Importance of Risk Management Mindset

This article, published by the University of Pennsylvania, discusses how companies that were confident in their forecasts and projections are growing less willing to make judgments about the future and act on those beliefs with the uncertainty in the global economy. Companies need to have the ability to understand and manage risk to be willing to act on decisions about the future with confidence. Unfortunately, many of the models created to analyze potential outcomes and probabilities were based on past performance and failed to prepare companies for the current economic situation. For companies to regain confidence in making risk-informed decisions for the future, there needs to be a realization that risk management models are only as good as the decisions that are made based on the models. Therefore, the risk management mindset is just as important as the model.

Re-defining Risk

A start to changing the risk management mindset is for organizations to get a fuller picture of risk, as there are many types of risk that influence future outcomes apart from financial risks. Risk managers’ primary concern is often the potential for loss, and companies frequently pull back if the risk of loss is too great. In looking at the potential for loss, risk managers need to keep in mind that an integrated view of risk is necessary to see the types of risks a company is taking. By considering the many types of risk being taken in different areas of the business, companies will have a better picture of the true risk portfolio of the organization. Finally, companies ultimately succeed by taking risks based on their core capabilities and it is the responsibility of managers to ensure those risks pay off more often than not. In order to do this, managers need to have a solid understanding of the risks involved in decisions.

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Constructing a New ‘Risk Architecture’

Another change to the risk management mindset is the new risk architecture emerging for organizations as a result of companies needing to make decisions increasingly faster based on often uncertain information. This creates the need for organizations to move beyond traditional, internally-focused risk management practices and look beyond company boundaries to consider what is happening externally that could increase an organizations’ risk exposure. Instead of just looking at known issues and their potential probabilities and impacts, companies need to examine links and interdependencies among the issues. Companies need people with a broad perspective that are willing to challenge assumptions about the future. There are many areas in which an organization can implement this broader perspective. New technologies and techniques can be used to improve visibility across a company, consulting firms can help provide a more multidimensional view of risk, and “business intelligence” can change from an operating performance focus to include monitoring risks internal and external to organizations.

Making Better Decisions

Many companies are facing the challenge today of moving beyond reliance on numbers generated by models to look beneath the surface of the models to understand the underlying factors that drive the models and the quality of the data in the models. There are many proactive steps a company can take in making better, more risk-informed decisions. Well-designed efforts to look ahead to the next three to five years often identify many important risks. Company-specific assessments to understand the company’s operating environment using both internal and external sources can capture major risks. Companies also need to consider the level of risk taking needed to succeed in their particular industry. Risk management is becoming a more strategic discussion requiring an understanding of the industry and how much risk the company needs to incur in order to make strategic choices about the future. Ultimately, risk management is a central part of managing any business and it is important for companies to focus on their risk management mindset in addition to model results in order to manage their risks successfully.

Original Article Source:  “Re-thinking Risk Management: Why the Mindset Matters More Than the Model,” Knowledge@Wharton, 2009

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