In a study conducted by Booz & Company in 2012, on companies that had substantial loss of wealth over a 10 year period, the driving factor was underestimating strategic risk. This was the number one cause of shareholder value destruction. However, this doesn’t have to be the case for companies going forward. It was determined that mismanagement of strategic risk (top-level decisions made by the executives) was the culprit. Mismanagement of strategic risk included what products and services to offer, whether manufacturing should be outsourced, and what acquisitions should be made.
Today, sources of strategic risk continue to increase. Advanced technology development is forcing companies to rapidly adopt new products, services, and business models. Organizations are more vulnerable to theft and loss through digital information. Disruptions in supply chain affect both companies and customers. A company’s mistakes are broadcast instantaneously across social networks and natural, political, or regulatory distress can cause major turmoil. Companies need to learn how to effectively anticipate and prepare for these types of risks to survive.
In the past decade, companies have steadily increased their focus on risk, partly as a reaction to the requirements of the U. S. Sarbanes-Oxley Act of 2002. However, they’ve mostly done this with a bottom-up approach. This approach is proven to be a flawed approach. Risk controls in individual functions such as accounting, finance, and compliance have improved while enterprise risk management (ERM) teams are accountable for identifying and evaluating risks facing their companies. Although ERM teams can effectively identify and prepare for risks associated with smaller business decisions, they don’t have the ability to evaluate the risks entrenched in senior management’s decisions. ERM teams have to assume that the strategic decisions made by senior management are sound. For example, ERM teams can evaluate risks associated with doing business with manufacturers in Asia, but, they can’t evaluate whether the company should be outsourcing there.
Out of the 103 companies studied, strategic mistakes were the primary factor 81 percent of the time. Half of the time, loss of value happened gradually, over many months or years if it took the company too long to grasp the changed economic environment or it lacked the dexterity to react. The other half of time, loss value occurred in months, weeks, or even days. These sharp decreases were either caused by strategic failure or operational issues. The study went as far as segmenting loss drivers into primary, secondary, tertiary, and quaternary causes. However, even after the second-order causes were accounted, strategic failure still caused over 60 percent of shareholder value depletion.
Companies need to take a more balanced approach to strategic decision making to enhance traditional cost and value considerations. To improve risk management capabilities, senior executives should incorporate three steps: increase their awareness about uncertainty and risk, combine risk awareness directly into strategic decision making, and focus on strategic resiliency.
Change and uncertainty in the business world will continue to increase. Companies can’t accurately predict extreme events and their consequences, but, they can anticipate them. Management needs to think about what could occur and constantly add new risks into calculations as they emerge. Management can fully understand uncertainties, by discussing risk at the top levels and involving key individuals. Managers also need to include the company’s resiliency into all decision making. These steps are essential to strategic decision making in today’s business climate.
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