Risk management has become a bit of a hobby-horse for me. It’s part of corporate governance for UK Plc’s and US corporates. I was exposed to it first when I was on the board of Tempus Plc and then again at SABMiller Plc. It’s fair to say that like a lot of corporate governance, company directors regard Risk Management as at best a necessary chore and at worst a pointless exercise. Business is at its heart a risk/benefit decision process and well-run businesses would claim that their normal management processes take care of risk assessment. Every time Risk Management came on the agenda at SABMiller, my old boss, Graham Mackay, would, with some irritation, point out that the origins of Risk Management lay with governance for banks and their particular needs rather than manufacturing businesses like ours. He had a point and to be fair SABMiller is an extremely well run business.

However, always the contrarian, I really enjoyed Risk Management (I was on the RM committee at Tempus and had to oversee its implementation for the marketing function at SABMiller). The arguments made sense to me:-

When businesses suffer serious calamity people with hindsight always say the risk could have been forseen. They are right more often than not. In fact, more often than not someone in the organization or a disaffected former employee claims they wrote a memo about it.

An exercise where you take a hard look at what could go wrong and then discuss ways of either avoiding, mitigating or insuring against it, is a fundamentally very strategic exercise. Of course you see risks but you can also see opportunities. At the very least you get fresh insight.

There are various ways to approach RM (good old Wiki lays them out) but it is essentially fairly straightforward. An experienced and accountable group of people look at all the potential risks for all aspects of the business and draw up a list. They then catagorize the list into how likely they are to happen (high, medium, low probability) and how serious the effect would be if they did (high, medium, low impact). This then gives a matrix and of course you start with the highest probability/highest impact and work your way through them. Can they be avoided by improved management processes and/or better monitoring? Can they be insured against? Is further work or more fundamental change required? Logical stuff.

The point is, the risk is brought out into the open – what is the worst that can happen, how likely is it, what can we do about it? It’s impossible to do this without getting some great insights about the business and identifying some sensible actions to manage the risk.

The reason I am so obsessed by this subject is that for me it lies at the heart of what triggered the Recession i.e. the failure of the banking system (ironic that isn’t it?). It is also the solution, for me, as to what we should do to prevent a future reoccurrence of the systemic failings in the financial institutions, and a preferable one to lots more regulation and red tape.

Surely if Risk Management had been effective – that is to say applied with conviction and purpose – at Lehman Brothers (and the rest of the banks) they would have realized that they were massively exposed if house prices turned down? Does anyone now believe that Risk Management (forget the ethical questions just focus on the good business sense argument) was alive and well under Lord Browne at BP?

We don’t need loads more legislation. We have Risk Management – we just need to ensure that it is taken entirely seriously. And whom do we rely on to do that? Non-Executive Directors, that’s who. There has been a lot of whinging and whining among that elite group NED’s on the boards of the big corporates. They complain that they carry so much accountability and responsibility for very little by way of reward as a result of all this pesky governance. How can they be held accountable, they have to rely on what the executive board tell them about a business they get involved with only 6 or 8 times a year? Bullshit.

A well chosen, vetted and experienced Non-Exec should know enough to be able to ask the tough questions and should be relied upon to see that protocols like Risk Management are taken seriously. Are you telling me an experienced banker could not have asked a few probing questions about toxic debt and the impact of a downturn in house prices (especially given how deep Lehman and others were into it)? Are you telling me an experienced oil man could not have spotted the shortcuts that BP were taking and the risk they were exposing themselves, their shareholders (which includes a lot of pensioners) and all of us to? I’m bloody sure I can in marketing which is my chosen area.

We do not need to change much. Keep the governance and regulation we have, just make sure it is applied vigorously and hold the NED’s to account if it is not. The one change I’d make is to have a potential Non-Exec vetted and approved by an independent authority. And I don’t buy the argument that any of this will put the good Non-Execs off joining a board. It is very prestigious, very interesting and already well paid. They get circa $50 -100,000 to attend 6-8 board meetings a year (and read the papers and take an active interest in the business). This fee could be increased – surely it’s worth it – but in my view that is not the issue or the barrier to having good non-execs. Breaking up the cosy club of senior businessmen and well connected retirees and opening it up to better qualified people is the issue. No names, no pack drill but I have met some truly ineffectual and disengaged Non-Execs in my time.

Business is risky and the impact of corporate calamities affects all of us. It can be made much less risky and no less profitable with a bit of common sense.

Post Script

For those interested in the application of risk management thinking specifically to marketing you might like to read ‘Brand Risk’ by David Abrahams. You’ll see some contribution from yours truly but despite this, it is an interesting book from a smart author.

At least I think it is but then Risk Management is a hobby-horse of mine.

Malcolm Gladwell is a great writer and a true thought-leader. I chose to include him and his first book, Tipping Point, and stuck with that choice even after the publication of his second book, Blink. His third book, Outliers, may in fact be his best book yet. No-one can argue the influence of Tipping Point. It propelled Gladwell to being one of the world’s most highly sought after and highest paid speakers and writers. The notion of there being a Tipping Point in how ideas, including new business ideas, catch on has itself caught on like wild fire. Mark Earls, featured on my site, takes issue with some of the social science behind Gladwell’s theories but even Mark would acknowledge the power of Gladwell’s work in reshaping thinking in the business world.

