Managing Opportunities and Risks · MANAGING OPPORTUNITIES AND RISKS CONTENTS EXECUTIVE SUMMARY...

ManagingOpportunities and Risks

By

Tamara Bekefi,

Marc J. Epstein

and

Kristi Yuthas

MANAGEMENT ACCOUNTING GUIDELINE

M A N A G E M E N T

S T R A T E G Y

M E A S U R E M E N T

Published by The Society of Management Accountants of Canada, the AmericanInstitute of Certified Public Accountants and The Chartered Institute ofManagement Accountants.

Copyright © 2008 by The Society of Management Accountants of Canada (CMA Canada), the American Institute of CertifiedPublic Accountants, Inc. (AICPA) and The Chartered Institute of Management Accountants (CIMA). All Rights Reserved.

No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, withoutthe prior written consent of the publisher or a licence from The Canadian Copyright Licensing Agency (Access Copyright).For an Access Copyright Licence, visit www.accesscopyright.ca or call toll free to 1 800 893 5777.

ISBN: 1-55302-212-2

NOTICE TO READERS

The material contained in the Management Accounting Guideline Managing Opportunities and Risks is designed to provideillustrative information with respect to the subject matter covered. It does not establish standards or preferred practices.Thismaterial has not been considered or acted upon by any senior or technical committees or the board of directors of either theAICPA,CIMA or The Society of Management Accountants of Canada and does not represent an official opinion or position ofeither the AICPA, CIMA or The Society of Management Accountants of Canada.

INTRODUCTION

Risk taking, the engine driving business,is vital to companies seeking marketsuccess. Risks are, however, often thoughtof only as hazards, despite the fact thatthey can present significant opportunitiesand possibilities for organizationalinnovation and new competitive advantageleading to short- and long-term profita-bility. In fact, risk and opportunity are aduality—like two sides to the same coin.

Managing hazardous risk has beenincreasingly recognized as a criticalbusiness issue prompted by events asdiverse as the financial debacles ofcompanies like Enron,Worldcom, andParmalat, the terrorist events ofSeptember 11, 2001, and the hurricane

disaster of Katrina in 2005. CMA Canada,the AICPA, and CIMA have respondedwith four Guidelines that address thisissue:

a) “Identifying, Measuring, and ManagingOrganizational Risks for ImprovedPerformance”;

b) “The Reporting of Organizational Risks for Internal and ExternalDecision Making”;

c) “Integrating Social and Political Riskinto Management Decision Making”;and

d) “Business Continuity Management”.

Though these four ManagementAccounting Guidelines on risk provideexcellent coverage of many of the most

MANAGING OPPORTUNITIES AND RISKS

CONTENTS EXECUTIVE SUMMARY

Recent corporate financial debacles, the threat ofglobal terrorism, and other social, political andenvironmental issues have prompted an increasedrecognition of hazardous risk as a critical businessissue.While the awareness of risk as a threat isimperative, so too is the recognition that risks canprovide opportunities for innovation leading tonew competitive advantage.

This Guideline builds on previous Guidelines onrisk, but focuses on the opportunities created by organizational risks. It provides insights into the positive aspects of risk and views the riskmanagement process as a way to exploitopportunities and drive new organizationalinnovation. It also provides tools and recommen-dations to financial professionals on how todevelop a risk and opportunity managementframework, measures, and management processto drive innovation and win in the marketplace.

INTRODUCTION 3

THE ROLE OF FINANCIAL PROFESSIONALS 5

BACKGROUND 5

MODEL FOR RISK & OPPORTUNITYMANAGEMENT 7

1. IDENTIFYING RISKS & OPPORTUNITIES 9

2. MANAGING RISKS & OPPORTUNITIES 17

3. EVALUATING RISK & OPPORTUNITYTHROUGH ROI AND OTHER METHODS 29

CONCLUSION 33

ENDNOTES 34

BIBLIOGRAPHY 36

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critical issues in risk management, they conceptua-lize risk as it is typically defined—as a potentialhazard.They examine how organizations canprotect themselves against various risks bypreparing for, mitigating, and responding to them.These Guidelines do not, however, elaborate onthe fact that risks are not only hazards that shouldbe avoided but are also opportunities that propelbusiness growth. By focusing on the downside ofrisk, companies can sometimes forego opportuni-ties that might initially appear too risky, but whichhave never been formally analyzed.

This Guideline builds on the previous guidelines by focusing on the importance of risk and opportunity management and the value-creationopportunities often hidden in risks. It aims to help create a more rigorous understanding of therisks that organizations take and provide tools tobetter evaluate and manage opportunities relatedto taking risks.This Guideline suggests a methodfor avoiding hazardous risks or minimizing theirimpacts while proactively seeking opportunitiesand risks that can reward the organization. Ittouches on three different, yet related, pursuits:

1) Identifying and managing risks discussed astraditional risk management in otherManagement Accounting Guidelines,

2) Identifying and managing opportunities, oftenrelated to innovation, and managing relatedrisks, and

3) Identifying and managing opportunities whereothers see only unmanageable risk.

In essence, this piece gives guidance on how todevelop the capacity to minimize unrewardedrisk1— risks that have no upside even whenhandled perfectly, and maximize rewarded risk—risks that present opportunities for success, todevelop an ambidextrous organization. Somecompanies with superior organizational knowledgeand capabilities can accept risks and mitigate themeffectively while their competitors may choose to avoid potential investments due to a low riskappetite or a narrow assessment of risks. Inaddition, organizations may be able to identifyvoids in the marketplace that provideopportunities for innovation others may not see.

This guideline articulates the positive aspects ofrisk management and how to capture opportunitythrough innovation. It views the process andoutput of risk and opportunity management as a source of competitive advantage and a way tosuccessfully navigate charted and unchartedwaters to drive new organizational innovation.It also provides recommendations to financialprofessionals on how they can expand the riskmanagement framework, measures, and manage-ment processes to capture opportunities and gaincompetitive advantage. Financial professionals havea critical role in risk and opportunity managementas the creators and designers of systems thatestablish key performance indicators and measureperformance against them.

Managing risks and opportunities is, in many ways,separate from the daily toils of business, and

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Exhibit 1: Risk & Opportunity Management Continuum2

Improved returns through improved risk & opportunity management

Enhancing capital allocation

Protecting corporate relations

Achieving global best practices

Understanding and evaluating business strategy risks & opportunities

Understanding the full range of risks & opportunities facing business

Avoiding personal liability failure (the personal fear factor)

Compliance with corporate governance standards (fiduciary responsibility)

Other company crises

Own company crises

Complianceand Prevention

OperatingPerformance

Shareholder ValueEnhancement

{{

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GreaterSophistication

M A N A G I N G O P P O RT U N I T I E S A N D R I S K S

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therefore necessitates an explicit effort to stepback and see the full risk and opportunity picture.Managing risk and opportunity is a continuum,illustrated in Exhibit 1, which is increasingly related to strategy, operating performance, andshareholder value enhancement, in addition tocompliance and prevention.This ManagementAccounting Guideline describes a best practiceand we acknowledge that risk and opportunitymanagement described here is a journey. Not all organizations will be able to undertake thepractice as described. But even those who cannot,may still use this piece to help sensitize theirmanagement to begin broadening the approach to risk rather than focusing exclusively on risk as a threat.

