The long view getting new perspective on strategic risk

l Andrew Blau, president of Global Business Networkl Dr Hugh G Courtney, professor of the practice of strategy at the University of Maryland l Michael Denison, research director at Contr

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Contents

About this research

T he long view: Getting new perspective on strategic risk is an Economist Intelligence Unit report

that explores how companies manage long-term strategic risks in their business The report is sponsored by ACCA and Willis

The Economist Intelligence Unit bears sole responsibility for the content of this report Our editorial team executed the online survey, conducted the interviews and wrote the report The findings and views expressed in this report do not necessarily reflect the views of the sponsor

Our research for this report drew on two main initiatives:

l We conducted an online survey of almost 500 executives from around the world in October 2011 The survey included companies from a wide range of different sectors All respondents have direct responsibility for, or influence over, their firm’s risk management, either as CEO or board-level executive (42%), as chief risk officer or other dedicated risk executive (39%), or as a non-executive director (19%)

l To supplement the survey results, the Economist Intelligence Unit conducted a programme of qualitative research that included a series of in-depth interviews with industry experts

The author was Rob Mitchell and the editor was Iain Scott We would like to thank all those who were involved in this research

l Andrew Blau, president of Global Business Network

l Dr Hugh G Courtney, professor of the practice of strategy at the University of Maryland

l Michael Denison, research director at Control Risks Group

l Steve Fowler, chief executive at the Institute of Risk Management

l Javier Gimeno, professor of strategy and Aon Dirk Verbeek chaired professor in international risk and strategic management at INSEAD

l Peter Johnson, vice-president of strategic planning at Eli Lilly & Co

l Andrew Kakabadse, professor of international management development at Cranfield University

l Anne Nobles, chief ethics and compliance officer and senior vice-president of enterprise risk management at Eli Lilly & Co

l Richard Pascale, an associate fellow at University of Oxford’s Sạd Business School

l Michael Raynor, director at Deloitte Consulting LLP

l Roland Rechtsteiner, managing partner of the global risk and trading practice at Oliver Wyman

l Martin Reeves, senior partner and managing director at Boston Consulting Group

l Harri Spolander, chief risk officer at Fortum

l Tiger Tyagarajan, chief executive at Genpact

l Freek Vermeulen, associate professor of strategy at London Business School

l Chris Worley, senior research scientist at the Center for Effective Organisations at the University of Southern California

Interviewees

During times of uncertainty and change, current challenges will often take priority over long-term

plans With the euro zone crisis still in full swing and with developed markets facing the prospect

of a double-dip recession, many business leaders will naturally focus their attention on the immediate future They will seek assurances that their short-term financing needs will be met and will pay careful attention to the quarterly results to detect signs of market deterioration

This short-term focus is ingrained in institutional structures and thinking Most chief executives will enjoy an average tenure of around six years, which means there are few incentives to bring long-term problems to the top of the agenda A relentless focus on shareholder value creation has encouraged business leaders to prioritise short-term profits and share price moves over long-term performance Incentive structures have often reinforced this focus by rewarding managers for meeting short-term targets

Short-term metrics will always be important indicators of performance, and companies will always need the ability to take decisions quickly and adapt to immediate opportunities and threats But a retreat into the present will reduce a company’s chances of long-term, sustainable success Business leaders must therefore combine their skills of adaptability and addressing immediate challenges with a focus on longer-term risks and opportunities

At a time when the world is changing so rapidly, it may seem as though any attempt to think about the future will be doomed to failure In one respect, this is true No one can predict the future and the current pace of change means that it is more difficult than ever to attempt it But by considering how different futures might evolve, and ensuring that their organisation is equipped to deal with a range

of outcomes, business leaders will not only be better prepared for the future but will also be more knowledgeable about their current situation

This report explores current approaches to long-term strategic planning and risk management Based on a global survey of senior executives with responsibility or influence over their company’s risk management, and a programme of interviews with industry experts and commentators, the report looks at how companies link risk management with strategic planning Key findings from this research include:

