Disruptive risk reflections - autumn 2022

In recent articles, I have made the case that the significant developments in the external environment are driving changes in the risk profile and indeed the resilience of individual businesses. However, no sooner has pen been put to paper than new economic, geopolitical and energy data emerge to further complicate the outlook for business leaders. In many ways, there seems to be only one constant, that disruption has become a permanent and defining factor in decision-making. It is therefore inevitable that strategies, plans and business cases should incorporate stress testing to reflect the increased level of uncertainty. 

In the UK we are once again faced with further political upheaval as Liz Truss has taken the reign as the Prime Minister and the Government’s response to energy price volatility, inflation, cost of living challenges and the public sector debt burden is being articulated and implemented. At the same time, business leaders have to make both tactical and strategic decisions to protect value in the short term whilst continuing to create long term value for shareholders and wider stakeholders. These are complex decisions which involve challenging risk-return trade-offs. 

It is clear that management must take the lead in articulating the difficult questions that are facing business as well as coming up with well-reasoned answers that reflect the uncertainty that surrounds the strategic and tactical choices they face. As discussed in other articles, scenario based planning and active use of stress testing is required provide additional insight to support such key decisions. Additionally, implementation of the decisions will only be successful if the reward systems are updated to reflect the new priorities and measures of success.

In many recent discussions it has become evident that some businesses do not have the ‘muscle memory’ required to navigate the current situation, which is hardly surprising given, for example, the low inflation and low interest rate environment we have experienced in recent history. It has also become apparent that data is scarce in terms of building distributions or modelling the range of possible outcomes. Therefore, scenario modelling and use of techniques such as curve fitting (e.g. estimating best fit probability distributions based on limited data) to build estimates for risk parameters will be required. 

So, what should the Board do in addition to the Business-as-Usual risk management activities:

• Engage in stress testing of strategies and business models to get a better handle on how resilient they are in the context of the level of disruption they are facing
• Use the stress testing and the discussions with management to assess whether the business has the right level of agility (see link above) or whether unintended internal barriers have been created
• Demand even more robust risk analysis in support of key decisions and / or business cases for change
• Encourage management to view disruption from a value creation perspective by identifying potential new business models or value propositions
• Evaluate risk appetite in relation to the changed risk profile as well as the financial strength of the firm

For many senior leaders and Board members, the trade-offs between short term survival and longer term value can often lead to sub-optimal decisions and value destruction – often caused by not taking into account the value of optionality. It is also the case that, in the post decision analysis, the context in which the decision was made can have changed dramatically. 

In summary, there are a plethora of challenges facing management decision- making – a range of perspectives and inputs are required, and this can be seen as an impediment to the speed and agility with which the organisation is able to respond. At the same time, striving for a gold standard of analysis and insight can prevent the organisation from acting even if acting means that they have to reassess and even course correct as new data points become available. Equally, given the pressure to act, insufficient time might be allocated to ‘kick the tyres’ on the outputs to surface gaps, biases and unrealistic assumptions. For Board members, the question is therefore; Are your businesses ready and primed to provide the analysis and insight required to make prompt decisions to protect as well as enhance value, while recognising the uncertainty surrounding each of these?