THE ROLE OF FINANCIALPROFESSIONALS

The role of financial professionals in capturing and capitalizing on opportunities related to riskcannot be overstated. The corporate finance andaccounting functions may not have full ownershipof the risk and opportunity management processbut they do possess the strategic vision, riskmanagement expertise, financial managementdiscipline, project management skills, andcomprehensive perspective essential to improvingthe effectiveness and efficiency of risk andopportunity management. Management of theseissues is heavily grounded in the role of financialprofessionals because of their contribution to 1) designing, implementing and overseeing thetechnical aspects of the process described in thisGuideline, and 2) informing the Board of thisprocess and its outcome. Financial professionalscan develop approaches to identifying andmeasuring opportunities and risks, contributing in six essential ways:

1) Establishing guidelines and procedures forstrategic planning around opportunities andrisks;

2) Improving the identification, measurement, andmanagement of risks and opportunities;

3) Preparing the evaluation;

4) Integrating the model;

5) Training managers to make more effectiveevaluations of risks and opportunities; and

6) Implementing processes to monitor andcommunicate business risks and opportunities.3

BACKGROUND

In “Identifying, Measuring, and Managing Organiza-tional Risks for Improved Performance”, Marc J.Epstein and Adriana Rejc-Buhovac present amodel and measures for enhancing the identifica-tion and measurement of risks for improvedmanagement decisions. Stemming from the riskassessment requirements of the 2002 Sarbanes-Oxley Act in the U.S., and similar new regulationsin other countries, it also builds on the TreadwayCommission’s Committee of SponsoringOrganizations (COSO) “Internal ControlIntegrated Framework”, and its more recentlyissued “Enterprise Risk Management IntegratedFramework”. Epstein and Rejc-Buhovac’s workfurther specifies the tools necessary for organi-zations to identify and measure a broad set ofrisks. More significantly, however, it concentrateson improving the quality and effectiveness of bothoperational and capital investment decisions,through more effective management of organi-zational risk.

Epstein and Rejc-Buhovac demonstrated thatincreased measurement of a broader set of risksis necessary, both to meet recent regulatoryrequirements and to improve managerialperformance and stakeholder confidence.Theyprovided a six-step risk assessment model,illustrated in Exhibit 2, which builds on the 2004COSO Enterprise Risk Management – IntegratedFramework, and includes:

1) Event Identification

2) Risk Assessment

3) Risk Response

4) Control Activities

5) Information & Communication, and

6) Monitoring

This Guideline builds on the previous guidelineson risk, expanding the risk assessment model toinclude opportunities and innovation, and providesthe needed tools and techniques to capture thepositive side of risk while rigorously managing itsdownside impacts. It outlines strategies foridentifying risks and opportunities, techniques thatorganizations can use to alter their risk appetiteto capitalize on opportunities, and methods tomanage risks and innovations that stem from therecognition of these opportunities.

Although identifying opportunities that igniteinnovation is often considered a lucky coincidenceoccurring when smart and creative people comeup with a good idea that happens to spark market

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interest, in reality innovation is a process. Itincludes a good idea that is embedded inestablished policies, procedures, and informationmechanisms that allow for innovation to thrivewithin and across organizations.4 Whereopportunity is concerned, often it is the ability to identify and manage risks that others cannot,that leads to innovation and market success.These risks—which can be to a particularbusiness (such as declining market share), anindustry, or society at large (such as globalwarming) —can spur innovation. Some risks facedby organizations or society provide significantopportunities for innovation and growth where

superior organizational knowledge and capabilitiesenable innovation. Some of these are summarizedin Exhibit 3.

The ability to use tools to simultaneouslyrecognize and assess risk and opportunity canenable a company to manage offensively as anopportunity rather than defensively as a hazard,which is the more typical response.

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Exhibit 2: Risk Management Process

Event Identification1

Ris

k R

espo

nse

3

Control Activities4

Risk Assessment2

QuantifyMagnitude

Avoid Risk Can Risk Be Mitigated?

Yes No

No

AssessProfitability

QuantifyImpact

Cost/BenefitAnalysis

Priority/Rank

Is Risk/RewardAcceptable?

Share RiskAccept Risk Transfer Risk Reduce Risk

Yes

Information & Communication5

Monitoring6


7

Being able to see risks and opportunitiessimultaneously is similar to perceiving both thevase and the two faces in the optical game inExhibit 4.

Exhibit 4: A Vase and Two Faces

The capacity to see both the faces and the vase,or risks and opportunities, allows companies todevelop flexible organizations that can managevalue protection and value creation simultaneously.Developing the capability to recognize suchopportunities requires a change in the riskmanagement mindset and is critical for financialprofessionals interested in helping their organi-zations to better manage and benefit from risk.

MODEL FOR RISK & OPPORTUNITYMANAGEMENT

Companies that are successfully exploiting andprotecting present opportunities and exploringfuture innovations, all the while managing risk,have been called “ambidextrous organizations.”5

These organizations are able to attend to theproducts and processes of past successes whilecapturing the opportunities that will define thefuture.Creating an ambidextrous organizationthat 1) manages the downside risks and 2) focuseson value creation by capitalizing on opportunities,requires a system to identify, manage, measure,and monitor both risks and opportunities withinthe existing management structure. Such a systemincludes:

1) Effective identification of risks andopportunities, including,

• Sources of risk

• Sources of opportunity

2) Effective management of risks andopportunities, including,

• Assessing and altering risk appetite

• Assessing risks and opportunities

• Managing risk

• Managing opportunity

• Monitoring and a management controlsystem to review the strategy, costs andbenefits, structure, systems, and appetite for risk.

Risk Type Risk Opportunity Example

Social Risk Obesity litigation Develop new products McDonald’s innovates to provide sliced apples,for healthier eating. treated with natural product to ensure freshness,

in Happy Meals. Creates more appealing salads and partners with Newman’s Own to provide high quality salad dressing.

Human Aging Workforce Develop creative solutions Southern Company, the large power company,Resources Risk to retaining retirement-age devises a “Retirement Reservist Pool” to allow

workers in more flexible an aging workforce to transition into retirement positions. over time and still provide expertise to the

company on a part-time basis, thus retaining institutional memory.

Innovation Risk Demand for core Project 10-20 years into Toyota develops Prius hybrid gas-electric car product diminishes the future and think about years before competition.GE develops a variety of

where the industry is headed; energy efficient appliances including water-savingcompete in advance. washing machines and high efficiency light bulbs.

Business Market gets Ensure ongoing and Wal-Mart lobbies for increased Federal Continuity Risk saturated increasing consumption in Minimum Wage to boost disposable income of

existing markets if cannot rural Americans, its core market, and ensure expand to other markets. continued success.

