A Hazardous Environment
One measure ofthe increased strategic risks companies face is the sharp drop in the percentage ofthe 3,000 5&P-rated stocks receiving a high quality rating (based on S&P's assessment of a company's ability to achieve long-term, stable earnings growth) and the increase in the percentage of stocks receiving a lowquality rating. High-quality stocks include those rated A-f, A, and A-. Low-quality stocks include those rated B, B-, C, and D. (B+ stocks are omitted.)
You're insured and hedged against many risks-but not the greatest ones, the strategic risks that can disrupt or even destroy your business. Learn to anticipate and manage these threats systematically and, in the process, turn som^ of them into growth opportunities.
Strategic risks take a variety of forms tbat go beyond sucb familiar challenges as the possible failure of an acquisition or a product launch. A new tecbnology may overtake your product. (Think of how ACE inhibitors and calcium channel blockers stole share in the hypertension drug market from beta-biockers and diuretics.) Gradual shifts in the market may slowly erode one of your brands beyond the point of viability. (Recall the demise of tbe Aitiian /. Slywotzky is a Boston-based managing director of Oldsmobile brand.) Or rapidly shifting customer prioriMercer ManagemetU Consulting and a coauthor of How to ties may suddenly change your industry. (Consider how Glow When Markets Don't (Warner Business Books, 2003). quickly baby boomer parents migrated from station wagJohn Drzik is the presidetU of New York-based Mercer Oliver ons to minivans, catching most automakers off guard.) Wyman, a global financial services consulting firm. The auThe key to surviving strategic risks is knowing how to thors can be reached at info@. assess and respond to tbem. Devoting the resources to do 80
the Biggest Risk of All
by Adrian J. Slywotzky and John Drzik
HATEVER YOUR BUSINESS, Consider for a
moment the remarkable turnaround over the past decade in the U.S. banking industry. In the early 1990s, the industry - rocked by the Latin American debt crisis, a major real estate bust, and economic recession - suffered massive loan losses, erratic earnings, and the highest rate of bank failures since the Depression. A decade later, as much of the economy reeled from the dot-com bust and another recession, banks were generally flourishing. The number of bad loans was down, earnings were relatively stable, and the banking industry was outperforming the market as a whole.
HARVARD BUSrNESS REVIEW
Countering the Biggest Risk of A M
The tuinaround occurred in large part because banks were able to develop new tools and techniques to counter risk, in the process giving birth to an entirely new discipline ot financial risk management. Sophisticated creditscoring measures reduced banks'credit losses. New forms ofoptions.futures, and counterparty agreements allowed banks to redistribute their financial risks. In fact, banking regulations now require companies to employ financial models that quantify their market risks. We cite this example because the risks that plagued banks 15 years ago are emblematic ofthe challenges that companies across oil industries increasingly face today. What if these companies could also employ tools and techniques that would provide some protection against a bioad set of high-stakes risks? 1 hese looming threats form a category we call strategic risk - that is, the array of external events and trends tbat can devastate a company's growth trajectory and shareholder value. The evidence of strategic risk is becoming ever more apparent. In the past 20 years, there has been a dramatic decrease in the number of stocks receiving a high quality rating by Standard & Poor's and a dramatic increase in the numberof low-quality stocks. (See the exhibit "A Hazardous Environment.") And our own analysis indicates that from 1993 through 2003, more than onethiid of Fortune 1,000 companies-only a fraction of which were in volatile high-technology industries-lost at least 60% of their value in a single year. So how should a company respond to threats of this magnitude? The answer lies in devising and deploying a systematic approach to managing strategic risk.
Many of these early adopters are at a rudimentary stage, in which they treat enterprise risk management as an extension of their audit or regulatory compliance processes. Other companies are at a more advanced stage, in which they quantify risks and link them to capital allocation and risk-transfer decisions. Even among these more advanced practitioners, however, the focus of enterprise risk management rarely encompasses more than financial, hazard, and operational risks. Most managers have not yet systematically addressed the strategic risks that can be a mucb more serious cause of value destruction. (A method for assessing and responding to the strategic risks your company faces is presented in the sidebar "A Manager's Guide to Strategic Risk.")