But when does risk-taking make sense?
By Eve Tahmincioglu
A majority of board members and top executives see value in taking on risk, but not enough are actually being risky.
Directors and executives see risk as playing an important role in value creation, but only 17 percent are actively harnessing risk to drive returns, according to a recent Deloitte Global report titled, “Taking aim at value: Avoid overconfidence and look again at risk."
The key is figuring out when risk makes sense and making the strategic leap, says Sam Balaji, Deloitte’s Global Risk Advisory Business Leader.
The following is a Q&A with Balaji:
Q. Can you explain risk?
A. Risk is the potential for something to gain or lose value and fundamentally revolves around uncertainty about the future. Historically, it has a negative connotation – i.e., anything that might happen that could harm a company and destroy value. Businesses face countless negative risks - here are a few examples:
· An economic slowdown that reduces revenue and growth
· Employee misconduct that costs a company money and damages its reputation
· A cyberattack that generates bad press and results in lost intellectual property, or interferes with operations
· Market changes and shifting customer preferences that make a company’s products less appealing
All of these examples reflect the traditional negative slant to risk. However, in reality risk and opportunity go hand in hand.
Although risk management has traditionally focused on minimizing risk -- i.e., reducing the potentially negative impacts of uncertainty -- it is just as important to capitalize on the upside of uncertainty, taking advantage of opportunities by intelligently embracing risk.
Companies that actively embrace risk with a strategic lens and appropriately balance risk vs opportunity will drive long-term value creation and impact.
Q. And what does it mean, that directors are not actively harnessing risk? Are they just focused on short-term results and not investing in innovation?
A. “Actively harnessing risk” means looking for opportunities where the upside potential more than justifies the associated downside risks. Embracing risk, rather than running from it.
Traditionally, many companies have focused on avoiding and minimizing risk, which caused them to overlook (or actively avoid) valuable market opportunities.
Digital disruption is a good example. For established companies, digital disruption tends to be viewed as a risk, since it threatens the status quo. However, it also presents a wealth of opportunities. Although current market leaders might be tempted to address the risk of digital disruption by shoring up their traditional business models and sales channels, this defensive approach will likely just result in a long, slow death spiral. On the other hand, market leaders that embrace the risk of disruption by becoming their own disrupters may stand a better chance of retaining – and even strengthening -- their position of leadership.
Q. What advice would you give to directors who are wondering how to balance risks and rewards, especially in an environment where quarterly results are what folks are so focused on?
A. Boards need to remember that one of their primary fiduciary responsibilities is to focus on long-term value creation. That realization alone can help individual board members stand up to short-term pressure from investors and analysts.
Also, from a practical standpoint, it is critically important for Chief Risk Officers (CROs) to have frequent, direct, and transparent contact with the board. Many board members don’t have a strategic view of risk – and don’t embrace risk as an opportunity – simply because they aren’t fully aware of the risks and opportunities the company is facing. Recurring contacts with the CRO can help them get up to speed so they can make informed decisions that properly balance the company’s short- and long-term needs.
Board composition is also an important area for improvement. Most boards are relatively homogeneous, and while they might have a wealth of business experience, their lack of diversity can lead to groupthink. At the very least, boards should strive to include a more tech-savvy perspective that can help them address the profound risks and opportunities associated with digital disruption.
Q. Do most corporations have CROs?
A. According to the survey, 63% of companies have a full-time CRO. However, in our view that number needs to be 100%. Also, in many cases the full-time CRO – despite the title – is overly focused on tactical issues and risk mitigation, rather than viewing risk as a strategic opportunity. What’s more, many full-time CROs do not have a sufficiently close relationship with the board, which limits their effectiveness.
Q. What if a company doesn’t have a CRO?
A. Companies that don’t have formal, full-time CRO need to get one. However, simply having someone with the title of CRO is not enough. As noted earlier, the CRO needs to be directly involved in strategy formulation, and needs a direct relationship with the CEO and the board.