Exhibit 3: Examples of Risks and their Potential Opportunities

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3) Effective evaluation of risks and opportunitiesthrough ROI coupled with real options analysisand / or scenario analysis

Aggressively seeking opportunities can beconsidered a “play to win” (PTW) strategy. PTWhas the explicit goal of investing in innovation toproduce significant advantage that the competitionwill not be able to easily or quickly match. In thePTW innovation mode, a company invests inchanges in technology, products, and businessmodels, intending to outpace its competition.The company uses innovation as a key part of itsbusiness strategy, taking risks and managing themeffectively. However, when the main objective is to preserve value and bring risks back within anacceptable range, this can be considered a “playnot to lose” (PNTL)6 strategy. Althoughinnovation is acknowledged as important, high

risks and rampant uncertainty may not warrant asaggressive an investment as might be appropriatein PTW. PNTL is not a long-term strategy. Rather,it is a method of preserving value during periodsof flux. Regardless of whether a company isfollowing a PTW or PNTL strategy, formal analysiscan aid in managing risk and in identifying andcapitalizing on opportunities.

Exhibit 5 depicts the process of risk and oppor-tunity management. It builds on and modifies theRisk Management Process model in the 2005Management Accounting Guideline “Identifying,Measuring and Managing Organizational Risks forImproved Performance”7 (Exhibit 2), by includingopportunities and offering additional tools andtechniques to foster and manage innovation within the risk management context for improveddecision making.

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IDENTIFY RISKS & OPPORTUNITIES1

MANAGE RISKS & OPPORTUNITIES2

EVALUATE RISKS & OPPORTUNITIES3

SOURCES OF RISK

ASSESS & ALTER RISK APPETITE

ASSESS RISKS & OPPORTUNITIES

SOURCES OF OPPORTUNITY

MANAGE RISKS

Share Risk Transfer Risk Reduce Risk

MANAGE OPPORTUNITIES

Exhibit 5: Risk & Opportunity Management Process

MonitorInnovation

}


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1. IDENTIFYING RISKS & OPPORTUNITIES

With the seemingly endless stories of natural andman-made disasters and corporate missteps thatdevastate earnings gracing the front page of majornewspapers, risk has increasingly been considereda negative that must be managed. Although true,this is but one side of a two-sided coin. In fact,companies prosper by taking risks and lose moneyby failing to manage them.

Sources of Risk

The first step to managing unrewarded* risk andcapitalizing on opportunities is to identify theissues that are relevant to one’s organization.This identification can then assist in developingcountermeasures or seeking hidden rewards.

* Unrewarded risks are those that have little or no upside evenwhen handled perfectly.

As outlined in the previous risk-focusedGuidelines, risks are often placed in fourcategories—strategic, operational, reporting, andcompliance.

• Strategic risks relate to an organization’s choiceof strategies to achieve its objectives. By theirnature, these risks endanger the achievementof an organization’s high-level goals that alignwith and support its mission. Strategic riskassessment identifies the risks associated withspecific strategies.

• Operational risks relate to 1) threats fromineffective or inefficient business processes foracquiring, financing, transforming, or marketinggoods and services, and 2) threats of loss offirm assets including its reputation.

• Reporting risks relate to the reliability, accuracy,and timeliness of information systems and toreliability or completeness of information foreither internal or external decision making.

• Compliance risks address the presence or lackof systems to 1) monitor communication oflaws and regulations, internal behavior codesand contract requirements, and 2) provideinformation about failure of management,employees, or trading partners to comply withapplicable laws, regulations, contracts, andexpected behaviors.8

Exhibit 6 illustrates this risk classification schemeand lists some of the issues that fall within eachcategory.

Each of strategic, operational, reporting, andcompliance risks have a number of subcategories.Organizations should establish their own list ofrisks that are most relevant to their businessesand business environment.Those included inExhibit 6 represent a selection of some of themost critical issues organizations face today.Therisk classification scheme thus does not attemptto be comprehensive; rather it provides a generallisting of risks and a sample of relevant risks facingorganizations.




SOURCES OF RISK




MANAGE RISKS

SHARE TRANSFER REDUCE


MonitorInnovation

}

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Sources of Opportunity

In addition to identifying threats to the organiza-tion, it is also critical to identify opportunities,both as they relate to risk and beyond. Expandingmanagement awareness into these areas may yield fruitful insight into 1) potential opportunitiesfor which innovation may be appropriate, and 2) which risks should be mitigated.

Opportunities can emerge not only from withinthe organization, but also from outside the narrowfocus of day-to-day business. Exhibit 7 illustratessome other potential sources of opportunity.

Exhibit 7: Sources of OpportunityClassification Scheme

This list is not meant to be comprehensive.Rather, it represents a selection of potentialsources from which to identify opportunities and innovation.

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Exhibit 6: Sources of Risk Classification Scheme

Risks

Strategic Risks

Economic risks

Industry risks

Strategic transaction risks

Social risks

Technological risks

Political risks

Organizational risks

Environmental risks

Financial risks

Business continuityrisks

Innovation risks

Commercial risks

Project risks

Human resource risks

Health and safety risks

Property risks

Reputation risks

Information risks

Reporting risks

Legal and regulatoryrisks

Control risks

Professional risks

Operational Risks Reporting Risks Compliance Risks




SOURCES OF RISK




MANAGE RISKS



MonitorInnovation

}Opportunities

Supply chain

Product andservice offering

Process

Technology

New markets

Within theOrganiztion

Customers

Competitors andcomplementors

Emergingtechnologies and scientificdevelopments

Influencers andthought shapers

Political, legal andsocial forces

Beyond theOrganiztion


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Sources of Opportunity Within the Organization

Supply Chain: Supply chains, or how value iscreated and delivered to the market, can be asource of opportunity and innovation. How acompany structures itself, partners with otherentities, and operates to deliver its products andservices can be examined for opportunities.Perhaps bundling services can secure above-average margins, as was GE’s experience when it began to couple service contracts with itsmanufactured electric turbines. Maybe a newapproach to outsourcing can create value, similarto the value Sun Microsystems gained when itcreated strategic partnerships with otherorganizations. The vastness of many corporatesupply chains means that innovation is possible at many of the links along the chain.

Product and service offering:The search foropportunities and innovation can also concentrateon new products and services, or changes toexisting products and services. Increasingly,customers are coming to expect these types ofinnovations, and companies that can identify anddeliver on these expectations often achieve greatsuccess.New models of cars,mobile phones,iPods, and computer software are but a few of the successful innovations that repeatedly bringcustomers back for more.Other examples ofproduct and service innovations to capture new market segments include 1) Coach bagsexpanding from offering elegant bags marketed tomature women to designing small wrist pouchesfor twenty-something women going clubbing inresponse to a potential reduction in market share;and 2) famous concert halls offering discountedtickets to dinner and “introduction to music”evenings for singles in large cities worldwide inresponse to shrinking audience size.

Process:Process improvement opportunities canlead to faster, better, and less expensive products.Examples include innovations in petroleumrefining that save energy and costs, electricitygeneration, and equipment like telephone routersand mail sorting machines.

Technology:Technology provides another source of opportunity by allowing companies to executestrategy quickly, thereby making time a source ofcompetitive advantage. For example, communi-cations technology can speed up planning and theexchange of ideas, while information technologycan help to improve systems for managing supplychains and finances. Beyond technology’s ability tohasten and streamline operations and communi-cation within companies, the Internet has

dramatically impacted the marketplace. Recentcommoditization of a range of products—fromshopping to banking online—has changed how we do business.

