Governance of risk is a two-way street

With any new project it’s valuable to have strict criteria around when, and how, to review projects and have some clear go-no-go points. And to consider potential bail-out options before proceeding, writes Cathy Parker.

Pretty much everything we do in life involves risk. If we were too risk adverse we would end up frozen in our present state and the same applies to businesses. You generally have to embrace risk to develop. And risk covers both upside and downside.

Much has been written around governing risks such as health and safety but I want to focus here more around governance of business risk as it applies to business strategy and implementation decisions. 

This might be launching a new product, entering a new international market, making an acquisition or conversely shuttering a product, exiting a market or making a divestment. All of these have risks but all also have rewards (upside risk) and it is rare you can look for an upside without having a downside risk.

Often people, and especially management, can get swept up looking at the upside part of the equation for a project or proposal. It is part of a board’s role to ensure that consideration has also been given to the downside and especially what might be the worst-case scenario which, in some cases if things don’t work as planned, could be the death of the business.

I have certainly had a couple of past governance experiences of proceeding with projects where only the upside was seriously considered that have not worked out and the downside that occurred had the potential to cripple the business.

The governance role is looking to ensure that projects are pursued where there is a distinct (and probable) upside and, ideally, a smaller potential downside. Or one that can be managed and contained in a worst-case scenario and where, even if the result is negative, it is not significant in overall terms for the business’ ongoing viability.

Things that can help in this decision-making is having some robust ‘what if’ analysis around costs, projected sales volumes and similar. Based on personal experience there can be a trend for management to massage project projections to demonstrate the board’s required outcomes in terms of sales, costs, etc, rather than being realistic on projections. So it is useful to see what happens if sales are lower and/or costs are higher than estimated and also what the potential exit costs might be.

It is also valuable – in fact probably invaluable – to have some strict criteria around when, and how, to review projects and have some clear go-no-go points and criteria. And to consider potential bail-out options before proceeding.

For instance, in my own business we have developed several new products recently where we have set a firm go-no-go date and revenue target – if we don’t reach the revenue target we bail. 

Another project I was involved in recently at a governance level had a significant upside potential, but the downside worst case would potentially end the organisation. So again we set some clear parameters and dates that the board had to meet and sign-off on based on progress as after that date some significant unavoidable costs would be incurred.

I am pleased to say we achieved the goals and proceeded but had the option to pull the plug before crossing a threshold that could have endangered the organisation, which is the essence of good governance.

We need however to ensure we don’t become too risk adverse which could paralyse decision-making and take away many genuine growth opportunities. Rather that we acknowledge, and look to manage the downside risk, and aim for the upside risk being significantly higher than the downside so the weighted return is strongly positive.    

 

Cathy Parker is a director of Adrenalin Publishing, the owner of Management magazine, and serves on a number of boards.

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