ERM and Intelligent Risk

Guest Post by James J. Kline (first posted on CERM ® RISK INSIGHTS – reposted here with permission)

In the Baldrige Excellence Framework the term “Intelligent Risk” appears.  It is defined as: “Opportunities for which the potential gain outweighs the potential harm or loss to your organization’s future success.”  This definition expresses a concern that risk might inhibit innovation. With the addition of Enterprise Risk Management to the 2017-18 Framework has a condition been created where two best business criteria, innovation and risk management, might cancel each other out? More basically, does Enterprise Risk Management (ERM) inhibit innovation related risk taking?

Intelligent Risk

Daniel Kehrer in “Doing Business Boldly: The Art of Taking Intelligent Risks” emphasizes the need to accept innovation related risk.  While he uses the term “Intelligent Risk” sparsely, he stresses the need to take risks.   To drive home his point, he uses a number of examples.  The two most prominent are Coke’s decision to move to new coke and the decision to create a new national newspaper, USA Today. A third less prominently discussed example is Kodak’s response to digital cameras.

New Coke

The decision to add new coke came after examinations of market trends and customer responses to taste tests.  At the time, Pepsi was gaining market share on Coke.  Further, blind taste test found that consumers liked the taste of Pepsi over Coke.  Consequently, the old formula was locked away and New Coke introduced.  The result was a financial and marketing nightmare.  Sales plummeted and boycotts of Coke products were initiated.  Eventually, and relatively quickly, the old formula was brought back as Classic Coke.

Coke was innovative in creating a new product based on all the objective information available. So what went wrong?  It was not quite a Black Swan event, but close. The company did not factor in the emotional attachment that people had for both the Classic Coke product and to Coke itself.  When the product was taken away, they reacted on that emotion.

A comprehensive ERM approach requires examination of the aspects which could inhibit the obtaining of management objectives.  Since not all can be accounted for, Black Swans are unpredictable; ERM practitioners emphasize the development of contingency plans for unexpected events.

In the case of Coke, there was no contingency plan. But, management reacted relatively quickly.  Further, by bringing back the old formula as Classic Coke, they found that having two Coke products on the market at the same time, actually increased revenue, and market share, while growing the brand.  Thus, today there is Diet Coke, Coke Zero, etc.

USA Today

In the case of USA Today, the development process was methodical and taken in small steps, with substantive reviews at each step. Further, the project was thoroughly discussed with the Board of Directors.  In fact, one director indicated that all the risks were laid out, as were the potential benefits.  It was also understood that while a failure of the project would significantly impact the bottom line, management was not betting the entire Gannet enterprise with this project.

For the development of USA Today project, the company essentially did a risk assessment.  Further, management laid before the Board of Directors, the positive and negative aspects of the risks associated with the project.  Based on the Board’s risk appetite, they authorized the project.

Kodak

Kodak provides a case where a formal ERM might have helped, but essentially management’s risk appetite was low and the company suffered from institutional lock in. Kehrer praises Kodak for improvements in its production cycle time.  However, both Kodak and Polaroid, tended to introduce hybrid film and digital products in the face of the Japanese’s’ fully digital cameras.  Neither was willing to take the step of creatively destroying their film business.  Because the film market was such a large contributor to the bottom line, psychologically they were locked in. 

A risk analysis would have pointed out many of the impacts fully digital cameras would have on Kodak’s bottom line.  However, in the end it still comes down to the risk appetite of Management and the Board.

Conclusion

The ERM process is not an inhibitor to innovation.  It is simply a methodology designed to allow management to understand, in a comprehensive and systematic way, the risks which might inhibit the accomplishment of their goals. The inhibitors to innovation are far more complex and have to do with factors such as: the company’s culture, the organizational processes and the degree to which both contribute to institutional lock-in.

References

Daniel Kehrer, 1989, “Doing Business Boldly: The Art of Taking Intelligent Risks”,
James Utterback, 1996,   “Mastering the Dynamics of Innovation”,
Paul B. Carroll and Chunka 2008, Mui, “Billion Dollar Lessons”

Bio:

James Kline is a Senior Member of ASQ, a Six Sigma Green Belt, a Manager of Quality/Organizational Excellence and a Certified Enterprise Risk Manager.  He has over ten year’s supervisory and managerial experience.  He has consulted on economic, quality and workforce development issues.  He has also published numerous articles related to quality in government and risk analysis.