New markets:New markets often createopportunities to source products differently ortap into new consumer groups. For instance,companies like the piano manufacturer Steinway & Sons that twenty years ago may have seenChina as beyond the scope of its businesses arenow sourcing from,manufacturing in, and sellingtheir products to this enormous market.

Sources of Opportunity Beyond the Organization

Customers: Sensitivity to customer needs or trendscan open vistas of opportunity. Companies thatfocus on shifts in customer behavior and theirneeds can sometimes anticipate changes, andthrough innovation, meet needs before thecompetition does. For example, nightclubs inmajor U.S. metropolitan areas recognized that agrowing share of their clientele were becomingparents and could no longer attend late nightshows.This new generation of parents wasreluctant, however, to relinquish their identities as hip club goers or stop listening to the cutting-edge music to which they were accustomed.Further, these young parents expressed aninterest in exposing their children to such music,albeit in a calmer, quieter, environment.Thisresulted in “Baby Loves Disco”—a loose affiliationof clubs nationwide that open their doors onSaturday mornings to put on rock and discoshows at a lower volume, with diaper-changingstations, clowns, food and drink for kids andalcohol for their parents. Using the space that was empty during daylight hours, these clubs arerunning wildly successful add-on businesses withrelatively low overhead and have re-captured anaudience they were losing to other entertainmentproviders.

Competitors and complementors: Although beingsensitive to the opportunities seized by thecompetition can provide important learning,developing sensitivity to what competitors avoidbecause of perceived insurmountable risk canyield opportunity. Identifying how one’s ownorganization is better equipped to deal with these issues than the competition can unlockopportunities.This is illustrated in a later sectionby the Belgian chain, Kinepolis’ experience in the seemingly stagnant European movie theaterindustry.

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Emerging technologies and scientific developments:Technologies and scientific developments, evenwhen not apparently related to one particularindustry, can also be a source of opportunity.For instance, the Internet revolutionized groceryshopping in urban areas when supermarkets began offering online shopping and delivery. Somemarkets went a step further, with innovations likeproviding clickable recipes where the appropriateingredients and amounts are automatically placedin a virtual shopping basket. Electronic in-housemedical records have also changed how doctors1) collaborate to treat patients, 2) share infor-mation with the public health department, and 3) ensure data is available to all caregivers.

Political, legal and social forces:Opportunities can be found in the political, legal, and social landscapein which business is conducted. For instance, theincreasing concern over climate change andhuman impact on the environment in Europe,Canada, and the United States has led manycompanies to develop “green” products to meetboth consumer demand and increased legislativepressures. For example, General Electric’s productline of energy-saving equipment under theEcomagination umbrella, with offerings rangingfrom light bulbs to appliances, has allowed it tocapture $12 billion in market share. Likewise, theniche market of eco-friendly cleaning products likeSeventh Generation and Ecover is growing rapidly.

Each organization should establish its own list ofopportunity sources that are most relevant to itsbusinesses and its business environment.The priorlist is not meant to be exhaustive, rather it isprovided to aid organizations that engage in theprocess of listing opportunities.

Strategies for Identifying Risks & Opportunities

To hone in on potential risks and opportunities,managers should return to the list of key risks andopportunity subjects applicable to their company.

Organizations can use a variety of methods toidentify risks and opportunities, and to overcomebarriers to pursuing opportunities that had beenneglected due to perceived but unexamined risk.Techniques to encourage such thinking include:

• Learning from the past

• Developing Customer sensitivity

• Learning from others

• Scanning

• Scenario planning

• Seeing the market gaps and change thegame

• Developing idealized designs and competingin advance

• Developing Market sensitivity

Learning from the Past

One method of identifying risks and opportunitiesis learning from the past. Although pastexperience cannot necessarily predict futureperformance, signals that were ignored, missedopportunities, and business surprises can provideinsight into organizational blind spots.To detectthese, some suggest beginning a few decades backand systematically listing the social, technological,economic, environmental, and political changesthat occurred in and around one’s industry.9

Then identify those that were missed that had abig impact on the organization.This process,similar to maintaining a loss or near-miss database,enables organizations 1) to grasp how they havereacted to external changes and 2) to identifypersistent blind spots in certain areas.This processassists in shifting focus from competitors toalternatives and from customers to non-customersto broaden the scope in which to innovate.This,in turn, can lead to value innovation that movesbeyond just beating the competition to providingcustomers (old and new) with value that faroutpaces the competition.10

Customer Sensitivity

Customer sensitivity can be a key to identifyingrisks and opportunities. Understanding customertaste and retaining customers, by delivering onwhat often seem to be highly variable demands,habitually poses a huge risk to companies.However, this area of risk also provides anenormous opportunity.Trying to understandcustomers in a way that the competition does not,and creating systems to exploit this understanding,can lead to great gains. Creating a customer-sensitive company by focusing on proprietaryinformation can help to achieve this goal.

The first step to achieving customer sensitivity is to cull information on what they value, whatthey need, their interests, and shifts in their taste.Creating a system to collect and use thisinformation is critical to maximizing opportunityin the value-creation process.

Tsutaya, Japan’s premier distributor of entertain-ment and information (often likened toBlockbuster, Amazon, and Barnes & Nobles rolledinto one) has done just this. In 1984 Tsutaya was

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simply a video rental company. However, thecompany’s CEO, Muneaki Masuda, envisionedcreating a cultural resource driven by under-standing customers’ new needs in an increasinglyaffluent Japan awash with material goods. One of the first Japanese companies to invest intechnology to manage and mine customer data,Tsutaya initially used information collected fromits membership cards—like many supermarketchains internationally—to track sales andinventory patterns across the whole retail chain.This allowed the company to see who was buyingwhat, where, and when.The information helpedTsutayato predict what customers may next beinterested in.Tsutaya then took a further step,using the Internet and later cell-phone-basedtechnology to dramatically expand its relationshipwith, and data gathered about, customers.

Through its use of proprietary information,Tsutaya has built itself into a “cultural convenience”providing 1) Online shopping, product reserva-tion, and availability confirmation—these servicesalso serve the company by ensuring less unusedinventory and providing an early warning systemthat shows a ground swell of popular demand fora product, thus guaranteeing that stores areappropriately stocked, 2) E-mail magazines sent tomobile phones or computers enabling trackingwhich cultural categories are shrinking, growing,or changing, 3) Electronic coupons sent to themobile phone that attract customers to thestores; the company has found that coupon users shop 22% more often and spend 7% morethan those without coupons, and (4) Onlinerecommendations that drive over 60% of onlinesales.Tsutaya’s sophisticated customer trackingsystem enables it to avoid excess inventory,delivers an accurate product mix to each store,and serves as an early warning system about shiftsin customer tastes. It allows the company tochange with, or even earlier than, their customers.There are now 1,273 Tsutaya stores in Japan, andalmost 40% of Japanese twenty-somethings aremembers.The company is ranked number one inmusic sales and movie rentals and number threein books and computer games. In 2006, thecompany’s revenues were $1.9 billion, with $120million in profits and a $2.3 billion marketcapitalization.11

Tsutaya saw that it could beat the competition bydeveloping keen customer sensitivity andinnovating with data collected on customer tasteand shopping habits. It transformed what otherssaw as customer risk into an opportunity tocapture huge market share and continuously servecustomers in ways they never imagined. In a

market that has found customer taste to be fickleand very difficult to keep pace with,Tsutaya sawan opportunity to combine technology and insightinto people’s everyday lives to make customertaste—the very thing others saw as risk—thekeystone of its success.

