The New Face of Enterprise RISK

The New Face of Enterprise RISK

Künzler, Simon

The old model of basing corporate strength on industrial might and production capacity is becoming a thing of the past. Information is the new currency of corporate success, and with that comes a new primary asset and source of risk people. In the last three years, managing threats has become at least as important as managing investment opportunities for most companies. The collapse of the new economy, corporate governance failures, terrorist attacks and a series of costly natural disasters are all high-profile events that have focused senior management's attention on risk mitigation. Enterprise value is usually not destroyed through these kind of spectacular events, however, but through more mundane, more common organizational risks.

The last ice age favored big animals with large weight-to-surface area ratios. As things warmed up, however, these big creatures became easy prey for the smaller, faster-moving carnivores of the open field. Many firms find themselves in a similar transition today, from managing stable, fixed-asset businesses to more fluid, knowledge-based organizations that bring their own set of dynamic risks.

The industrial revolution was the age of big capital, in which the most productive resources were efficient factories that used technical breakthroughs, new sources of energy and abundant, cheap labor to take advantage of growing consumer markets. Scale and competitive advantage were integrally linked by cost advantage, thus motivating ever larger and more specialized production facilities. These industrial platforms were not economically nimble, however, and were sensitive to demand fluctuations. Profits quickly evaporated when revenues dropped, since costs were largely fixed. Like receding glacial ice, however, these types of industrial risks have quietly shifted. Only 15% to 20% of employees produce goods in the industrialized world, and the remaining capital asset risks of most companies have been transferred through lease arrangements, securitization and interest hedges.

Creative, intelligent, team-oriented people are now the critical resources that generate wealth and risk today. An organization's "cultural platform" has replaced the capital platform as that which drives profits and determines success or failure in business. Or, according to renowned management theorist and business writer Peter Drucker, "Knowledge has become the central economic resource. The systematic acquisition of knowledge has replaced experience as the foundation for productive capacity and performance."

Hard facts support Druckers assertion. Nearly 75% of the Dow 30's value is now in intangible, peoplebased "assets" including knowledge, business processes and intellectual property that is not yet adequately reflected in financial statements. Various studies from consulting firms such as Marsh show that the leading causes of collapsing shareholder value, whether externally or internally driven, are strategic and operational in nature. Analyzing these findings in more detail, one finds that most collapses are directly or indirectly the result of human resource failures. Managing personnel risks therefore demands top management's utmost attention.

The value of harnessing the power of an organization's intellectual capital is many orders of magnitude greater than the incremental productivity gains from process improvements during the industrialist era. 3M's legendary success with the chance invention of the Post-it note, and Microsoft's Windows computer operating system monopoly are just two examples of the value growth potential of well-managed knowledge organizations.

A New Breed of Risk

Corporate cultures are slow to change following 250 years of successful industrialist tradition. Only now are they realizing the risk management implications of the knowledge organization. The key concern is whether corporate leaders recognize the growing importance of such people-related risks and what steps are being taken to mitigate them.

Personnel risks can be broadly divided into a few categories. Reduced productivity is the most common, subtle and measurable effect of people-based risks. Unlike production workers, whose productivity is largely dictated by external factors such as production line speed and quotas, knowledge workers largely determine their own productivity, driven mainly by their physical and emotional condition, education, and above all, motivation.

Shockingly, employee motivation surveys routinely report that most employees are not motivated. In many cases, this is driven by internal organizational issues such as poor communication, leadership problems, excessive workload stress or corporate restructuring. Obviously, external shocks such as a terrorist attack can also act to reduce motivation and productivity. These problems often result in poor morale and extensive absenteeism.

The loss and/or abuse of critical knowledge and information also represents a key threat to firm value. Modern, networked organizations and information technology have placed unprecedented volumes of sensitive information at the fingertips of more employees than ever before. Most companies' complete customer files, for example, can now be carried out the front door in a palm computer. Information risk can manifest itself in a number of forms in modern organizations. The salesman who never documented his sales contacts or the scientist who carries specialized knowledge only in his head are just two common examples. And the information threat goes beyond simple loss. In an increasingly competitive business environment, the damage caused by proprietary information falling into the hands of a new or existing competitor can be catastrophic.

Intellectual property rights management is another related area of subtle but very high risk Years of lost R&D investment, blocked market access, litigation costs and/or compensation payments threaten companies that fail to diligently and strategically manage their patent portfolios.

A company's decision-making processes also embody significant organizational and people-based risks. Power concentrations might be accepted for making quick decisions in an otherwise risky situation. They represent a risk themselves, however, for the longterm stability of networked, knowledge organizations. An overbearing or centralistic decision-maker not only tends to drive other talent away, but the negative consequences of losing such a leader can also be catastrophic.