Executive summary

Long-term risk management is rising on the agenda for many business leaders Over the past

year, almost one-half of companies say that they have made their risk management more looking At the most senior level of the organisation, discussions about long-term prospects and risks are becoming more frequent Just over one-third of respondents say that their board and senior management has increased the time that they allocate to long-term risk analysis

forward-Links between risk management and strategy are strengthening in many organisations More

than one-half of respondents say that their risk function plays a formal role in strategy-setting and in evaluating new market investments A similar proportion of respondents believe their organisation

is effective at linking risk management with strategy It is an encouraging sign that companies are adopting a more rigorous approach to considering the risks associated with their strategy, and that risk functions are gaining a more influential position within organisations

Many companies are using scenario planning, but few embed it into the overall strategy process

A large majority of companies are already using scenario planning and other tools to identify and assess long-term risks But few companies are embedding these techniques into their overall strategic decision-making Only 20% of respondents say that scenario planning plays a vital role in helping their company to formulate and adapt strategy in uncertain times Companies also admit that they may need

to allocate more time to a longer-term view More than one-half of respondents agree that they should spend more time thinking about the risks they will face ten years from now

The time horizons for strategy and risk are often misaligned Some companies are making

long-term strategic plans without a proper consideration of the associated risks Asked about the maximum period over which they consider strategic objectives, 58% say that their timeframe is greater than three years But asked about the maximum period over which they consider risks, the proportion with the same time horizon is much smaller, at % In other words, strategy discussions are less likely to incorporate an assessment of risk as the time horizon increases

A short-term focus among business leaders can prevent a more thorough assessment of long-term risks Asked about the barriers that can prevent their company from taking a longer-term view of its

risk exposure, respondents point to an executive management that is more focused on immediate risks as the chief culprit At a time of considerable uncertainty in the external environment, this short-term focus is understandable But boards and senior management must move beyond this myopia and ensure that immediate priorities do not crowd out longer-term strategic planning and risk management

Risk functions need to do more to challenge entrenched views of the future Despite progress

towards a more widespread long-term assessment of business risks, there is a danger of complacency Business leaders can often have deeply embedded mental maps of how the future might evolve It is notable, for example, that almost one-half of respondents agree that looking into the future merely tends to confirm what they already know rather than providing them with new information This highlights the importance of a risk function with the stature to question strategic assumptions Two-thirds of respondents agree that the risk function needs to do more to challenge management’s view about how the future might unfold

“It is tough to make predictions, especially about the future.” This famous quote, attributed to

the Danish physicist Niels Bohr, neatly summarises the challenge facing companies when they try to set long-term plans Despite their best efforts, and despite a plethora of consultants, tools and methodologies that try to convince them otherwise, the future is inherently unknowable So-called

“black swan” events, such as the global financial crisis, can quickly unravel even the best-laid plans And in an environment of extreme volatility and uncertainty, many executives will no doubt wonder why they make bets on the future at all

Prediction may be impossible but this does not mean that thinking about the future is pointless Indeed, in sectors with long-term investment horizons, such as energy or pharmaceuticals, it is absolutely critical to explore a range of potential future scenarios This vision of the future may not always be right, but it will at least provide some guidance on the range of potential outcomes for a particular investment “If you take your long-term opportunities seriously, then you’d better take the long-term risks seriously as well,” says Michael Raynor, director at Deloitte Consulting

Even in sectors with much shorter product life-cycles, such as fast-moving consumer goods, a term focus is important Demographic or generational changes can create new dynamics for business, which can have a dramatic impact on long-term prospects Major new threats, such as climate change, pose considerable long-term uncertainty that will ultimately require a response from every business And macroeconomic prospects in emerging markets will have a significant bearing on the success of new market-based investments

long-“If you’re wondering which emerging markets to bet on, you’ve not only got to think about year population trends, but you’ve got to think about ten-year wealth distribution changes too, and

ten-if you don’t, you may end up investing in the wrong market,” says Martin Reeves, senior partner and managing director at Boston Consulting Group