Creating a focus beyond specific products toexamine the entire user experience can also leadto business model innovation.This is whatStarbucks did when it focused on creating a “thirdspace” outside the home and the workplace forpeople to convene and socialize. Its stores aredesigned to encourage customers to spend timein them—from the round tables that have beenshown to make people look less alone to the freeWi-Fi hotspots that allow customers to go onlinefrom their laptops at any Starbucks. Although itearns most of its profits from the take-out coffeebusiness, the company has created a businessmodel based on people’s social behaviors. As aresult, it can charge a premium for a product thatnot long ago the public thought was a commodityreadily available at a lower cost. Starbucks saw amarket space to combine social behavior with acommodity that was commonly considered un-alluring. Before Starbucks came along andtransformed coffee into a luxury to which mostworking people could treat themselves, the coffeemarket in the U.S. had remained, for the mostpart, within the four walls of the supermarket andthe convenience store. Starbucks createdopportunities where others saw no potential.

Observing customer behavior has become apractice in a range of companies that hireethnographers to examine customers’ underlyingvalues, thus helping to identify unmet needs.

Beyond sensitivity to current customers,considering the needs of those who are not yetcustomers also has the potential to driveinnovation.

Learning from others

The adage,“A wise person learns fromexperience, but a wiser person learns from theexperience of others,” holds as true in business asit does in life. In 1999 the Institute of Medicine, anarm of the National Academies, released thereport “To Err Is Human”, estimating that 98,000patients die annually from preventable medicalerrors—the release of this data coincided withseveral high profile medical errors includingamputation of an incorrect limb. As a result, therewas a wake-up call among many health careproviders regarding patient safety.They realizedthat the majority of adverse events in health care

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are the result of human error—particularlyfailures in communication, leadership, and decision making.

Realizing that devising solutions to the grave risks related to human error could take years todevelop, leaders in the health care industry beganlooking to other sectors for solutions and modelsof innovation. A few top health care managersrecognized the similarity between the structuresof medical and aviation teams, as well as thecauses for medical errors and plane crashes. As aresult, health care organizations began to innovatearound patient safety, guided by the aviationindustry, which has a similar structure of captain(surgeon) and crew (nurses and anesthesiologist).

Research found that hospitals that institutedaviation-inspired practices like pre- and post-operative briefings, simulator training, checklists,annual competency reviews, and incidentreporting systems, had fewer malpractice suits and post-surgical infections, as well as shorterpatient recovery times and higher employeesatisfaction.The health care industry is successfullylearning from an industry very far from its corecompetency, thereby leapfrogging decades ofpotential mishaps that would come only fromtrial-and-error learning.12 This process of learningfrom another industry allows health careproviders to efficiently address a major risk andsave costs by quickly honing in on solutions forpatient safety instead of taking years to developthem.

One company,Vista Medical Technologies, took a step beyond risk mitigation, seizing on thesimilarities between surgery and aviation, when itinvented a minimally invasive cardiac surgery usingfighter pilot technology.Vista devised a helmet,similar to the one that fighter pilots use, fitted tomeet the needs of heart surgeons.The aviationhelmets have pop-up display technology thatproject all of the gauges and targeting informationpilots need on a transparent screen in front of thepilot’s eye.This means they do not need to lookdown, avoiding distraction when split-seconddecisions are required.The helmet modified forheart surgeons provides a stereoscopic image ofthe inside of the chest from two lenses of a probethreaded into the chest cavity prior to surgery.The rest of the cardio-thoracic team gets thesame view thanks to television screens that displaythe images inside the operating theater.With thistechnology, the surgeon no longer has to crackthe patient’s chest to perform surgery, and thesurgical team is assured that they are all seeing the same image of the surgery.This streamlines

information and cooperation under high pressure.The success of endoscopic coronary bypass usingaeronautical technology has expanded into othermicrosurgical fields.

Looking across industries to a seemingly totallyunrelated sphere allowed the medical field tomitigate one of its central risks, as well as deviseinnovative technology that could drasticallychange the practice of microsurgery.

Scanning

Active scanning of the business environment,potential competitors, or rival technologies iscritical to successfully seizing opportunities andcombating risk. Although all managers who arecognizant of the environment in which theircompany is doing business passively scan to someextent, the data from this scanning may be flawed.Passively receiving information from customarychannels usually reinforces managers’ assumptions.Active scanning, however, is often driven by ahypothetical threat, such as how a new technologycould disrupt the current business model.13

Had the music industry stopped to reflect on thepower of the Internet and the allure of peer-to-peer sharing of single songs using this technology,it could have innovated before Napster stole sucha large part of its market. At its zenith, Napsterboasted 60 million users swapping three billionMP3 music files, while album sales dropped 30%.14

At the same time the music industry sufferedsetbacks and resorted to suing illegal file-sharingcompanies, Apple Computers saw an opportunityat the periphery of its business and quicklyinnovated to create the iPod and iTunes, acomputer-based music library.

iPod was created because Steve Jobs realized thata missing component of digital music and theexperience of listening to it was the ability tomake it portable.The iPod was rolled out withinnine months and was quickly followed by iTunesMusic Store to store and play music on thecomputer. Although the iPod and iTunes weretechnological innovations, the iTunes Music Storewas a business model innovation that changed theway people purchased music. Apple recognizedthat instead of buying entire albums, consumerswanted access to individual songs for easy loadingonto their iPods.The company had hoped to sell amillion songs in the first six months, but did that inthe first six days.Where others only saw threats,Apple saw an opportunity and expanded itsbusiness significantly. By 2005, Apple’s share priceand profits had tripled15 and it still continues to

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dominate the market. As a result of scanning the peripheries of its business, recognizingopportunities, and innovating, Apple catapulteditself from a boutique computer maker to a multi-platform company that changed the rules of thegame for three industries—PCs, consumerelectronics, and music—and it has not stoppedinnovating.

Scenario Planning

Once mainly the domain of crisis managementteams, scenario planning is a powerful tool foridentifying both risks and opportunities. Identifyingthe factors that could weaken or decimate one’sbusiness allows for 1) early action to avertcatastrophe, and 2) the creation of well thought-through action plans in case the risk materializes.Likewise, this identification can lead to innovativethinking that can generate new ideas.

