Risk Management: The path to competitive advantage

I remember first learning about Michael Porter and sustainable competitive advantage during my MBA (Porter, M. E. The Competitive Advantage: Creating and Sustaining Superior Performance. NY: Free Press, 1985). The potential benefits of a sustainable competitive advantage struck me as being a highly valued objective. My career took me into the realm of risk management where I have observed that many firms view risk management as a necessary governance function. Much of my career has involved developing and implementing risk management programs. In doing so, I have often been asked “what is the benefit?”. The answer usually involved describing regulatory imperatives, loss avoidance, or esoteric references to superior performance, and rarely caused excitement. We, collectively, got it wrong. Risk Management is the path to sustainable competitive advantage.

Successful decision makers recognize that the future is uncertain. They consider the different potential outcomes and make choices today which favour the likelihood of beneficial outcomes in the future. This is risk management. Michael Porter identified different strategies for developing a sustainable competitive advantage including competing on cost, differentiation, and focus. I observe that even the choice to pursue any of these strategies is a decision with risk, and therefore requires risk management. Porter, and others, have proposed a variety of tools and techniques to help firms make better decisions while accepting inherent risk. In recent years, various authors, including myself, recognize that an effective risk management program is the means by which quality decisions can be made.

Strategy and competitiveness are time sensitive. Risk management optimizes the likelihood to stay on the path to consistent success. The outcomes of strategic decisions become evident over time. Absent risk management, the resultant path will more likely diverge significantly from the desired path to success, especially over longer periods of time. Effective risk management adds another dimension to strategy and decision making and minimizes the undesired divergence over time allowing a firm to repeatedly, and with higher probability, reach the desired state.

An effective risk management program can be described simply, albeit implementation is often much less simple. The first requirement is to clarify the business objective: what is to be accomplished and by when. With this, we can start to employ risk management. First, we need to consider what different outcomes could occur. These are the inherent risks. A structured language to describe these risks is very advantageous. As we consider the inherent risks, we need to consider the acceptability of those risks. Some will be desired, some will be intolerable. We need to understand what actions we can take, or avoid taking, given the likelihood of each risk. We need to consider what resources we need to deploy, or need to hold in reserve, to enable us to maintain acceptable levels of risk. These discussions effectively lead us to discover the optimum strategy. Once we begin executing strategy, risk management continues to add value.

Effective risk management recognizes that circumstances continuously change. For each risk identified as part of the strategy we need to identify how we will monitor the risk over time and appropriate contingency plans. A clearly defined plan to observe, decide, and deploy resources to address the changing risk landscape. This step is the one we are likely familiar with and includes the establishing of policies and procedures, monitoring and reporting, and contingency plans. This last step is also what led many of us to describe risk management as a governance function. The challenge, however, arises when the rules and restrictions become disconnected from the strategy they aim to support. The rules take on a life of their own. The benefit became a burden.

The successful leaders of tomorrow will choose to include risk management practices in strategic decision-making processes. They will recognize their risk management experts as the key to their ultimate sustainable success.