Javier Gimeno, a professor in international risk and strategic management at INSEAD, the business school, argues that long-term risk management can be fundamental to corporate survival “If you look

at why companies fail, it’s usually because of a failure to identify and mitigate long-term risks,” he says “They might miss a change in the market, or a change in technology It takes so long to react to these risks that you need to be able to position yourself well in advance That can only be achieved by

Chapter 1: Bringing the future into focus

long-term risk management.”

Long-term thinking may be important, but most companies admit that they are not good at it Less than one-half of the respondents to our survey think that their risk function is effective at managing the pace of external change or the emergence of new and unpredictable threats Only one-quarter say they are good at dealing with long-term challenges, such as climate change (see chart 1) “Long-term risks are the most important ones of all but they are also the ones for which the available tools and solutions are not necessarily optimal,” says Professor Gimeno

Andrew Blau, president of Global Business Network, a consultancy, believes that one of the reasons companies struggle with long-term challenges is that they limit their discussions about risk to factors that are unique to their organisation While this helps them to deal with operational risks, it

is completely useless at dealing with a major external event, such as the Arab Spring “When regimes started to fall in the Middle East and Africa, there were various multinationals with business in the region who really hadn’t factored this kind of geopolitical risk into their thinking,” he says “They assumed that political structures were stable and that the recent past would be a good guide to the future It’s important to take a broader view of risk, which is informed by perspectives from outside the company, and think through different scenarios about how external risks could interact with internal vulnerabilities in surprising ways.”

The key, then, is not to predict the future or become wedded to a particular vision of what it might hold, but to consider a range of different possible outcomes and assess how they might affect the business “It’s important to keep your options open and ensure that you have the flexibility to respond

to different scenarios because you cannot guarantee any particular outcome in the world,” says Harri Spolander, chief risk officer at energy company Fortum

Many companies recognise that they ought to do more to think about the future Just over one-half

of the survey respondents agree that their company does not spend enough time thinking about the risks it might face ten years from now (see chart 2) But although companies recognise the importance

of long-term risk analysis, it remains a minority pursuit Among the companies surveyed for this report, only around one-quarter say that analysis of risks that may occur more than a decade into the future is a vital part of their strategy process A further % conduct this kind of analysis, but mainly as

a thought exercise rather than as a key input to strategy (see chart 3)

The pace of external change The emergence of new and unexpected threats Continuing economic volatility

Increasing business complexity Unpredictable market demand Spotting emerging opportunities Dealing with long-term challenges such as climate change

Chart 1: How effective are your company’s risk functions at helping to manage the following?

Rate on a scale of 1 to 5, where 1=Very effective and 5=Not at all effective

Pressure to think short-term

Long-term risk management is inherently challenging As they look further out to the future,

companies will be dealing with uncertainty, rather than risk In his 1921 treatise, Risk, Uncertainty

and Profit, the economist Frank Knight defined risk as randomness with knowable probabilities, and

uncertainty as randomness where the probabilities are unknown “Long-term strategy over periods

of more than ten years is much more about uncertainty than risk,” says Freek Vermeulen, associate professor of strategy at London Business School “You really have no clue what the world is going to look like ten years from now so it can be somewhat dangerous to start measuring the probabilities of a future that may well never materialise.”