I actually prefer Outliers although I hate the title – it is positively misleading. This book is about the secret of success and, in a similar vein to Freakonomics, another of my Top 10 Best Business Books, it takes a closer look at the data and facts that lie behind freakish success. As Gladwell puts it “Success is not a random act. It arises in a predictable and powerful set of circumstances and opportunities”. He then sets out what these are based on a series of true stories stretching from Bill Gates and The Beatles to Korean Air (whose story was originally about spectacular safety failures).

You could criticize Gladwell for stringing out these stories and it is true that no detail or flowery description is spared in first saying what appeared to happen, then showing what really happened and the lessons to be learned. I forgive him for this for two reasons. Firstly, he is a writer and so like all writers he wants to paint a picture in words, which he does very well. You get drawn into the stories, you get to know the people and their lives. Secondly and most importantly, he has to spin the story because if he did not the conclusions would seem trite and they are anything but. They are powerful and very important – to blow the denouement of the book, Gladwell’s point is that if only we could see past the myths and apparent blind luck we could see that with the right opportunities and circumstances we could help create a million Bill Gates.

I always like to give people the summary, the 2 minute version, because that is my thing – I like to give the maximum return on the time you spend to learn about business. You then make up your mind whether to invest more time to learn in more detail. So here they are, the 6 key points, but they will sound trite, even platitudinous.

Here is the secret of success:-

1. Be born at a certain time – e.g. people born in the first quarter of the year do better simply because they are older than their school peer group.
2. Spend at least 10,000 hours getting really, really good at something – as Bill Gates did because he luckily had access to a computer, which was rare at the time, and he was a geek.
3. There is an IQ threshold of 130 – above that other things come into play like being a divergent thinker – in the same way that above a certain minimum height other things determine how good a basket ball player you are.
4. Your family circumstances are key – middle class kids grow up empowered, with a sense of entitlement and in a home full of books.
5. Your cultural legacy is key – Asians have a much harder work ethic because they come from a rice growing culture (much, much more demanding work than growing other crops as they did in Europe i.e. 3000 hours work a year versus 1200). On the other hand they tend to respect authority too much and that accounted for Korean Air’s appalling safety record until they brought a westerner in to get Pilots and First Officers to work as partners.
6. In one sentence success comes down to chance and opportunity plus hard work, persistence and experimentation.

They may not sound earth shattering but Gladwell’s point is that if we see success in this way, we can stack the odds to create much more success in the world. Simple but very well argued and very powerful. The title could have been “Outliers i.e rare success stories need not be rare” – ok, not that catchy. The sub title of the book, “The Story of Success” is catchier but again misleading – these are the facts not just the story of success.

I like Outliers a lot and if you enjoy reading a well written book so will you. I won’t change the book against Malcolm’s name in our Top 10 Best Business books list just yet – I will wait until you and other business people regard it as more seminal that Tipping Point. I think you might. Success is everything in business – and this book is all about the secret of success.

This topic always seems to attract interest, I guess since so much of business is spent doing it and then living with the consequences.  The most common problems with budgets is that either people just look at the past and add on a bit for inflation (or the expectation that they will get cut back so better to start high) or else they double guess whoever will have to sign off the budget. “We better not go in asking for more than X or they’ll think we’re mad”. Another common mistake is to work the percentages based on benchmarks – it is just a version of setting budgets based on historical precedents. “Other businesses like us typically spend 2% of revenue on R&D so we will so the same”. Interesting to know but not the way you set a budget.

A budget, any budget, is an investment in the future that is intended to have a positive outcome. That is where you start – if successful what is this worth to us? The next thing is to look at the tasks that need to be accomplished and the realistic costs. “Task related budget setting” has to be the baseline.

Then you see how this can be funded, over what timescales and the effect on cash as well as P&L and balance sheet. Not so hard.
Adjust accordingly – if the budget outweighs the benefit (or is uncomfortably close) then re-evaluate the benefits not the budget. If the benefits by far outweigh the budget but there is an issue with funding then look at alternative ways of funding or alternative timescales over which the budget is invested – but don’t re-evaluate the budget.

Finally, when you are happy with all of that, then you look again at the budget. As I suggested before, do the plus 10% or minus 10% test. If you spend an additional 10% where would you spend it? If you had to cut 10% where would you cut it? This tells you a lot – where are you scimping, where might you have some slack (in which case put it in a contingency budget).

This leads on to the final two stages – risk management and procurement. Look at each individual task within the budget and evaluate the risks on two axis – how likely are they to happen and how big a financial impact? Decide what you need to do about the high likelihood/high impact. Then apply sensible procurement disciplines – have you compared alternative suppliers or ways of doing it? Do you understand how your suppliers costs are made up and examined ways of reducing them.
It is not that complicated and it is not that hard. But is a whole lot better than “last year’s budget plus 5%/what we spent last time/what our competitors do”.

The next time you are in a budget setting or review meeting go through this simple process:-
•    Benefits
•    Task related budget
•    Funding
•    Plus or minus 10%
•    Risk management
•    Procurement

I guarantee a better discussion and budget outcome!