How to Manage Risk Like a Pro
The other day while browsing the web, I stumbled upon an old, but still very much applicable McKinsey report on risk management. Here are some of my favorite takeaways:
Risk management doesn't always mean getting things right. It means getting them less wrong, less often, with less damaging consequences. Given that we exist in a capitalistic society (good? bad? who knows), we often thing about success in terms of capitalizing on risk. However, our natural tendencies as humans often guide us through life with a focus on loss mitigation, rather than risk capitalization.
Method for identifying risk:
1. Insight and Risk Transparency: Do you have structured information regarding the situation(s) that present risk? What’s your intel like?
Less intel = more risk
More intel = less risk
2. Natural Ownership and Risk Strategy: What risks should your organization capitalize on given it’s natural talents vs. which risks should be passed on due to natural shortcomings. Not every opportunity should be taken. You have to identify which opportunities align with your long-term goals and focus on those.
Some risks should be handled directly, while other risks are delegated to more suited parties; prioritization is key.
3. Risk Capacity and Appetite: What is your overall capacity to manage risk before you over-extend or become over-leveraged?
4. Risk-related Decisions and Managerial Process: Are critical decisions made with a clear view of how they change your companies risk profile? Are you taking a shot in the dark or do you have a clear visualization for how things should go down?
5. Risk Organization and Governance: Are systems in place to help easily navigate the risk, i.e. a clear understanding of game rules or the processes of a governing body?
Examples of risks across different industries:
- Pharmaceuticals: How robust is the R&D pipeline? What drugs should we license?
- Consumer goods: Should we lock in volatile materials and packaging costs? Will we be able to pass through commodity price increases?
- Electric utilities: How should we invest in view of the controversy over climate change with regard to regulations and renewable power?
- Telecom: How and where should we invest to compete in Voice over Internet Protocol (VoIP) markets?
- Software: Do our global sales justify multi-local manufacturing? Can we manage currency risks more effectively with derivatives?
- Automotive: Should we continue to grow our call-center in India or look for a lower cost site that will take longer to become operational?
- Railroads: Should we hedge our fuel costs? Are we helped or hurt by higher oil prices given their competitive impact on truckers?