allows managers to make strategic mid-course adjustments and lays the foundation for the creation of new strategic initiatives. What follows is the development of new descriptions to be used in formulating the next generation of strategies.
And so on.
It all comes back to culture
Frank Knight suggests that risk and uncertainty occupy the very heart of the strategic process. Strategy and uncertainty go together. A company cannot hope to be successful without some failures.
An important source of strategic failure is the confusion of risk and uncertainty. The strategic cycle begins and ends with descriptions of risk, and “taking the consequences.” Any confusion at this level permeates the entire analysis and all actions that follow; risk and uncertainty are built into the strategic process, so it is important to get them right.
Knowledge of this process is a key component of corporate culture. A company can be said to be developing a mature risk culture if it actively:
- Constantly defines risk and uncertainty and differentiates between them.
- Understands risk and uncertainty in the context of the company’s experience with internal and external factors.
- Systematically disseminates this understanding throughout the organization so that staff on all levels may use the information and knowledge to make better decisions.
Again, the cycle of describe, analyze, and act.
Starting with risk literacy
Most companies find it very difficult if not impossible to create an adequate risk culture, much less a mature one. The tendency is to create risk awareness at the top, among the Board and in the C-suite. The problem with this approach is that risk is not managed at that level. Once the audit committee becomes aware of risks, it is often too late. General Motors is a good example of this.
This is the problem. Catherine Bolgar of Zurich Insurance Group writes that risk management “needs to be embedded in all aspects of the organization.”
It is bad enough that risk and uncertainty are confused at all organizational levels. At many levels, there is no concept of risk and uncertainty. The lack of a risk culture throughout the organization is especially detrimental to the strategic process. If it is to deliver on its full potential, corporate strategy must begin with an proper understanding of these concepts.
What is required at the Board and C-suite level is the will to implement a risk literacy approach throughout the corporate structure.
