The core mandate for businesses across the world is to maximize their shareholders’ wealth through strategies meant to increase their revenues, while maintaining an efficient operation; in order to optimize their bottom lines. To boost their top lines, businesses make strategic decisions such as development of new products, expansion into new markets or mergers and acquisitions. Strategic risk stems from the probability that such decisions might not achieve the intended goals; and that the impact of such failure on the organization would be significant.
Strategic risk can also be simply defined as a risk emanating from failure of business strategies. For example, a change in the tax regime of a particular jurisdiction that a company was planning to expand its operations into would affect the market entry strategy that the company had. However, not all strategic risks are inherently fatal for the business, as some must be taken in order for the company to realize its shareholder value maximization objective; such as merging with another company to smoothen an entry into a new market. Businesses should therefore seek to strike a balance in strategic risk management between protecting value and creating value.
An effective strategic risk management plan should allow you to identify, assess and treat any risk to your business strategy. Strategic risks are mainly caused by factors beyond the control of your business; hence they need to be consistently monitored even in cases where the probability of them occurring is minimal. For example, oil and gas companies have to consistently monitor the political stability in countries where they have invested; even for countries with perceived long-term political stability. Any changes to this stability would directly affect their operations and threaten any investments that they may have made in the country.
Scenarios that could expose a business to strategic risks:
- Developing/launching of new products or services. There is a risk that the market research done to validate the existence of the products could be outdated and therefore the target market has better alternatives to what is being offered.
- Mergers and acquisition. Businesses engage in mergers and acquisitions to gain a competitive advantage or increase their market share. However, cultural misfit between the merging companies could lead to operational challenges that jeopardize the envisioned synergy. In the 1990s 2 car manufacturers merged, but differences in their organizational structures and approach to design meant that their employees were not able to work together.
- Entering into new markets. Businesses main objectives is to increase shareholder value by bringing in more revenue. By expanding into new markets and regions they are able to achieve this objective. The risk here is that the target customers in the new market may chose to remain with their current options due to familiarity. The new product may also not be the best fit for that particular target group..
- Changes in senior management. Investor confidence in a business is directly influenced by the senior management of the company. If there is a change in management and the shareholders feel that the new management would be unable to deliver on their promises to shareholders; then the company share price could drop significantly due to an emotional sell off.
- Financial challenges. How effective a business strategy is depends on how well they are resourced. For example, an SME in the fintech space would need resources to pay development teams in order to expand the capabilities and offering that their application or platform has. If such a company is facing a liquidity crisis due to having a long cash conversion cycle, then they would not be able to allocate resource towards product development.
How To Effectively Manage Strategic Risk
The key driver within an organization in management of strategic risk should be at the board and C Suite level. Strategic risk posses’ threats not only to the business strategy but also the positioning of the firm in the industry. In addition, strategic risk has a roll-on effect where it could lead to other financial and operational risks.
Policies that guide the management of strategic risk should be set by the company boards or risk management committees within the boards; together with the C-Suite as they are charged with implementation of business strategies. Over the years, there has been an increased awareness to strategic risk and a change in how to manage it. However, this is a trend that is seen in industries that are heavily regulated such as the financial and consumer goods sector. One immediate action that businesses can take to manage strategic risk, is to have this responsibility sit with a particular person in the organization. For SMEs it can be the responsibility of the CEO; in the event that they do not have enough resources to employ a risk manager.
Strategic risk management should be guided by the organization’s key performance indicators (KPIs) that are derived from its strategic plan. The KPIs help company management to determine if they are moving towards their objectives. As mentioned, strategic plans require capital in order to succeed. With well defined KPIs in place, a business is able to determine whether the resources they have allocated are returning the desired results or if they need to do away with the entire strategy. KPIs help the organization avoid strategic risk by consistently monitoring the business plans to determine if they are successful or not. It is important to note that these KPIs can be both long and short term but they have to be reasonable targets that the business can achieve.
As the company continues to monitor their performance, they should also monitor their risks through key risk indicators (KRIs). KRIs look into the future of the company’s business strategy and try to predict any risks that they might face in the future, depending on the actions they take today. This gives the management time to react to the risk either by reducing, avoiding or accepting it. KRIs work as an early warning signal for potential risks yet to come. The starting point for implementing a KRI is by listing all risks that a particular strategy would be exposed to. For example, a market entry strategy faces both financial risks (the company not able to meet the initial capital required to sustain the marketing efforts in the new area) and people/operational risk (not having enough employees in the area to push the new products among the target group).
Author: David Kageenu