Michael Mainelli and Ian Harris, The Z/Yen Group
[A version of this article originally appeared as"Risky Business – A Balanced Approach to Organisational Problems" NGO Finance (May 1999)]
Enchancing Strategies: Risk/Reward Management For The Voluntary Sector
"Prediction is very difficult, especially about the future" - Niels Bohr
Analytical studies repeatedly show that external observers are incapable of distinguishing the performance of organisations which use popular strategic planning techniques from those which do not use strategic planning. Strategic planning cannot be proved to work, yet we still do it. Risk/reward management is a way of looking at strategic planning and realising what we knew all along - we undertake strategic planning to help us feel better about the future. True, some risk/reward techniques are predictive, but at least they also estimate how big a pinch of salt you should take along with the predicted results. That physicist Niels Bohr knew a thing or two about uncertainty.
Chance and Circumstance
The origins of risk/reward management lie in risk management. Risk management is a discipline which has, in the past few years, moved into the voluntary sector from its more traditional homes in, for example, banking, insurance, health and project management. The common core of risk management is the identification of risk, the handling of risk and the tracking of risk.
The techniques used in risk management are similar from field to field - risks are the probability of an adverse occurrence; risks can be measured by severity and likelihood; risks can be accepted, avoided, mitigated or transferred. Risk management as a discipline has assembled a set of powerful tools culled from a variety of disciplines - actuarial tools, engineering tools and simulation tools. Risk management has been gaining in popularity. Books, seminars and courses abound; for example The Institute of Chartered Accountants in England and Wales (ICAEW) has issued "Business Risk Management" (Technical Focus, January 1997, ISBN 1 85355 640 8); naturally, there is an Institute of Risk Management.
Risk management is a system of control, not a strategic perspective, even less a holistic approach to strategic thinking; nor have risk managers made such claims. It focuses on the negative, i.e. how to minimise what could go wrong. Risk management needs to be balanced by reward management, how to enhance what could go right. Risks and rewards are measured in terms of likelihood of positive and negative impact. When risks are better understood, more risks can be undertaken. However, there is no point in taking on more risks without increasing rewards - we call it "enchancing" the organisation.
Risk/reward management began about ten years ago when some strategists toyed with defining strategy as a set of risks and rewards that the organisation was prepared to accept. The resulting definition of an organisation, "an entity pursuing a set of goals which controls resources and owns a set of risk/reward contracts, both explicit and implicit, with other entities and the environment", has real use as a means of decision making and problem solving. Sets of risk/reward contracts can be visualised as a set of probability distribution functions which encapsulate the organisation's potential future. Risk/reward management has become the "love of knowledge" of risks and rewards and the intellectual quest involved in understanding them; it can apply to large and small voluntary sector organisations.
Gambling on Views
People solve problems by looking at them from particular viewpoints. From some viewpoints, problems are more difficult, or impossible, to solve; from others, easier. Today's risk is tomorrow's reward; tomorrow's reward is today's risk. Risk/reward philosophy recognises the duality. A potentially world-beating new care service (full of rewards) is also a potential flop (risks). A potentially weak communications and fundraising network (risk) may hasten moving to the internet (reward). Risk/reward management provides a methodology for solving organisational problems at all levels, from the strategic to the mundane, within an integrated framework. Risk/reward problems have included, amongst others, process re-engineering, performance improvement, culture change, fraud reduction and information systems reviews.
To illustrate sets of risk and reward contracts, imagine two charities, "Care With Attitude (CWA)" and "Friendly Compassionate Care (FCC)", engaged in advocating care for and providing care to the needy. Assume that both charities have "providing excellent care to the most needy" as a first objective and "promoting the provision of care as a priority within our society" as a second. CWA funds the "provision of excellent care" through grants to small care providing organisations; FCC runs fifty-five projects of its own, each of which "provides excellent care" to the needy. CWA has an assertive negotiation style with government and influencers, which sometimes gets good results quickly but sometimes seems to cause setbacks; FCC is friendly and popular with government and influencers, but perhaps does not always get lobbying results quickly. CWA's staff have detailed job descriptions and are remunerated via a local authority grading structure. Most FCC staff have flexible posts and remuneration is set on a person by person basis.
