Four simple steps to integrating risk management into strategic planning

Let me first start by saying integrating risk management into strategic planning is not the same as conducting a strategic risk assessment or having a risk conversation at a strategy meeting. It is so much more.

You will find it difficult to relate if the objectives have not been defined or documented or if the objectives are not measurable.

Kevin W Knight, during his first visit to Russia a few years ago, said: “risk management is a journey… not a destination.”

Risk practitioners are free to start their integration journey at any process or point in time. But I believe that evaluating strategic objectives at risk is a good starting point. The reason for this is because it is relatively simple to implement yet has an immediate and a significant impact on senior management decision-making.

Here are my four steps:

STEP 1 – STRATEGIC OBJECTIVES DECOMPOSITION

Any kind of risk analysis should start by taking a high-level objective, which is broken down into more tactical, operational key performance indicators (KPIs) and targets.

When breaking down any objective, it is important to follow the McKinsey MECE principle (ME – Mutually Exclusive, CE – Collectively Exhaustive) to avoid unnecessary duplication and overlaps.

Most of the time, strategic objectives are already broken down into more tactical KPIs and targets by the strategy department or HR, so this saves the risk manager a lot of time.

This is a critical step in ensuring that risk managers understand the business logic behind each objective and helps make risk analysis more focused.

Important note, while it should be management’s responsibility to identify and assess risks, the business reality in your company may be that sometimes the risk manager should take the responsibility for performing risk assessment on strategic objectives and take the lead.

STEP 2 – IDENTIFYING FACTORS, ASSOCIATED WITH UNCERTAINTY

Once the strategic objectives have been broken down into tactical, manageable pieces, risk managers need to use the strategy document, financial model, business plan or the budgeting model to determine key assumptions made by management.

Most assumptions are associated with some form of uncertainty and hence require risk analysis. Risk analysis helps to put unrealistic management assumptions under the spotlight.

Common criteria for selecting management assumptions for further risk analysis include:

The assumption is associated with high uncertainty.

• The assumption impact is properly reflected in the financial model (for example, it makes no sense to assess foreign exchange risk if in the financial model all foreign currency costs are fixed in local currency and a change in currency insignificantly affects the calculation).
• The organisation has reliable statistics or experts to determine the possible range of values and the possible distribution of values.
• There are reliable external sources of information to determine the possible range of values and the possible distribution of values. For example, a large investment company may have the following risky assumptions: the expected rate of return for different types of investment, an asset sale timeframe, timing and the cost of external financing, rate of expected co-investment, exchange rates and so on.
• Concurrently, risk managers should perform a classic risk assessment to determine whether all significant risks were captured in the management assumptions analysis. The risk assessment should include a review of existing management and financial reports, industry research, auditors’ reports, insurance and third party inspections, as well as interviews with key employees.

By the end of this step, risk managers should have a list of management assumptions. For every management assumption identified, risk managers should work with the process owners, internal auditors and utilise internal and external information sources to determine the ranges of possible values and their likely distribution shape.

STEP 3 – PERFORMING RISK ANALYSIS

The next step includes performing a scenario analysis or the Monte Carlo simulation to assess the effect of uncertainty on the company’s strategic objectives.

Risk modelling may be performed in a dedicated risk model or within the existing financial or budget model. There is a variety of different software options that can be used for risk modelling. All examples in this guide were performed using the Palisade @Risk software package, which extends the basic functionality of MS Excel or MS Project to perform powerful, visual, yet simple risk modeling.

When modelling risks, it is critical to consider the correlations between different assumptions. One of the useful tools for an in-depth risk analysis and identification of interdependencies is a bow-tie diagram.

Bow-tie diagrams can be done manually or using the Palisade Big Picture software. Such analysis helps to determine the causes and consequences of each risk, improves the modelling of them as well as identifying the correlations between different management assumptions and events.

The outcome of risk analysis helps to determine the risk-adjusted probability of achieving strategic objectives and the key risks that may negatively or positively affect the achievement of these strategic objectives. The result is strategy at risk.

STEP 4 – TURNING RISK ANALYSIS INTO ACTIONS

Risk managers should discuss the outcomes of risk analysis with the executive team to see whether the results are reasonable, realistic and actionable.

If indeed the results of risk analysis are significant, then the management, with the help from the risk manager, may need to:

• Revise the assumptions used in the strategy. Consider sharing some of the risk with third parties by using hedging, outsourcing or insurance mechanisms.
• Consider reducing risk by adopting alternative approaches for achieving the same objective or implementing appropriate risk control measures.
• Accept risk and develop a business continuity / disaster recovery plan to minimise the impact of risks should they eventuate.
• Or, perhaps, change the strategy altogether (the most likely option in our case). Based on the risk analysis outcomes it may be required for the management to review or update the entire strategy or just elements of it. This is one of the reasons why it is highly recommended to perform risk analysis before the strategy is finalised.
• At a later stage, the risk manager should work with the internal audit to determine whether the risks identified during the risk analysis are in fact controlled and the agreed risk mitigations are implemented.