Sunday, June 12, 2011

How Do Effective Leaders Balance Risk and Sustainability?

“Even when the dust settles, economic downturns will not be a thing of the past. Business cycles - which entail ups and downs by their very definition - are here to stay. If companies are willing to accept that, the key question becomes: How can organizations adopt reliable risk management through the business cycle to deliver sustainable performance?” (Wim van der Stede, 2009, p.24).

Though organisations are often good at reacting to downturns, they can have a tendency to forget about them when times are good again. Business teams talk about times gone by as if they won’t return – as if some nightmare from the past.

Van der Stede raises an interesting point, that “the tendency inside many firms to investigate an unusual profit is smaller than the tendency to investigate an unusual loss. But, as post-mortems of crises suggest, unusual profits are often where the seeds of future distress are sown. The unusual profit may be a sign that managers have been too aggressive, been taking too much risk or been excessively short-term focused,” (p.25).

It takes an effective leader to balance the focus on risk and performance and to optimise the reporting and decision making process through the organisations business cycle.

For as van der Stede mentions “companies tend to oscillate between under and over-scrutiny triggered by strong versus poor performance, respectively. Under scrutiny often prevails during expansion times when there is a “top-line” focus driven by aggressive, rose-tinted growth plans, ‘can do’ attitudes, minimally required compliance and control weaknesses. It often results in ‘empire building’ through risky investments and ill-advised acquisitions. Over scrutiny, on the other hand, is manifested by tightening the screws during contractions through cost cutting, lack of investments (even worthwhile ones), balance sheet ‘clean ups’ and divestments (sometimes at huge discounts) driven by too much risk aversion, over compliance in the face of potential litigation and other stifling, protective attitudes,” (p.25).

Research by CFO Research Services and IDG Research Services in 2009 found that “to compete successfully, companies need to look beyond simply improving operating efficiency to improving their processes for managing performance. Now, high performance companies compete on their ability to identify emerging threats and opportunities and to respond to them quickly, with well-informed decisions. The challenge for senior finance executives is this: How to implement excellent processes for managing performance and, by doing so, institutionalize excellent managerial decision making?” (p.36).

Effective leaders ensure that their organisations have the right systems to give the right information, to the right people, at the right time. This helps the strategic leaders and business teams assess business risk from a position of ‘understanding’ and legitimacy – where decisions can be made with a strong degree of confidence (and a full understanding of the risk) which is often lacking in other poorer led organisations.

Van der Stede highlights how “research suggests that companies often still treat performance and risk management separately. For example, one study suggests that companies implement ERM (enterprise risk management) primarily as a reaction to regulatory pressures and corporate governance requirements. In other words, they don’t seem to do it primarily because it makes good business sense, but rather because they feel pressured to do so. But when asked about the benefits of risk management, these same sample companies hint primarily at performance benefits, such as allowing them to make better-informed decisions, to obtain greater management consensus, to improve management accountability, to better meet strategic goals and to use risk as a competitive tool. Not surprisingly, they also mention some compliance benefits such as better governance practices and better communication with the board. They even mention some ‘cycle busting’ benefits, such as reduced earnings volatility and increased performance,” (p.27).

One of the interesting conundrums of effective business and leadership is how a solid business principle, such as analysing performance and risk together, can be agreed in discussion, but can then fail to be implemented effectively into the business operation. It’s the old principle of ensuring you walk the talk.

The research by CFO and IDG concludes that “for a time, many companies were able to differentiate themselves through their ability to deliver goods or services faster, less expensively and more accurately than their competitors. High-performance operations are now more common place and as a result operating process improvements are less of a source of additional value for companies. Today, companies increasingly compete on their ability to identify market opportunities and risks, and their ability to respond to them faster than their competitors can,” (p.37).

So the two questions you should ask yourself are; do you agree that a source of competitive advantage is your organisations ability to respond to opportunities and risks quicker than your competition? - and if you do, what are you doing about it in practice?


CFO Research Services and IDG Research Services. (2009). Structured management processes lead to better business performance. CFO. Vol. 25, Issue 2, p36-37.

Van der Stede, W. A. (2009). Enterprise governance: Risk and performance management through the business cycle. CMA Management. Vol. 83, Issue 3, p.24-27.

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