In 2002, weak signals of a possible supply chaindisruption began to emanate from the increasinglyacrimonious labor negotiations concerning thewest coats ports of the U.S. between theInternational Longshore and Warehouse Unionand the Pacific Maritime Association.When theunion staged a work slowdown, the ports werelocked for 10 days in late September to earlyOctober.This lockout froze a massive flow ofcontainers through the 29 ports that accountedfor $320 billion in annual imports and exports.Because freight could not be offloaded at nearbyports which were unable to handle the hugecontainer ships, a vast inventory of goods wasmarooned offshore.Those companies that had aplan, and were sensitive to the weak signals ofdeteriorating labor negotiations, successfullyavoided huge negative impacts on their businesses.Large retailers like Costco were able to get theirholiday inventory shipped in September, averting aloss of millions of dollars of revenue.Wal-Martprovided for early shipments, and “was able toclear port on most of (their) Christmas itemsbefore the shutdown began… (they) had acontingency plan and it worked.”16 In contrast, thecompanies that did not have, or implement, acontingency plan reported reduced sales as aconsequence of the lockout. Mattel reported that even three weeks after the lockout it had$75-$100 million in wholesale goods stuck on thewater due to a logjam of ships waiting to unload.17

Scenario planning can also help managers identifypotentially disruptive competitive technologies,helping to spur innovation to stay ahead of thecompetition and new market entrants. Scenarioplanning was a tool used by Jim Manzini, CEO of

Lotus, to recognize the threat posed by Windowsin 1992.That year Lotus was at an apex, havinglaunched Lotus 1-2-3, which grabbed 70% of the global spreadsheet market. Although stockprice, revenue, and profits were soaring, Manzinirecognized that this could be his company’smoment of maximum risk. New market entrantsand other companies would likely try to innovateand beat Lotus at its own game. In addition, thecomputing world was shifting from an MS-DOSplatform to Microsoft applications that ran onWindows. Manzini drove through the design andlaunch of Lotus Notes, the world’s first collabora-tive software program, despite resistance frommost of his senior management. Customersflocked to use Notes and as a result, Lotussurvived, and thrived, while other software makersthat failed to anticipate the disruptive technologyof collaborative software posed by Windowscollapsed. By 1996, Lotus’ revenues grew from $1 billion to $3.5 billion thanks to Lotus Notes,while its competitors, Borland and WordPerfect,lost 90% of their value.18

See the Market Gaps & Change the Game

Instead of continuously trying to compete withother businesses in one’s category, particularlywhen there seems to be a large, unbeatablecompetitor, companies can change the parametersof the game. What gaps exist in the currentindustry model? Are there different customers to serve, another type of business model togenerate? Are there complementary products orservices that hold value?

Consider Kinepolis,19 a Belgian movie theateroperator that entered the market when cinemaaudience numbers were in steep decline andcinema operators across Belgium were closingdown.The first Kinepolis opened on the ring roadoutside of Brussels—a location challenging theconventional wisdom that movie theaters neededto be centrally located to capture foot traffic andspontaneous movie watchers. It also entered themarket when most observers believed that amovie theater could not be successful.The world’sfirst megaplex, with 25 movie screens and 7,600seats, provided superior screens, sound, and seats,the latest movies, and free parking in a citynotorious for its high parking cost and scarceparking in the downtown area. Kinepolis achievedspectacular growth, capturing 50% of the marketin Brussels in the first year, expanding to France,Spain, Poland, and Switzerland, and posting a 14.6 million Euro profit in 2006.20 It createdopportunities where others only saw insurmoun-table risk.

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Idealized Design & Competing in Advance

Much like a well-played game of chess, idealizeddesign formulates best outcomes by envisioning anideal solution, and then works backwards to thepresent. A master chess player sees the board andimagines a multiplicity of scenarios to achievecheckmate, then works backwards move-by-moveto the current state of the board. As in chess,business strategizing that projects to an imaginaryfuture and then moves back to the present allows for free thinking without allowing presentconstraints to impede potential breakthroughideas.This constructs a much wider canvas onwhich to envision risks and opportunities.

This method was used when, in 1951, the VicePresident at Bell Laboratories challenged hismanagement team to imagine the future oftelephony and re-invent the telephone with noneof the then current technological constraints.Given this wide scope, the group anticipated allbut two changes to the telephone system,including touch-tone phones, consumer ownershipof phones, call waiting, call forwarding, voice mail,caller ID, conference calls, speaker phones, speeddialing of numbers in memory, and mobilephones.21 Free of the technological limitations ofthe day, the team at Bell Labs envisaged ourmodern day telephone 50 years before most ofthe equipment was invented. Releasing peoplefrom the constraints of what is possible in thepresent can lead to inventiveness that producesbreakthrough innovations.

Consider also the story of the Toyota Prius gas-electric hybrid car,22 the concept that was bornwhen Toyota was at the pinnacle of its unrivaledmarket supremacy.Trying to envisage what mighttransform its industry and threaten its marketshare in the future,Toyota’s leaders convened ateam to create the first great car of the 21stcentury in 1993, nearly a decade before thatcentury arrived.Toyota’s leadership pushed theteam beyond the technological limits it hadpreviously worked within, and created a new equalaccess system of communication and informationsharing to replace the traditional hierarchicalmodel. It also brought engineers normally based atproduction plants to the planning floor to workout glitches at the blueprint stage, before the newcar ever started on the assembly line. As a resultof a series of technological breakthroughs,manufacturing innovations, and careful marketing,Toyota has sold more than 1 million hybrid cars—five times as many as its nearest competitor—since introducing them in 1997, and has tripled itsU.S. monthly sales to 24,000.23

Market Sensitivity: Seeing opportunities whereothers are blind

When Cirque du Soleil, the Montreal-basedentertainment empire, burst onto the circusscene, Ringling Bros., Barnum & Bailey and othersmaller circuses were busy competing with oneanother for an ever-shrinking market. Audiencesizes were decreasing, and with them, revenues asalternative forms of entertainment and increasedconcern about use of animals in traveling circuseseroded the mass appeal of the traditional big-tops.However, as revenues and audience sizes declined,the traditional circuses missed the signals that themarket was changing rapidly and that they werequickly becoming outdated. Had any of thesecompanies taken stock of the situation and seenbeyond their direct competitors, they may haveidentified the opportunity to capture a newmarket beyond the children and families whowere no longer interested in sitting through athree-ring circus.These companies could haveshifted their focus to adults who were willing topay a premium for a theater experience, orchanged their offerings to appeal to an audiencethat was enthralled with movie stunts and videogames. Instead, two street performers, GuyLaliberté and Daniel Gauthier, recognized this shiftand innovated to create a hybrid circus/theaterthat has been viewed by over 60 million people in90 cities globally. Cirque du Soleil’s Annual revenuenow tops well over half a billion U.S. dollars.24 Itnot only provided a new way to increase revenue,however, it also devised a new way of reducingcosts by eliminating a major cost component—the animals. In so doing, Laliberté and Gauthierchanged the very definition of the circus and with it, the market.

As in the case of Cirque du Soleil, thinking beyondthe boundaries within which companies in anindustry traditionally compete allows forbreakthrough innovation. In Blue Ocean Strategy:How to Create Uncontested Market Space and Makethe Competition Irrelevant,Kim and Mauborgneadvocate looking systematically across alternativeindustries, strategic groups, buyer groups, andservice offerings to innovate and tap intounclaimed “blue oceans” of new market space.In so doing, a variety of opportunities can beseized and their risks minimized.

