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Enabling the Risk Intelligent Enterprise

Deloitte & Touche’s Rick Funston, a co-author of Surviving and Thriving in Uncertainty, spoke at Chief Executive Magazine’s CEO2GOV Summit on the missteps that lead to failure and how to avoid them

I’d like to begin with the quote, “Life is short.” Ninety-six to ninety-nine percent of all species that ever lived on the planet are now extinct. The average life expectancy for a white male living in North America is now about 79.2 years, a new record. But the average life expectancy for a Fortune 500 company is about 45 years and declining.

Opportunity is fleeting. One of the biggest challenges for dominant incumbents in any industry is the risk of inaction—failing to make a bold enough move in time to survive. Interestingly, what was once the recipe for success can overnight become a recipe for disaster. We saw this with the banks leading up to the financial crisis, and see it again in those in the position of being the dominant incumbent, who fail to see what’s changing in the environment around them.

Rather than seeing the enterprise as something inanimate, we really have to start seeing it as a living organism with a limited lifespan and high mortality rates, especially the younger it is or the older it is. The challenge, then, is that we all want to survive and thrive in turbulence and uncertainty. The world as we know it is constantly being destroyed. It’s also being created. The question is whether we will adapt or die.

The challenge with innovation is that you can expect some failure. The CEO of IDEO said, “Fail early, fail often.” The question is what’s acceptable failure versus unacceptable failure? And that’s something that needs to be understood in advance, not after the fact. The problem is that at a lot of companies risk management means risk aversion.

If we’re to do anything in our economy, we must protect what we’ve got. We need to do that or we don’t get to play. But competitive success and competitive advantage depend on the ability and the willingness to take calculated risks. Because when I talked to Mario Andretti or a combat pilot and asked, “How much do you factor in chance in your chances of success and your chances of winning ?” Their unanimous response was, “We try to eliminate chance by doing everything that we humanly can to prevent that kind of a problem occurring. But that doesn’t mean that we don’t do it. We take on the mission. But the objective is to control all the things that you can control, which again is no guarantee of success.

So the question really becomes for a lot of organizations, what’s an acceptable outcome versus an unacceptable outcome? And I can’t tell you the number, as I talk to organizations nobody really thinks about how far will you actually go before you say enough is enough, when you enter into a new country or launch a new product or enter into an acquisition. How much is enough? Do you actually have a stop-loss as part of the strategy? Most organizations don’t.

But these forces of creative destruction are always at work. And either you position your business to be the creator, or you will be destroyed. So there are elements of continuous improvement, which is getting better at what you do all the time; and discontinuous improvement, which is doing something new.

As I talked to [racecar driver] Mario Andretti, [Everest climber] Jamie Clarke and others about where their missions failed and why, I came up with this list of fatal flaws in conventional wisdom:

First, they didn’t challenge their assumptions. Second, they relaxed their vigilance. Third, they did not take into account velocity—how bad can it get, and how fast can it get that bad. Ask somebody who’s a jet pilot how fast can it get bad. Ask Mario Andretti how fast can it get that bad. Ask somebody in a company how fast can it get bad—nah, it won’t happen to us. We have almost a national taboo against anticipating failure and discussing failure. And in corporate cultures, it’s very hard to challenge the CEO’s strategy without being seen as not being a team player or not being committed.

Fourth, they failed to verify sources and corroborate information. Seventy-five percent of all wrongful convictions in the U.S. are the result of eyewitness error. And 80% of all accidents are caused by operator error.

Fifth, is the failure to take enough of the right risks, which is really critical factor. I see that as a significant factor when you think about companies that have declined. They may have been the first to invent a new technology, but they may be the last ones to take advantage of it.

Sixth, is operational discipline or “felt leadership,” that things do not get translated from paper into reality. DuPont, when he first formed the company and wanted to create his first gunpowder mill, went to the people in the community and said, “I will build my family home within the kill zone of the blast radius of the gunpowder.” And they said, “I guess you’re serious about understanding what that means to us, and you’ll put your family in the same boat as us.”

There’s some real accountability there. The Romans had a similar practice: they made their engineers stand under the stone arches when they removed the wooden truss work. You got rid of the bad engineers and you have a lot of arches still standing. If you’re a parachute packer in the U.S. Air Force, you get randomly chosen to jump with one of the chutes that you’ve packed. This fosters felt leadership.

Going back to creative destruction, as Andy Grove says, sooner or later something fundamental in your business world is going to change. The problem is that if you’re the dominant incumbent, you’re usually the last one to recognize it.

I’ll use the example of the encyclopedia business. How many of you had encyclopedias as kids? How many of your kids have encyclopedias? How many of your grandkids know what an encyclopedia is, unless they look it up on Wikipedia? So since cave-writing, reference knowledge has been transferred and communicated in printed media, from papyrus to the parchment and quill to the Gutenberg press. So that was one assumption.

The second assumption was that if it’s reference knowledge, then it should be in a nice leather-bound volume and periodically updated. Third, because of the size and weight of these volumes, they’d have to be housed in a library or in an office. In other words, they’d be stationary. Fourth, the dominant model for revenue would be based on subscription fees. And finally, because of the specialized nature of the knowledge, it would have to be developed by in-house experts. Sound familiar? That’s the encyclopedia model. But it’s also pretty characteristic of what’s happening in the printed media.

If you take the opposite view, reference knowledge will be communicated in media other than print, will be refreshed instantly, and will be accessible on a mobile basis. The revenue model will change away from subscription fees, and that the content will be developed by users themselves. That’s where we are today.

So what I’ve begun doing with a number of companies who have CEOs willing to look at and challenge their assumptions to go through the exercise and see what are our assumptions about the world and what’s the exact opposite of that. Are you seeing any signs of that? And in many cases they’re actually saying those signs are everywhere. A lot of companies are saying, how do we find the unexpected before it finds us? I would suggest to you, look to your assumptions.

The next one is maintaining constant vigilance. The problem is that most of the information systems that exist in organizations today are designed to reinforce what is, not to challenge what may change. Take the example of Blockbuster. You defined yourself as being in the retail business, so you had 8,000 stores around the country. You had bricks and mortar to support that. You had people, you had operating expenses. Along comes Netflix. Never have to leave the comfort of your own home, no bricks and mortar, no stock-outs, and no late fees.

How many of you, if you do risk assessments, actually include velocity in your risk assessments? Most organizations look at how bad can it get and how likely is that, and they typically underestimate the risk of ruin. How fast did commercial paper dry up? How fast did the automotive market dry up?

The challenge then is how do you identify the critical dependencies in your business model? What products and services do you critically depend on, and what customers do you critically depend on? And that’s a two-way flow. And how long can you go on without them—and how long will it take you to recover? If companies had asked themselves that question before commercial paper dried up, they might have found themselves in a more comfortable position.

One of the biggest challenges I think that organizations deal with – and Mark Twain probably put it best: “Denial ain’t just a river in Egypt.” So how do you actually begin to understand what your assumptions are, be willing to test that, be willing to hear the noise from the Street, and then take all of that information and boil it down into something that’s actionable.

Finally, we must take calculated risks. If we cease to take calculated risks, we will become extinct. I think Kennedy had it right here, is that “The long-range risks of inaction far outweigh the risks of comfortable inaction.”

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