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Identifying business risks: two consultants urge finance executives to become the eyes of their corporations--looking for threats and opportunities inside and outside--and to take the lead in risk management and decision-making to ensure their companies' long-term survival.

Often, companies stagnate, decline or die because they minimize or miss profound changes. No one individual is responsible for observing external and internal risk factors to assess their implications on the company. To influence the outcome in such situations, finance should become the eyes on the inside and outside of the corporation, watching for threats and opportunities. Issues that emerge as pressure points over decades then often behave like dominoes, cascading in causal relationships that affect multiple organizations.

Consider these examples:

* The serial decline in U.S. manufacturing in the 1970s and '80s in the face of lower-cost foreign competition;

* The demise of numerous minicomputer makers due to the rise of the personal computer;

* The rise of special-interest attacks around sensitive issues such as foreign child labor, employment discrimination and offshoring;

* Regulatory assaults like that perpetrated by New York Attorney General Eliot Spitzer, which have roiled the securities, mutual fund and insurance industries in rapid succession.

To prepare for and respond to such threats, finance needs to be able to identify trends and to determine materiality and probability. A starting point is to analyze external change drivers (demographics, technology, globalization, channels, competitors and regulations) and determine how they affect the specific organization.

With an examination of the key external change drivers in hand, information in silos throughout the corporation should be ascertained and amassed from multiple sources and could prove invaluable. New technologies that enable the aggregation and organization of data can speed this process greatly.

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In today's crusade for corporate survival, the finance function is in position to lead the organization through the uncertainty, volatility and complexity impacting every business and industry. The real value-added role for finance is in helping the organization extend the life of a flagging business, to lessen the steepness of a decline or to seek new opportunities that can fill a void.

A new management model is needed to alert senior management to impending risks. This system involves an understanding of market risk, the development of dynamic planning and decision-making processes and the maintenance of operational control in the face of continuous turmoil.

To launch such a system, finance should start by halting all incremental process improvement efforts and begin outsourcing all transaction processing and administrative work. Next, those seeking long-term survival must take four steps:

1. Establish a risk-based early-warning system to recognize major threatening trends that take years to emerge, assess the degree of exposure to the business and enable managers to act early and decisively.

2. Radically refocus performance reporting and analysis on key relationships and linkages; rebalance measures in terms of leading and lagging, internal and external information.

3. Replace the annual planning process with a repeatable, short-cycle, tactic-focused process that takes less effort and time and yields better results.

4. Recapture intuition as a factor in decision-making, fostering dialogue, debate and discovery to develop meaningful scenarios, create practical action plans and identify the first signs of flawed decision-making.

Establish a Risk-based Early-warning System

To be effective in establishing a risk-based early-warning system, companies must get beyond the data in their enterprise resource planning (ERP) system. Finance can begin to identify gaps in the company's intelligence and fill them. The emerging picture should then be circulated throughout the company, with orders to begin thinking about how to respond and embed the responses in business plans.

A set of risk factors will emerge that requires monitoring. Measurement could be systematic or discrete. Periodic research might be commissioned, or there could be event-triggered reviews. The point is to identify leading indicators and sources of data relative to positive or negative trends regarding a corporation's key risk factors that can then be programmed into the organization's performance management system to provide early warning as a prompt for management action.

Running a risk-based early-warning system is a full-time activity. Identifying the threats is relatively easy, but getting the organization to take the predictions seriously is harder. There will be more effort on changing what is inside than outside. Finance must educate the company on the emerging threats and the possibilities.

To ensure full leverage of data regarding risk, finance should establish an enterprise risk-management (ERM) team. A small team of analysts is supported by people with a range of skills sets--futurists, economists, sociologists, anthropologists, former management consultants and the like--with expertise predicated on the factors that most threaten the company. One might begin with an expert in changing demographics. The risk management team will identify and monitor trends, build and maintain the overall risk profile and, more critically, ensure risk is factored into all decision-making, collate and disseminate information and educate the organization.

Finance will lead the project: conveying new anticipatory information, advising senior management, redefining the decision culture, reallocating resources and driving change. These efforts are vital to corporate survival, permitting companies to either stay in business and have time to get ready for future trends--or prepare to exit the business when appropriate.

Radically Refocus Performance Reporting and Analysis

Stagnation and decline of businesses will likely accelerate if companies persist in how they presently measure, report and analyze performance. Here, too, finance must lead in radically refocusing performance reporting and analysis on relationships and linkages. Measures must be rebalanced in terms of leading and lagging, internal and external information.

Measurement should be based upon exceptions, driven by materiality, triggered by events and anticipatory of the future effects of current events and trends, all filtered by technology. Only actionable data should be reviewed, and reporting should be driven by the data that is needed, not simply what can be obtained from systems.

There is a defined universe of measures of importance based around financials, markets, customers, operations, employees, suppliers, competitors, infrastructure, risk, projects and compliance. These measures provide a comprehensive framework for defining the key relationships and ratios that allow managers to understand performance and rapidly respond to opportunities and threats.

Finance needs to refocus the organization on measures that are key to its operations and reduce the focus on single-point measures that offer little insight into the true drivers of performance.

The secret is to abandon the reliance on absolutes. Ratios are the solution, measuring linkages, relationships, interdependencies and trends. Finance can start by helping the organization define no more than 20 critical business ratios for the corporation, such as revenue growth relative to the market, or the relationship between changes in customer satisfaction and revenue per customer.