One way of spurring innovation is to focus oncustomer conditions that might stimulate changesin technologies or industry.Three groups ofcustomers can be sources of this information:

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• Those who are over-served and consider theexisting solutions to be more than they need;

• Those who are under-served by thesesolutions; and

• Those on the fringe who lack the skills andresources to benefit from these solutions.25

Intuit, the developers of Quicken,TurboTax, andQuickTax (for the Canadian market) — personalfinance and tax software tools—recognized ahuge under-served group of potential consumersof personal finance and tax preparationtechnology.The company’s founder, Scott Cook,recognized that many people were interested inpreparing their own taxes and organizing theirfinances but that the complexity of the existingsoftware was a barrier to its use. Intuit, thecompany he founded, researched the softwaretools that financial advisors and tax preparerswere using, gleaning insight into whichcomponents were critical and which parts wereadd-ons and under-used.The company thencreated a simplified version of this tax preparationsoftware, stripped of the financial jargon, with auser-friendly interface and provided excellentcustomer service. Today, Intuit is one of thelargest software companies in the world, withapproximately $2.3 billion in annual revenue and a $10.4 billion market capitalization.26 Intuitexamined customer conditions around personalfinances and recognized a need that could be filledwith some relatively simple technologicalinnovation. So simple, in fact, that Intuit cites thepencil as one of its main competitors.

Financial professionals have a critical role at thestage of identifying risks and opportunities.Developing a well-defined process for identifyingand categorizing risk and opportunity factorswithin a framework that includes financialevaluation falls within the purview of theseprofessionals.Their involvement at the strategicplanning stage to ensure that major changes areconsidered within such a framework ensuresmore rigor from the outset. In addition, after risksand opportunities have been identified, theyshould be prioritized by means of strategic gridanalysis or a similar method.The CharteredInstitute of Management Accountants hasdeveloped a tool—the CIMA Strategic Score-card—that can assist in prioritizing risk andopportunity.27 Financial professionals can play a critical role in this process because of theirexperience implementing such scorecardmethodologies.

2. MANAGING RISKS &OPPORTUNITIES

After risks and opportunities are identified andprioritized, they must be assessed and managed to see if the risks pose a large enough threat,and the innovations a big enough opportunity,to implement mitigation techniques or bring aninnovation to market.

Assessing, and potentially altering, theorganization’s risk appetite is the first step tomanaging risks and opportunities. Evaluating itsrisk appetite allows an organization to decide howbest to respond to the opportunities and risks ithas recognized. Risk appetite should be definedand agreed upon at least annually, well ahead ofassessing individual risks and opportunities.

Assess and Alter Risk Appetite

Risk appetite is generally defined as the amount ofrisk exposure, or potential adverse impact froman event, that an organization is willing to acceptwithout taking action.28 Once the risk appetitethreshold (also termed the risk tolerance) hasbeen reached, measures can be taken to bring theexposure level back within the accepted range,thus matching risk exposure with risk appetite.




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Risk appetite can also be described as intelligentrisk taking, coupled with disciplined riskmanagement.

Assessing Risk Appetite

A company’s risk appetite is heavily influenced byits culture and changes over time.The formalenablers of a company’s culture—and determinantsof its risk appetite— include the CEO, othercompany leaders, and the strategy these leadersimplement. Informal processes and enablers alsoinfluence corporate culture and the company’sattitude towards risk, including the company’shuman resources and other factors. One way thatsenior financial executives can influence managingrisk and capturing opportunity is to developformal mechanisms to determine and adjust riskappetite.

Risk appetite guidelines should be established bysenior management and agreed upon by theboard. Each major opportunity and risk mustusually be examined to evaluate whether it fallswithin tolerable limits.To assess and determinerisk appetite, it can sometimes be useful to beginwith asking the following questions:

1. Where should the organization allocate itslimited time and resources to maximize

opportunity and minimize risk exposure? Whythese opportunities and risks, and not others?

2. Which opportunities and what level of riskexposure require immediate action? Why? Isquick capture of the opportunity driven strictlyby fear that the competition may move first?Have other issues such as alternative oppor-tunities, market reaction, and resourceallocation been evaluated? Are reputation,regulatory interference, and impact on creditrating being included? The priority given theseissues should be based on predetermined risk tolerances.

3. What types of opportunities and what level ofrisk require a formal response strategy? Whythis type/level? What happens if the type/level is higher/lower? These levels should bepredetermined for the organization based onauthority and delegation limits approved by the board.

4. What opportunities has the organizationmissed, and what risks affected the organizationin the past? How were they handled and whomanaged them?

The answers to these questions can helpcompanies understand where in Exhibit 8 theorganization’s risk appetite is drawn, oftenreflecting the cost impact of a risk and thefrequency that it materializes. Everything that falls within the light gray triangle is within the riskboundary, and is acceptable to the company.Everything beyond the risk appetite line, in thegray section, represents risks at a level beyond the risk boundary, and therefore not acceptable to the organization.These risks require riskmitigation activities.

Exhibit 8: Organizational RiskAppetite29

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RISK APPETITE

High

RIS

K IM

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Low

Reject

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Low RISK HighFREQUENCY

The diagonal line representsthe company’s risk appetite.

The line thatrepresents the riskappetite alsodelineates the riskboundarybeyond which thecompany is notcomfortablemoving.


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A variety of factors influence an organization’slevel of risk appetite and its ability to accept morerisk.These can include:

• Willingness to Bet• Organizational Size• Financial Health• Reputation• Superior Tools• Experience• Agility

Willingness to bet: Some organizations are simplymore willing to bet; they are risk takers whileothers are more risk averse.This can often beattributed to their leadership or structure—thepropensity towards risk is often in the DNA ofthe organization. Such organizations may also haveless to lose than their competition. Companieswith an increased willingness to bet may have ahigher tolerance than their more cautiouscounterparts.

Organizational Size: Size of the organization caninfluence risk appetite. Larger more diversifiedcompanies are exposed to a wide variety of risks.They are often comfortable with this becauserisks and exposure are spread across the businessand, thus, any one event is likely to have a smallerimpact.This also holds true for the size of theinvestment compared to the overall portfolio.Take, for instance, a large company that has 5% ofits investments in a country that is becomingincreasingly politically unstable.This company maybe more willing to stay and see how the situationplays out than a small company with 25% invested(with similar liquidity of the investment and ratesof return).Thus larger organizations may have ahigher risk appetite, because exploitingopportunities will affect them less overall.However, some large organizations may have adiminished risk appetite as they move from beingentrepreneurial to wanting to ensure theirlongevity. In fact, some small companies may havea high risk appetite as a result of greater agilityand entrepreneurial spirit.

Financial Health:A financially healthy company isoften in a strong position to take on more risk,because it can withstand potential losses moreeasily than a less healthy firm.The healthyorganization, therefore, has a higher risk appetitethan its less healthy competition.This higher riskappetite due to financial health can encouragecompanies to take advantage of innovationopportunities that another company might not beable to take. In some cases, however, companiesthat have achieved a financially healthy positionbecause of their caution and risk aversion wouldcontinue to avoid risks deemed too great.