By extending their risk models further into the future, companies must be aware that the data being used to populate them are increasingly unreliable As financial institutions learned during the recent crisis, an over-reliance on models can be dangerous “You’ve got to be careful not to make model-based decisions without reflecting on the quality of the input and output to that model,” says Roland Rechtsteiner, managing partner of the global risk and trading practice at Oliver Wyman

Besides the inherent challenges of long-term risk management, there are good reasons that executives may be reluctant to focus too much energy on the distant future Over the past three years, volatility in financial markets and a highly unpredictable economic environment have made it difficult

to anticipate what will happen from week to week, let alone ten years into the future

Agility and flexibility are more important than the ability to plan for the long term Our company does not spend enough time thinking about the risks it might face ten years from now The relatively short average tenures of most C-level executives mean that there is little incentive for companies to look at risks more than five years into the future

Looking far into the future tends merely to confirm what we already believe rather than giving us any new information Investors are not particularly interested in knowing what risks the company will face ten years into the future

It is better to bring third-party consultants in to help us think about the long-term future because they introduce fresh perspectives The risk function in our business needs to do more to challenge management’s view about how the future might unfold

Chart 2: Please indicate whether you agree with the following statements

Strongly agree Slightly agree Neither agree nor disagree Slightly disagree Strongly disagree

It is a vital part of the strategy process in our business.

We do this, but more as a thought exercise than as part of the strategy process—it is difficult to incorporate it into our strategic planning.

We do not do it because we do not believe it has value.

24 44 32

Chart 3: What do you see as the value of risk analysis that considers events more than one decade into the future?

(% respondents)

At a time when many companies have been more worried about survival than how they will be positioned a decade from now, it is perhaps inevitable that long-term thinking slips down the priority list Asked about the barriers that prevent their company from taking a longer-term view of its risk exposure, respondents point to a focus on more immediate risks among executive management as the key factor (see chart ).

When companies are confronted by short-term challenges, there is a temptation to turn inwards and fix the problem by increasing efficiency or eliminating redundancy But as Mr Reeves points out, this can blind companies to the real issues “The human reaction when faced with falling returns or volatility is

to shorten the time horizon and seek out short-term tactical gains through increased efficiency,” he says “At the very moment when companies need to look ahead, they do exactly the opposite.”

Almost three-quarters of respondents agree that agility and flexibility are more important than the ability to plan for the long term (see chart 2) But while quick wits are important, these capabilities alone are not sufficient to ensure long-term success “Agility starts with a longer view because if I haven’t thought about the future, then I won’t have a range of ideas on which to draw when the unexpected happens,” says Chris Worley, senior research scientist at the Center for Effective Organisations at the University of Southern California “Instead, I have to make them up in the moment, which means that my decisions will tend to be focused on a very narrow range of options.”More long-standing, institutional barriers can also prevent a longer-term focus Pressure from investors and analysts can encourage companies to focus on quarterly results at the expense of longer-term performance “The fact that a long-term perspective is beneficial to the company is easy to grasp but it’s challenging to implement,” says Dr Hugh G Courtney, professor of the practice of strategy at the University of Maryland “There are lots of day-to-day pressures from the financial markets that make it difficult to stand strong and have the courage to prioritise a longer-term perspective over the short-term issues.”

Lack of expertise in long-term risk analysis Investor focus on short-term performance means that management does not spend much time on longer-term issues Lack of available tools

Lack of time and resources Incentive structures are geared toward shorter-term issues Relatively short tenure of most senior executives Other, please specify

We do take a longer-term view of our risk exposure

Chart 4: What, if any, do you consider to be the main barriers that prevent your company from taking a longer-term view of its risk exposure? Select up to three

(% respondents)

Management incentive structures can reinforce this focus on short-term performance Rewards are often geared towards short-term performance and there is only limited allocation towards longer-term ones There is an assumption that CEOs will only last a few years in a role, and this is often reflected in their pay structures More than one-half of respondents agree that this relatively short tenure means there is little incentive for companies to consider long-term risks (see chart 2)

But despite these challenges—which are both intellectual and structural—the ability to take a longer-term focus is becoming a vital capability for survival and success in an uncertain environment The goal is not to predict the future but to prepare for it by building up the capability to respond

to unexpected events “The strategy that you come up with may well need to change, but at least you’ve gone through the process of thinking through various scenarios,” says Professor Vermeulen

“This makes you better equipped to put together an appropriate response when something unexpected happens.”