Not being able to hire the right people or hiring the wrong people are two major personnel risks. A company that cannot attract and retain better talent than its current and future competitors is at risk. And, the damage that can be caused by a single dysfunctional hire, in today's networked organizations, is significant An emotionally unstable or insecure personality will not only likely make poor decisions, but can quickly drive many talented people out of the company before the situation is rectified.

Finally, expanded employer regulation in most developed countries and employees' increased will to wage lengthy court battles have resulted in a dramatic increase in employment litigation. Employment practices liability is a rapidly growing area of human resource risk that encompasses sexual and other forms of harassment, discrimination and wrongful termination. Employee fraud and dishonesty are also risks that are similarly landing in front of a judge with disturbing frequency.

Divining a Solution

So what can companies do to manage and mitigate personnel risks? Unfortunately, the answer is not as simple as mitigating foreign currency fluctuations with off-the-shelf hedge instruments. Mitigating personnel risks first requires a systematic understanding of the nature of the risks, their relationship relative to one another and to other enterprise risks. Each company has unique personnel risks based on its industry, culture, internal processes, organization and the people it employs. And these must be examined within the broader context of its overall enterprise risk management process.

Nevertheless, there are a few general measures companies can employ to mitigate personnel risks. Hiring and organizational planning are among the most important In particular, the development of a robust organization which avoids over-dependence on one or just a few people for decision-making is paramount. The greater the leadership role and influence of a position, the more care needs to be taken in selecting candidates who understand the risks and have the skills and emotional maturity to mitigate them. Clearly, this is more difficult in smaller companies, and it places a premium on hiring people with collaboration skills. Conducting thorough assessments and interviews with multiple team members is an essential step toward selecting the right people.

An open, constructively critical corporate culture also helps to mitigate decision-making risks. Tolerance and the need for critical inputs from different points of view on important corporate issues is more likely to lead to better, safer decisions than those based on a narrow input of a few like-minded employees. It also broadens the base of critical thinkers in the company, thereby reducing "key man" risks. In addition, an open culture minimizes stress, which can otherwise lead to the abrupt departure of talent or on-the-job disengagement.

Systematic leadership processes, such as employee goal-setting and feedback, are important mechanisms for minimizing personnel risks at all levels. To be effective however, feedback processes must be transparent and avoid power concentrations that often lead to dysfunctional behavior. They must separate private friendship from professional performance and force a discussion on alignment of individual with firm goals. Clearly linking objectively measured individual performance with compensation and promotion opportunities is a powerful force to maintain motivation. In addition, it provides an early warning on personnel issues and reduces high-risk employee behavior, even in turbulent times.

Evolve or Perish

Organizational changes and re-alignment with business goals are becoming constant features of corporate survival. Organizations that have been successful in the past, however, often resist change for the future. Personnel risks are therefore greatest at times of intense organizational change such as rapid growth, restructuring or downsizing. This contradiction represents a key challenge for corporations and places a risk reduction premium on their ability to effectively manage the people aspects of change. A sad but all too common example is poorly managed personnel reductions. They may not only miss cost reduction targets but also endanger the long-term viability of an organization if critical people and skills are lost, or a company's image is irreparably damaged in the process.

Organizational change is highly nonlinear because it is very human. Perception quickly becomes reality. It is therefore imperative to systematically assess potential personnel risks prior to initiating changes, and prepare a plan ahead of time for mitigating them. Once change is initiated, it is often too late to give adequate consideration to the important and time-critical decisions which could have been anticipated.

It is also easy to underestimate the degree of communications needed to make an organizational transition smooth. Not only those employees directly effected require individual communications, but also, simultaneously, all other stake-holders-the noneffected employees, customers, partners and the media. Inconsistencies in the message to any of these constituencies can quickly throw an evolving process off course and place a company's value at risk.

Managing personnel and organizational risks in networked, knowledge-based organizations is a new and difficult challenge for corporate leaders. It will require reconciling the complexity of human behavior and turbulent markets, with the objective of achieving stable financial returns. The creative new solutions which emerge from this selection process are likely to shape the fundamental structures, organizations and processes of tomorrow's most successful corporations. Those companies which can adapt will not only survive, but also generate superior enterprise value growth. For those that fail to adapt, the cold, Darwinian fate of the woolly mammoth likely awaits.

Simon Künzler is the head risk consultant of Kessler Consulting Inc. in Zurich, Switzerland.

Andres Poyne is CEO of Humatico AG, also in Zurich.

Copyright Risk Management Society Publishing, Inc. 2007
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