The above example can continue, but already there are two distinct sets of risk and reward contracts. In practice, much of the content of these contracts will remain unspecified. For instance, FCC may believe that it has an implicit contract with its staff for extra service when times are hard. This belief may be expressed as a probability distribution function of hours worked or a function of crucial service delivery, but almost certainly does not exist in contract. CWA may believe it obtains lowest staff cost through its reliance on local authority pay bands for its own staff and grant funding small "lean and mean" organisations for service delivery. This belief may be expressed as a probability distribution function of costs. FCC may believe that government and influencers will look kindly on its cause when times are really hard, while CWA may feel that regular "quick wins" from lobbying are worth more than winning long battles or calling in favours occasionally.
The distribution of resources on risk and reward contracts will vary as well. FCC probably worries more about regular income at sustainable levels to ensure the continuity of its projects. CWA probably worries more about the effect of public sector pay rises on its cost base. FCC probably spends more time on staff appraisals and annual pay awards. CWA probably spends more time reviewing each funded project's performance and deciding its funding priorities project by project.
Figure 1: “CWA” And “FCC” Scenarios Generate Risk/Reward Profiles
A number of organisational concepts benefit from risk/reward re-definition. Culture has been defined as "the way we do things around here". Risk/reward philosophy focuses on a definition of culture as "the way we decide to do things around here using a common set of risk/reward beliefs". The ethos of the organisation is captured in the common set of risk/reward beliefs at all levels of the organisation.
For instance, CWA and FCC almost certainly have different cultures, one charity making decisions against a principle of "friendly and fair", the other on "assertive and efficient". If FCC re-developed "friendly and fair" during a strategic planning exercise into "friendly, but assertive", the objective of the change would not be just to do things differently, but to affect all subsequent decisions by using the implicit risk and reward beliefs inherent in the new phrase. Throughout the organisation, decisions from pay to press contact should be made by different people in line with the common set of risk/reward beliefs - a culture and sub-cultures. Risk/reward beliefs within the finance functions of both firms might have elements in common (e.g. the risk of losing track and the reward of accuracy would be stronger than elsewhere). Finance might also retain some of the overall firm culture (e.g. "friendly, but assertive" credit control versus "assertive and efficient" credit control).
A typical risk/reward approach to strategy should illustrate these ideas more concretely, here using the Z/EALOUS risk/reward methodology for a quasi-government NGO client:
Environment phase: the team confirmed their objectives, the organisation's mission, goals, values and beliefs e.g. public sector values, private sector involvement. The team also developed some generic risk/reward `trees' (cascading sets of risk/reward structures) from research on similar organisations.
Analysis phase: a variety of strategic planning tools, e.g. Porter's five forces, BCG models and factor analysis, were used to find the risk/reward issues which affected the organisation achieving its mission. The tools were issue generators. All issues were valid, even though on later ranking of severity and likelihoods some might recede in importance. A unique risk/reward tree was built for the organisation. Political risk was the root risk in the tree.
Likelihood phase: the issues (40 to 50 major ones) were categorised as risks or rewards. Risk/reward issues were also reversed (risks became rewards and vice versa) to determine the full shape of the distribution function, as perceived by senior managers. Taking the final set of issues and their distribution functions, a Monte Carlo simulation was run, combining the risks and rewards with their severities and likelihoods, identifying those which had the greatest impact on the organisation either achieving or failing in its goals.
Option phase: for each issue, a variety of actions were developed. Likewise, a variety of actions, which senior managers hoped to achieve, e.g. Investors in People, were correlated, if possible, with risk/reward issues. Options were ranked on categories such as impact, certainty, safety/regret and ease.
