Last Updated Jun 23, 2008 9:39 AM EDT
Corporate risk comes in many forms: pricing moves by a competitor, a product liability lawsuit, departure of a talented manager, a sudden increase in fuel prices, a disruptive innovation that obsoletes your product, financial pressure suffered by a big customer.
These often catch us by surprise, but the fact is many risks are imaginable and avoidable, or at least can be planned for. Clearly banks and other financial institutions could have risk managed the subprime mortgage fiasco more artfully.
Harvard Kennedy School professor Malcolm Sparrow's research focuses on how regulators can mitigate risk, but his survey of current thinking in this area has broad ramifications for corporate and nonprofit execs as well.
His research advises risk managers to take small but determined interventions at early stages of a developing harm. The process begins by narrowing broad generalities of risk into well-defined, addressable problems.
Undoing the Knot. Risk can be assessed by picking it apart, like an adult undoes a knot, Sparrow says. A child tries to untangle a knot by diving right in, randomly pulling strands and often making the problem worse. An adult begins by looking at the knot, trying to understand its structure.
"First they hold it carefully, turn it this way and that, looking at the knot from each side, until they understand the structure of the thing itself. Then a plan begins to form: 'if I loosen this strand, it will release that one, and then I'll be able to pass this through that loop,' and so on. If they've understood the structure correctly, and formed the plan based on that understanding, then the knot falls apart, and is no more."Think Like a Saboteur. Focusing on specific bad things such as concentrations of risk or downward trends offers the opportunity to think and act like a saboteur, says Sparrow. Find a vulnerability in the harm itself and remove it, or produce a scarcity which the opposing forces cannot cure.
"If it's true that there is in fact an art to the destruction of bad things, which is different from the construction of good things, then it is surely an art that we really all ought to understand."Thinking About Catastrophic Risk. How do you mitigate against the extremely rare catastrophic event? Sparrow says pay close attention to near misses and other "precursor events", much like the FAA studies planes that almost crash, but don't.
"Dealing with catastrophic risks demands this type of systematic debriefing of near misses, precursor events, as well as disasters that might have happened elsewhere. It also demands the deliberate use of imagination, to figure out all the ways in which events, or near-events, could have been much worse., which has very few plane crashes from which to draw data."Companies and agencies that effectively deal with long-term risk spot tell-tale patterns of behavior early on and quickly deal with emerging problems, he says.
Read the interview for more details, then return to tell us how you assess and plan for risk.