These ratios will vary by company based upon the type of business, organizational structure, external environment, life-cycle stage of each line of business and chosen management model. Cascading the ratios throughout the organization, there should be no more than 10 key ratios per manager, and about 30 percent of these ratios should reflect external or market-based factors. Standard time-based reporting must transition to include reporting triggered by events, trends or tolerances.

The astute organization will test all reporting against seven measures of reporting value: relevance, trend, tolerance, early-warning, call to action, forecast/projection and additional contextual information.

Technology plays a key role in refocusing performance reporting. Finance should develop vehicles for using technology to filter, select and disseminate the information. In addition, technology should eliminate all manual data collection, consolidation, reporting, dissemination, formatting and presentation. Time is thus freed for analysis, interpretation and discussion.

Gut the Annual Planning Process

A vanguard manager must always know where the organization has been, where it is presently, what its destination is and how it will get there. Typically, planning is a painful, distracting, four- to six-month march fraught with political battles. The result is a static tool, obsolete from its conception, and the longer it takes, the more likely it is to be wrong.

It is time to start thinking of planning as a process that goes on continually, refreshed every day, and is the actual embodiment of the work of a manager. To reach this state, the annual planning process must first be gutted. Annual planning becomes a method for setting performance targets, agreeing upon performance metrics and building shared commitment for performance. It is tactic-centric and embraces risk and uncertainty; it should be completed in about five days.

In this new planning, action is top-down, rather than bottom-up. Performance management systems automatically generate a baseline business plan based upon past results, adjusted for predefined productivity and growth beliefs. Discussion ensues about material events and trends on the horizon that will affect the baseline, and appropriate performance targets are established.

The focus then shifts to determining the major tactics, improvement efforts or new initiatives needed to achieve the performance targets. Against each major business/project, managers assess the probability and materiality of key risk factors and define the criteria for success, and the exit/abandonment criteria that ensure failing initiatives do not continue to drain resources. Leading indicators and results measures are agreed upon, as are macro resource allocations.

The targets should establish a bandwidth of desired performance, so managers commit to tactics, actions and resources, rather than numbers. This significantly reduces the capacity for "sandbagging the numbers" and also establishes the basis for setting incentives.

Compensation target-setting should be kept separate from the target-setting for resource allocation, and should be established based upon net change in performance, combined with performance relative to a market or peer group comparison.

Rather than creating meaningless budgets that fail to account for changes in the level of business activity, standard departmental expenses are managed using key ratios and actual trends in spending, such as recruitment cost as a function of headcount added.

Complex inter-company allocations or transfer prices for indirect costs are replaced with a flat tax, eliminating apportionment of internal chargebacks, which consume vast amounts of time and create zero shareholder value.

Once the tactical planning process is complete, it should be able to be constantly refreshed upon demand, with new or modified tactics commissioned within a week, ensuring it is dynamic, continuous and inextricably linked to the ever-changing environment in which every organization must operate.

Recapture Intuition In Decision-Making

Today's outmoded managers follow a professional approach to decision-making--creating, executing and reporting on detailed action plans. The focus is on short-term results, covering the current month or quarter. As such, trends and their interrelationships are missed. This approach presupposes that analytics are better than, as opposed to complementing, intuition.

Finance must inspire the recapture of intuition as a factor in decision-making, fostering dialogue and discovery to create practical action plans and identify the first signs of flawed choices. Finance should guide the organization to ensure that the right amount of time is allocated to innovation, improvement and execution, and understanding risk and how initiatives might fail. Financial analysts should be co-located with business partners. Analyst resources should be shifted away from spreadsheets and into dialogue and discovery. Half of analyst time should be allocated to direct interaction with peers and business partners.

Technology promises the power to deliver insight through applied logic, selectivity and monitoring of key relationships, which offer rich inputs to the decision-making discussion and drive better and faster decision-making.

Both staff and management require education on the process of collaborative decision-making. Unstructured analysis should be encouraged. Working sessions should be planned for senior management to better understand key external risk factors, debate materiality, potential impact and actions the organization should consider.

Following the strategies promulgated above, the end result is a reenergized culture. The company no longer takes success and continuity for granted, nor is blind to the effects of potentially adverse external trends. The acceptance of risk is greater, as failure is contemplated along with success. Intuition and dialogue are promoted; change and speed are rewarded. Finance has the proficiency and the power to bring about these changes. The task may seem daunting, but at a time when corporate prosperity--and survival--are at stake, this may be your best approach.

David Axson (daxson@sonaxgroup.com) is President of the Sonax Group and author of Best Practices in Planning and Management Reporting. Greg Hackett (ghackett@mergershop.com) is President of MergerShop LLC and a pioneer in structural change, organizational success and tactical planning. Both are Cognos Innovation Center advisors.

RELATED ARTICLE: takeaways

* Finance has a big role in identifying trends and determining the materiality and probability of potential occurrences that can threaten a company's survival.

* To mitigate threats, analyze external change drivers and determine their affect. New technologies enabling data aggregation and organization speed this process.

* A four step-system for long-term survival includes: establishing a risk-based early-warning system; radically refocusing performance reporting and analysis; replacing the annual planning process with a repeatable, short-cycle tactical-based process; and recapturing intuition as a factor in decision-making.
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Title Annotation:risk management
Author:Hackett, Greg
Publication:Financial Executive
Geographic Code:1USA
Date:May 1, 2006
Words:2098
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