Genpact: Staying one step ahead of change

In a young, fast-changing industry, the ability to respond quickly

to evolving customer needs is vital But by identifying the early

indicators of change, companies in highly dynamic sectors can gain

a longer-term perspective that gives them an advantage over their

competitors

Genpact is a business process management consultancy that

began its life as a division within GE It operates in a fast-growing

sector that is barely more than a decade old In such a dynamic

environment, the ability to spot change early can increase the time

available to formulate a response

Tiger Tyagarajan, Genpact’s chief executive, emphasises the

importance of a balance between agility and foresight “You have

to have your antennae out and be able pick up signals of upcoming

change faster than competitors,” says Mr Tyagarajan “Our aim is

to take advantage of the distributed intelligence throughout the

organisation and identify signals of possible change To do this, we

need to be close to our clients and the market.”

Despite the pace of change in its sector, Genpact spends a lot of

time thinking about potential risks and how they could affect its business “We run ‘what if’ scenarios in different business lines and consolidate these across the company,” explains Mr Tyagarajan

“We discuss, for example, the implications of an increase in global protectionism and then try to think about how that might affect our business.”

Where possible, Genpact frames these scenarios as opportunities

as well as risks “We look at changes in our market and think about how we might be able to capitalise on them,” says Mr Tyagarajan

“If we can identify change and then position ourselves to drive the evolution of a new market, then that is much better than simply mitigating a risk.”

Although Mr Tyagarajan believes that Genpact has embedded risk thinking at the heart of its business, he feels that the company needs to do more to think about long-term risks “We are a very young company in a young industry,” he says “More importantly, the pace of change is so fast that it can drown out efforts to think about the very long term But we are continuing to push our horizons outwards We are on a journey but we still have some way

to go.”

Strategy development and risk management should go hand in hand As companies make long-term

plans and decide on major new investment initiatives, a rigorous and formal understanding of the risks that could derail that strategy is essential

Among the companies surveyed for this report, it is encouraging to note the substantial role played

by the risk function in key strategic activities Almost six in every ten respondents say that their risk function plays a formal role in setting overall corporate strategy, and more than one-half say that risk managers play a formal role in evaluating new market investments (see chart 5) Respondents generally think that the links between risk and strategy are strong, with more than six out of ten rating the alignment between the two as effective

This is a different picture from one year ago, when we asked the same question in a previous report

in this series Then, the proportion of respondents who said that they were involved in these activities was considerably smaller The overall message seems to be that risk functions are taking on an increasingly significant role in strategy development

But despite this progress, other findings suggest that there is still a gulf between risk management and strategy Asked about the maximum period over which they consider strategic objectives, 58% say

Chapter 2: A seat for risk at the top table

Key points

n Risk functions continue to take on bigger roles in their companies’ strategy development

n However, risk management is still primarily viewed as an operational, rather than strategic, function

n Some companies are trying a discovery-based approach, discussing risks and opportunities side by side and making decisions based on rigorous argument

Evaluating M&A opportunities Evaluating new geographical investments Business restructuring

Capital raising Performance management Recruitment of senior executives

Chart 5: In which of the following activities does your organisation's risk function play a role formally? Please select all that apply

(% respondents)

that their timeframe is greater than three years But asked about the period over which they consider risks, the proportion with the same time horizon is much smaller, at % (see chart ) In other words, a sizeable proportion of companies are considering long-term strategic plans beyond a certain timeframe without a proper consideration of the associated risks

What is causing this gap between strategy and risk? A common problem is that risk and strategy are not always well-aligned Although they say they are involved in strategy, risk officers are often brought into the process at a late stage By this time, senior executives are looking for information that endorses, rather than challenges, their strategy “Chief executives don’t want to hear the risk arguments because they feel that it undermines the strategic position that is driving the company,” says Andrew Kakabadse, professor of international management development at Cranfield University

“Even in organisations where there is a high awareness of risk, it does not form part of the strategic debate and difficult issues are prevented from coming to the surface.”