Understanding phase: both the risk/reward issues and the options for addressing them were then subjected to finding the `twist', i.e. a way of succinctly expressing the issues and options which revealed their underlying essence. The "issues twist" was a short tale describing the scenario of the organisation. The "options twist" was an easily remembered five-point strategy subsuming almost a hundred actions.
Sharing phase: the issues were shared with the organisation and its stakeholders. The actions were partially re-discovered, partially re-worked with the stakeholders, including more junior management. The strategy was implemented as both a hard system, i.e. corporate plan and objectives, and a soft system, i.e. culture change to achieve greater unity in both risk/reward beliefs and their priorities. Results, both successes and failures, were tracked and fed into the subsequent year's planning cycle.
Julius Caesar might have conquered all strategic planning projects with "venimus, cogitavimus, scripsimus" (we came, we thought, we wrote it up). Distinctions between the example in the paragraph above and other strategic planning exercises can be difficult to discern, but do include:
assessing risks and rewards against all goals - especially pertinent in the voluntary sector where goals are often multifarious and the relationship between goals can be complex;
blending qualitative and quantitative planning techniques;
recognition that risks are rewards, and vice versa, typically encapsulated in risk/reward trees. Risks and rewards can also be assumed passively - not just what we have decided to do, but what we have decided not to do;
using a variety of tools within a meta-methodology: most common strategic tools can be used for generating risk/reward issues. Scenario planning works particularly well with risk/reward philosophy, helping to flush out issues and integrating risks and rewards within a framework people can remember;
blending hard and soft systems: 'twist' is essential to gaining acceptance by people.
Risk/reward management is only to some extent a new insight. Risk and opportunity feature in the introductions to many textbooks in business studies, but at the same time many business texts obscure the fundamentally chancy nature of the organisation in a welter of mostly unconnected theories. Decision theory brings together many of these concepts, but usually solely for large, quantifiable projects. Almost never is the manager's daily quota of decisions linked with the organisational strategy, risks and rewards cascading down from the strategic plan and flowing back up to affect the management team.
Risk/reward management has some problems. The highly emotive word `risk' can leave the false impression that uncertainty should be minimised. Some organisations cannot hold the open debate which is necessary for sharing risk/reward perceptions. Risk/reward can be over-intellectualised. Risk/reward does not promise quick fixes and is therefore unsuitable to some types of manager.
"The best way to predict the future is to invent it" - Alan Kay
The key benefits of using risk/reward management for strategic planning are:
culture - risk/reward management develops empowering, performance-enhancing information, process and reward systems aligned with the organisation, its people and their beliefs;
integration - risk/reward management works with imperfect information and directs quantitative work to the areas of highest potential return, not just the most easily available numbers. The organisation develops a commonly used set of techniques, building the stock of decision-making knowledge;
dynamism - the focus on decision-making, as well as the ability to cascade risk/reward sets both up and down the organisation, permits decisions to be made separately in different parts of the organisation while increasing the likelihood that separate decisions are complementary;
robustness - changes in risk/reward perceptions through new information or new ways of analysing the environment invigorate the strategy rather than destroy a fragile intellectual edifice. The strategy should be reviewed when risks or rewards change, not just on an artificial calendar cycle.
One overall benefit is holism, looking at the organisation in its entirety. In complex organisations (and voluntary sector organisations of all sizes are often complex), the decisions that make the biggest difference are often the most subtle to perceive and enact, such as focusing on "donor retention" or "innovative care". Risk/reward management helps strategic planners reduce the risk of failure on strategic planning exercises while enabling them to innovate and enhancing their rewards - risk/reward enchancement of strategy.
Michael Mainelli and Ian Harris are directors of Z/Yen Limited. Z/Yen specialises in the application of risk analysis and return incentives to strategic, systems, human and organisational problems in order to improve performance. Z/Yen clients to date include blue chip companies in banking, insurance, distribution and service companies as well as many charities and other non-governmental organisations. Contact: Michael Mainelli or Ian Harris, Z/Yen Limited, 5-7 St Helen's Place, London, EC3A 6AU, UK. Telephone: 020-7562-9562.