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Five Factors For Managing In An Uncertain World: PART III – Risk

January 4, 2008

One of the key trends we observed at IACCM in 2007 was the rising threat to Western companies – and in particular, US companies – because of their attitudes to risk. They do not have confidence in their ability to manage risk, so they seek to avoid it. And in so doing, they open the way to their more nimble competitors from emerging markets. This is especially evident in the contracting and negotiation practices and policies followed by many international corporations.

Innately we all understand that we must take risks. Every moment of every day, we are surrounded by possibilities and uncertainties – things could go badly wrong at any moment.The big question is how comfortable we feel about consciously taking risks.  And the answer to this is very personal; it depends on how good we are at analyzing situations (do we recognize the risks?); how accurate we are at assessing their likelihood or consequence; and how confident we feel about accepting and managing that risk. As the table below shows, there are significant issues of trust that impact those who are responsible for forming and managing trading relationships. We asked our community of lawyers, procurement professionals and contract managers how they felt about the qualities of risk management within their organization.

% saying that they personally are ‘good’ or ‘excellent’ at risk identification and management

% saying that people generally in their company are ‘good’ or ‘excellent’ at risk identification and management 18%
% saying that their company’s executive management is ‘good’ or ‘excellent’ at risk identification and management 57%
% saying that their immediate colleagues (those performing similar jobs) are ‘good’ or ‘excellent’ at risk identification and management 51%

We then asked users of their services – people in Sales, Business Unit managers, project managers – how they felt about the risk management capabilities of their Legal, Procurement and Contract Management groups. Just 16% gave a ‘good’ or ‘excellent’ rating. Most felt that the groups were risk-averse and driven by rules, rather than judgment.

Who is right? Probably neither side is completely right or wrong; the important point here is that no one has a monopoly on good judgment and that perceptions of what is ‘good’ are frequently very subjective.

There is another aspect to taking risk, one that is often overlooked or is considered too narrowly. And that is to understand the nature of the opportunity that comes from taking the risk. Risky actions are not taken in a vacuum – they are in connection with doing or achieving something. So the counter-side of risk is opportunity – and we can make good risk decisions only if we understand what we might gain or lose as a result of our decision.

The problem we face – and the reason that risk is highlighted as Factor #3 in this series – is that business is contending with heightened complexity and uncertainty. This has tremendous impact on groups like Procurement, Legal and Contract / Commercial Management because they feel they are custodians of responsible risk behavior. And that is a very difficult task when the risks are not just hard to quantify, but may not even be recognized.

As we venture into the global networked economy, we daily encounter new experiences, new pieces of information, new ways of doing things. In such an environment, doing anything seems risky. Our networked world has also facilitated far wider input and involvement – and each of those involved has their own take on risk and on the things that might turn out to be problems. Some of the consequences of this environment are readily evident. They come in the form of supply chain disasters; exposures to safety or the environment; performance failures on major contracts; regulatory or compliance exposures.  Today, such failures are instantly visible through networked news and it is rarely possible to apportion blame to the other side.

Academics such as Rob Handfield of NCSU have undertaken massive research into the impacts of these supply chain failures. There is also extensive work on how companies should handle problems to limit the fall-out (or sometimes even turn it into a positive because of the excellent way they handle the situation). But behind the scenes, there are less visible – yet pervasive – consequences of this world of risk and uncertainty. We see it in our benchmarks and our research studies – decisions are taking longer to be reached; contract lead-times are extending; workload from review and approval is increasing; confrontation in negotiation is growing. And the hidden results of these ‘risk containment’ measures are that the vision of the opportunity is lost. Far from managing risk, we are often guilty of converting risk – and the new risks we create may be far more terminal in nature than those we avoid.

The last edition of IACCM’s newsletter, Contracting Excellence, contained some great examples of this. One was the story from the telecoms industry, where customers impose rigorous and rigid liabilities, indemnities and damages.  As these flow through the supply chain, they force companies to reduce the possibility that things might go wrong. They have two immediate methods by which they might do that. One is to create a defensive culture that always places blame and fault elsewhere. The other is to limit doing risky things – and in this case, that means constraining innovation. By using only tried and tested products or services, it is certainly possible to reduce the chances of things going wrong – but it also means that you are constantly behind the competitive curve.

One of the key trends we observed at IACCM in 2007 was the rising threat to Western companies – and in particular, US companies – because of their attitudes to risk. They do not have confidence in their ability to manage risk, so they seek to avoid it. And in so doing, they open the way to their more nimble competitors from emerging markets. It isn’t just a matter of those competitors being more prepared to take risks, it is also that they have become more attractive trading partners. My conversations with business leaders from a range of industries indicate that they are turning to overseas trading relationships not just because of future opportunities or lower costs, but because these companies are often easier to do business with.

To be blunt, the ‘sophisticated’ economies run the risk that they will become so paralyzed by rules, regulations, procedures and the fear of doing something wrong that it will be almost impossible to do anything right.  If lawyers, contract managers and sourcing experts truly wish to be viewed as responsible and credible managers of corporate and business risk, then they must start to challenge the behaviors that could otherwise destroy not just their company, but their nation’s competitiveness. At present, far too many either push a self-defeating ‘control and compliance’ approach, or alternatively they insist that every situation demands their personal oversight and judgment. In either case, they are effectively placing a straitjacket around their business and its competitiveness. Today’s trading conditions mean that we must abandon notions of controlling circumstances and creating certainty. We must stop taking the view that risk is somehow manged if it has been handed to someone else. In this world of inter-dependent supply networks, we must focus on building the tools, systems, techniques and skills needed to become exceptional ‘managers of uncertainty’.

Trading relationships are becoming more strategic and more complex. Therefore the challenge as we enter 2008 is to implement risk regimes that are far more holistic in their data collection and analysis. Risk categorization must be improved (there are some great models, such as that offered by Synaptic Decisions). Economic analysis must be faster and more complete (that means more integrated business functions and business information, a better understanding of the financial consequences of terms and conditions). Trend data must be collected to allow improved portfolio analysis (for example, contract management systems that identify frequently negotiated terms or capture repetitive performance issues). Fall-backs must be issued to support greater empowerment and to eliminate the need for such frequent review and approval. But above all, there must be accountability. Leaders in our contracts community must step forward and promote the measurements and KPIs that support an environment where risk is truly understood and managed, rather than simply contained. 

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