This problem often stems from a view that risk management is an operational, rather than strategic, function In recent years, many companies have become much more effective at supply chain risk management, business continuity planning, financial risk and a whole host of activities that help the organisation to become more resilient But these are tactical risks, and companies’ strategic risk capabilities are often less well-developed “When it comes to fundamental strategic decision-making, uncertainty and risk are not analysed nearly as rigorously or systematically as the day-to-day aspects

of risk management,” says Mr Courtney “That’s surprising, because the strategic risks are often the biggest bets that a company will make.”

Other findings from our survey also point to a gap in capabilities When asked what they thought were the most important objectives of the risk function, respondents point to the identification of new and emerging risks (see chart ) But when asked how they rate the effectiveness of their organisation

at various activities, anticipating and measuring emerging risks is seen as the biggest weakness (see chart 8) The problem, it seems, is that, despite recognising the importance of a long-term, strategic approach to risk management, companies find this extremely difficult to put into practice

Many companies understand these shortcomings and are working hard to resolve this problem Almost one-half of all respondents say that, in the past year, they have increased the extent to which risk management is forward-looking Just over one-third have increased the time that the board and senior management allocates to long-term risks (see chart 9) “What is starting to appear on the horizon is a greater integration between risk and strategy, and a more holistic approach that looks across the various silos that have been used to organise thinking about risk in the past,” says Mr Blau.

A more strategic approach to risk requires companies to integrate it with the strategy process, ensuring that any major investments or plans are tested and challenged across all the key risk categories “Rather than deciding on a strategy then testing it for risks and uncertainties afterwards, companies should approach their strategic discussions in a more exploratory way where they are

Communicating key risks to stakeholders Measuring and monitoring risk Ensuring regulatory compliance Enabling more efficient resource allocation Instilling risk culture in the organisation Setting and monitoring the organisation’s risk tolerance Other, please specify

Chart 7: What, in your opinion, are the most important objectives of the risk management function?

Please select no more than three objectives

(% respondents)

Linking risk management with corporate strategy Ensuring that risk information is timely and up-to-date Ensuring quality and availability of data

Instilling awareness of risk throughout the organisation Communicating risk information to investors Managing regulatory compliance Anticipating and measuring emerging risks Recruiting and retaining appropriate risk expertise Ensuring board level awareness of key risk issues

Chart 8: How would you rate the effectiveness of your organisation at the following activities?

Rate on a scale of 1 to 5, where 1=Highly effective and 5=Not at all effective

not just testing a chosen option but working with senior management throughout the process,” says

Mr Courtney

This more strategic assessment of risk requires a systematic approach to thinking through the implications of a particular decision “Companies need to accept that, with every type of strategic initiative, they are actually making a risk/return decision,” says Mr Rechsteiner “Once you accept that every strategic move has a different risk/return implication, then you can have the whole discussion around what level of risk you are willing to take, the long-term outlook for investments and how a particular strategic initiative fits in with your overall portfolio.”

In addition to taking this more structured approach to considering risks, leadership teams may also need to change the cultural framework by which they make decisions Mr Courtney points out that many organisations use an advocacy-based, rather than a discovery-based, method to reaching strategic decisions According to the former approach, members of the executive or non-executive team make their pitch, and those with the strongest influence or argument win But in a discovery-based approach, the idea is to decide on the best outcome through a process of dialogue, where the risks and opportunities are discussed side by side and decisions are made on the basis of rigorous argument “The tools that are available to manage risk and uncertainty are getting better all the time,” says Mr Courtney “Ultimately, what needs to change are the culture and mindset issues that will enable

a more rigorous assessment of risk as part of the strategy process.”

