Quick Insight
We underestimate the range and severity of outcomes. We overestimate our ability to control our environment. We overestimate the odds of good outcomes and underestimate the odds of bad outcomes. I list three types of risk from a Harvard Business Review article and how to best mitigate each type of risk.
We live in a risky world. Specifically, we live in an uncertain world. Every strategy we form doesn’t always lead to the expected results. We are subject to luck and a constantly changing business environment. The most recent examples were COVID, supply problems, staffing shortages, and inflation.
Some people try to ignore this uncertainty, but most of us try to control it. In our planning, we assess the environment through SWOT analysis and may even have some backup plans in case our main strategy falters. And so we sleep soundly knowing we have conquered uncertainty.
Unfortunately, we deceive ourselves. We underestimate the range and severity of outcomes. We overestimate our ability to control our environment. We overestimate the odds of good outcomes and underestimate the odds of bad outcomes.
A Harvard Business Review article from June 2012 makes the case that many companies incorrectly manage risk. They pick the wrong way to mitigate the types of risk they face. The article summarized three types of risk and how to mitigate each:
- For risks that arise in the company with no strategic benefits, you should eliminate these cost-effectively. You have more control over these, and they can usually be limited with policies and procedures.
- Companies often take on risks as part of their business model or strategy. For example, in banking, we took on credit risk by making loans. These risks take more active, ongoing, and technical management. Early warning indicators must be monitored and elevated quickly when falling outside of risk tolerances.
- For external, uncontrollable risks (e.g., natural disasters), use envisioning techniques like scenario planning
We rarely put in the time and effort to fully mitigate risks because they seem remote. Let’s face it, risk management isn’t as fun as making plans to seize opportunities. Those who do good risk planning find themselves grabbing huge opportunities from those who don’t.
I wish you discipline to mitigate the risk you can and the flexibility to ride through the unforeseen. I wish you well.
- Rob Stephens
Further Insight
CFO Perspective Resources
Get all the CFO Perspective resources with a FAST (Finance and Strategy Toolkit) membership.