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BLOG: The risk right under your nose

Dallon Christensen | July 29, 2011
Companies focused solely on financial or security risk must look harder at their operational risk.

Product development is the biggest differentiating factor in today's hypercompetitive business environment. Lead times continue to shrink, development budgets remain strained, and customers demand more and more features. When it comes designing a risk management strategy, then, you would think product and operational risk management would be a key topic, with alignment throughout the enterprise. You would be wrong.

Big Fat Finance Blog's Eric Krell exposed a dirty little secret of operations management in a recent blog -- operations risk management needs a lot of work. In a survey referenced in this post, 60% of respondents said the speed of their go/no go decisions hindered resource allocation to the right projects. Having spent time working in new product financial analysis, I was surprised that number was only sixty percent. I saw too many instances of silo thinking, feature creep, and lack of scenario planning slow the resource allocation process to a crawl. Approaches to implement statistical analysis and options valuation were met with blank stares and deaf ears.

Risk management is often seen as a brake, or a hindrance to effective portfolio management. Why manage portfolio risk when there are customer focus groups, engineering analyses, and cost-price reviews to undertake? But according to Innosight's Mark Johnson, risk management can actually increase the speed and effectiveness of operations management. A company focused on smart risk management actually can free additional capital to projects that demonstrate real potential.

I experienced the positive impact of risk management first-hand in a previous financial analyst job. My project involved introducing a new product at the low end of the price spectrum, and the project's success was heavily dependent on high volumes. We followed the generally-accepted practice of forecasting a "most likely" scenario with isolated sensitivity analysis holding all variables constant except one. During this project, I proposed a new analysis method using Monte Carlo simulation to determine a range of different outcomes. Unfortunately, my project fell upon deaf ears just as two key variables - volume and material costs -- turned negative as the product reached introduction. Had we considered more scenarios or the impact of multiple negative variances, perhaps our project would have reached a better outcome.

Companies must overhaul their operational risk management practices to adapt to today's changing landscape. Smaller cash outlays, risk-based cash flow analysis, and faster go/no go decisions must become accepted practices for companies seeking to innovate and improve their value propositions in an increasingly commoditized world.

 

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