Extent to which risk management is forward-looking Time horizon over which we consider risks Resources allocated to risk analytics Resources allocated to risk modelling Board and senior management time allocated to long-term risk analysis Investment in scenario planning and other long-term risk management tools Formal links between risk management functions and overall corporate strategy

Chart 9: Over the past year, what changes have you made to the following aspects of your risk management practices?

Challenging beliefs at Eli Lilly

In many companies, risk management remains a tactical activity

that focuses on identifying and mitigating operational threats Even

in companies that have put in place enterprise risk management

programmes, the focus tends to be on internal issues, rather than a

broader strategic discussion of risks and opportunities

Eli Lilly & Co, the US-based pharmaceuticals company, is one

of the few companies to have embarked on the next stage of

the journey—to connect and integrate risk management with

the company’s long-term strategic decision-making Given the

long-term nature of the pharmaceutical industry, with its

multi-decade drug development timetables, it is unsurprising that Lilly

recognises the importance of a long-term perspective “Looking at

risks more than a decade into the future is an inherent part of our

business,” says Peter Johnson, the company’s vice-president of

strategic planning “We have to make choices today about the kinds

of diseases that we want to focus on and the value that we think

we could get from developing a product that would be launched 12

years from now.”

The company encourages managers to think not just about

the downsides of risk, but the opportunities that may be inherent

in those risks as well “It’s a hard concept for people to grasp

initially,” says Mr Johnson “But when they think about it, they can

understand that we are trying to imagine a changing situation that

may look like it’s a downside, but in fact represents an opportunity

to change the way we do business.”

Taking a longer-term perspective on risks helps to challenge assumptions about what the future may bring Mr Johnson believes that this is important, because our beliefs about the future are rarely explicit “These implicit beliefs can create a lot of dissonance when you’re making strategic decisions,” he says “The very process of talking about the future will help a management team to understand that their current strategy is dependent on a set of beliefs about the way the world is going to work.”

Lilly’s approach to dealing with strategic risk has become more qualitative over time The aim is to understand the four

or five “seminal beliefs” that are the lynchpin of the company’s strategic choices “By identifying these beliefs, we can think about what would happen if they were different or wrong,” says Mr Johnson “Even if you don’t make any explicit changes, you start to understand the choices you’ve made in a deeper way.”

While Lilly’s strategy team is centralised, the risk function operates as a virtual team Anne Nobles, the company’s chief ethics and compliance officer and senior vice-president of enterprise risk management, stresses that it is important to get input from different parts of the organisation rather than rely on an overly centralised risk function “Our approach is to pull people together from across the business who have a range of expertise and knowledge,” she explains “This enables us to draw on the backgrounds of a diverse team who understand the business dynamics but from slightly different perspectives This is a vital tool for helping us to think strategically about the long term.”

In the 1950s, the Canadian-born psychologist Elliott Jaques developed a theory called the Requisite

Organisation One of its arguments was that time horizons should increase in line with seniority

in a company A low-level sales executive might worry about reaching his targets for the week, while

a marketing director might be focused on plans for the next year With each layer of hierarchy in the organisation, time horizons should get longer Those at the top of the company, the executive and non-executive management, should have the longest time horizons of all

Our survey suggests that this is broadly the case The chief executive is the individual who is most likely to be responsible for exploring the potential impact of long-term risks, followed by the executive board Very few companies delegate responsibility for long-term thinking to strategy departments or heads of business units (see chart 10)

Chapter 3: Roles and responsibilities for risk

Key points

n Senior managers can become over-confident in their abilities to ascertain future risks

n Boards and risk managers need to be willing to challenge management and ensure that there has been a proper discussion of risk as part of the strategy-setting process

Chart 10: Who in your company is responsible for exploring the potential impact of long-term risks on corporate strategy?

Please select one only

(% respondents)

But despite the prevailing view that the executive management and board are ultimately responsible for strategic risk management, there are barriers that can prevent them from fulfilling this role effectively For one thing, the pace of change and complexity of the business environment means that it can be difficult to know where to start “The challenge for people at the top is how you ration the bandwidth that you’ve got to pick those few themes that you think could be really consequential,” says Richard Pascale, an associate fellow of Sạd Business School “The danger is that certain risks simply fall off their radar and become a tick-box exercise rather than something of substance.”

Michael Denison, research director at Control Risks Group, highlights the importance of ensuring that long-term strategic discussions take place within a defined framework “There’s no point just shoving people into a room and asking them to talk about what’s going to happen in 20 years,” he says

“There has to be some structure and organisation to the kind of things you are thinking about It’s within that structure that you allow people to explore the types of issues that might occur.”

Chief executives and other members of the leadership team need the strength of character to support a long-term focus among their team and reports Asked to name the steps that are needed to ensure a better alignment between risk management and strategy, respondents point to a stronger risk culture and awareness among business units (see chart 11) This has to come from the top “There are a lot of CEOs who will acknowledge the issue but unless they are willing to pull the team aside and tell them stop worrying so much about short-term issues, then it will be very tough to get longer-term thinking on the agenda,” says Mr Worley

In many companies, the management team is far removed from the coalface of the business, and this means that information about risks can be filtered out before it reaches them It is notable that more than four out of ten C-level respondents agree that looking into the future merely tends to confirm what they already know rather than providing them with new information In other words, they have deeply embedded mental maps about how the future will unfold “People are systematically over-confident in many aspects of life, but particularly in their ability to predict the future,” says Mr Courtney “We rarely see change until after the facts and we become anchored on the status quo, which

Perception of risk management as a “support function” needs to be eroded Better knowledge of the business among risk professionals

Other, please specify

Chart 11: What steps does your organisation need to take to ensure better alignment between risk management and strategy?

Select all that apply

(% respondents)

frames how we view signals from the market and from competitors.”

Business leaders who are unwilling to hear dissenting opinions and who surround themselves with teams who share their viewpoint are particularly unlikely to miss the early indicators of new risks and opportunities “You might find that one manager perceives something as a risk but another will not,” says Professor Gimeno “The danger, then, is that something that is an early warning tends to

be suppressed because nobody wants to recognise those voices that are dissenting from the majority

of opinion.”

The non-executive board also has an important role to play in ensuring that a focus on the longer term is maintained “With the responsibility for the long-term health of the organisation sitting squarely in their lap, the board needs to push management to think beyond the next quarter or fiscal year,” says Mr Worley “The more they can get involved in encouraging management to think longer term, the better they will be fulfilling their own responsibilities.”

Rather than be compliant and simply sign on the dotted line, boards need to be willing to challenge management and ensure that there has been a proper discussion of risk as part of the strategy-setting process “You want people on the board who are willing to play devil’s advocate,” says Professor Gimeno “It’s important to have dissenting opinions about what the future will look like, but all too often what you get is support for strategy rather than challenge.”

Although board members may not be experts in risk management, having at least one member who can take responsibility for long-term risks helps to ensure an independent perspective and a challenge for management Survey respondents see board-level risk expertise as one of the key requirements for ensuring a better alignment between risk and strategy (see chart 11) “There should be board members

or executives whose responsibility is to assess risk who report to the chairman,” says Professor Kakabadse “This ensures that their views cannot be blocked by executive management.”

The role of the risk function

Chief risk officers and risk functions continue to grow in influence and stature within many organisations More than one-half of respondents say that risk management will play a bigger role in helping the company to meet its organisational priorities compared with a year ago Among financial services companies, this proportion rises to 63% (see chart 12)

55 5 38 2

Risk management will play a bigger role than a year ago Risk management will play a smaller role than a year ago Risk management will play the same role as a year ago Don’t know

Chart 12: How would you describe the contribution of risk management to meeting your organisational priorities in the coming year, versus the past year?

(% respondents)