Reputation:Companies with strong reputationsoften have a higher risk appetite because theirstakeholders and shareholders sometimes havemore confidence that the company will take riskswithout putting the business at stake.This is nottrue, however, for businesses based on trustwhere product safety is central, often calledfranchise risk. Contrast a pharmaceutical companywith an apparel company, both with internationalsupply chains that produce inferior products.The pharmaceutical company with a sub-par (andtherefore unsafe) product could be put out ofbusiness while the apparel company with clothesthat came apart at the seams would likely onlylose market share. In some cases, however, astrong reputation may derive from a history ofbeing risk averse. Understanding how muchdamage taking a risk could have on reputation isimportant to consider.

Superior Tools: Some companies have developedsuperior risk management capabilities that allowthem an increased risk appetite.These can include1) rigorous risk identification and evaluationmethodologies, 2) access to risk mitigationinstruments such as insurance, 3) joint venturepartners, and 4) superior access to networks ofstakeholders, advisors, and local contacts.Thesenetworks can both alert the company to risks andprovide some protection against risk impact. Forinstance, access to the foreign minister in adeveloping country where transfer payments arethe norm—for a company ethically comfortablewith and legally allowed to engage in suchpayments—can buffer a business willing to maketransfer payments from being targeted by apredatory government. On the other hand, lack of access to the minister can open a similarcompany up to risk of nationalization.

Experience:A history of dealing with specific risksoften helps organizations to improve riskmanagement and responses over time. Acompany with significant global experience, forinstance, is often better able to analyze, capitalizeon, and react to opportunities and risks in itsinternational operations than a new entrantunfamiliar with the political or supply chainchallenges inherent in such operations.Thisenables the experienced organization to have abigger risk appetite than its inexperiencedcompetition.

Another type of experience is gained fromlaunching a product in a limited market, orprototyping to test its reception before releasingit to the wider marketplace.Toyota did this withthe original Prius hybrid car, first releasing it onlyin Japan, and then refining its offering before its

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wider launch in the United States.This is also acommon practice among computer companieswho launch version 1.0 of software to a limitedmarket, then refine the product before launching a much-improved version 2.0. Prototyping allowscompanies to test their products on a small scale,where potential losses would have a smallerimpact.The practice of prototyping reduces therisk of introducing new products, thereby leavingadditional capacity for other risks in cases wherethe company perceives less potential loss frominnovation.

Agility: An agile corporation is one that predictsrisk well and can respond quickly and effectively to risks as they present themselves.Theseorganizations can measure risk early and thereforeplan for it. Establishing protocols for eventsranging from supply chain disruptions to inclementweather can help a company withstand the impactif risks materialize. Consider the experience ofUPS, the parcel delivery company, during theLouisville, Kentucky blizzard of 1994. Louisvillehappened to be the company’s central U.S.package sorting center, and when the snow shutdown the roads and airport, 100 UPS planesaround the country were ready to take off ladenwith packages bound for Louisville.While theplanes were re-routed to other sorting centers,UPS implemented its emergency response plan todeal with the hundreds of thousands of packagesat the Louisville site.The airport runways werecleared within a day, while the roads in and aroundthe city were closed for five days.This meant that UPS employees in the Louisville area wereunable to get to work. So UPS flew other workersfrom around the country to work at the sortingfacility.The company’s uniform machinery andstandardized processes allowed workers to step

in on an emergency basis. Such standardization can reduce risks whether due to a blizzard, aTeamsters strike, or because of an unexpectedlyhigh volume during the holiday season.30 Establish-ing a plan to deal with business disruptions andcreating standardized methods of doing businessas part of contingency planning has made UPS anagile organization with an increased risk appetiteand a better capability for capitalizing onopportunities related to risk than its competitors.The company delivers packages to all of theworld’s countries and territories not embargoedby the U.S. government, and has consistentlyoutperformed the Dow Jones Industrial Average,the S&P500, and its major competitors.

Altering Risk Appetite

Although the board sets the overall riskphilosophy, sometimes there is a sense withinorganizations that capturing opportunities posestoo many threats, preventing organizations fromcapitalizing on identified prospects. If the goal is to capture an opportunity, and risk appetite is ahurdle, altering the risk appetite might be desirable.This can be accomplished by developing thecapacity to accept more risk, thereby shifting therisk appetite boundary as depicted in Exhibit 9.

Organizations can alter their risk appetite in avariety of ways. Some of these include:

Through experience by:

• Improving organizational learning• Using networks for increased learning

Through superior tools, including:

• Expanding the time horizon• Expanding the breadth of stakeholders

considered in the analysis

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ALTERED RISK APPETITE

High

RIS

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Reject

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The diagonal line representsthe company’s risk appetite, shifted

through experience, superior tools, etc.

Exhibit 9: Risk Appetite Tolerance31


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Experience

Improving organizational learning:Developing theability to learn from effective and ineffective riskexperiences, and incorporating this learning intocontrol system policies and procedures, can helporganizations increase their risk appetite.This canbe done through building a corporate knowledgebase and regularly improving business processes.

Using networks for increased learning: Incorporatingstakeholder knowledge and managementstrategies into learning systems leads to a largerpool of knowledge to tap, both for risk mitigationand for innovation design. Gathering thisinformation can also foster more support andtrust from a wider network. For instance, theadvisors who can give insight into socio-politicalrisk can also be a good resource for testing ideasabout innovations in less stable markets.

Superior tools

Expanding the time horizon:Evaluating risks andopportunities over short-term horizons can lead to overly conservative behavior in somecircumstances, and overly risky behavior in others.Expanding the time horizon allows for thoroughexamination of potential risks, and provides morelead time for planning to generate creative,systematic responses to risk.The result of alonger time horizon is that, overall, theorganization becomes more comfortable withrisk.This increases its risk appetite becauseadequate response strategies are in place.This ispreferable to responding in the moment to putout emerging fires, which drain the capacity toapproach issues strategically. However, an overlylong time horizon can mean less clarity andgreater risk of error, so the horizon must be set ata place that balances these issues consistentlywith the nature of the business.

Expanding the breadth of stakeholders considered inthe analysis:Firms that focus only on immediatefinancial returns cannot fully explore the effect ofthe risk/opportunity management decision. Insome cases an affordable cash loss can signal aloss of control with a more important impact onreputation, regulatory interference, and a creditrating that would far outweigh the financial risk.Understanding who will be affected by yourorganization’s methods of dealing with risk, theirreaction, and in turn what impact this may have onthe company, can expand both the understandingof risk and the possibilities for innovation.

Likewise, innovations can capture new marketsbut also ostracize existing customers, suppliers,and others. For example, when the market of highfashion bag manufacturer Coach began to shift,the risk of innovating to keep up with women’schanging lifestyles had the potential to upset thedelicate task of serving its already devotedclientele. Although some in the company wereresistant to changing the iconic brand, thecompany’s CEO, Lew Frankfort, recognized the need to include more stakeholders in thecompany’s customer analysis.This led to 1) tracking customer behavior in Japan, deemedthe most “fashion forward” market, 2) developingnew techniques to track and serve Latinas whowere quickly becoming core Coach customers,and 3) creating new products like the wristlette (a small wrist pouch to hold lipstick, keys, andmoney) aimed at a much younger set of customers.Through expanding its focus to stakeholdersbeyond its core of mature women, Coach wasable to capture opportunities and stay ahead ofthe competition.

Financial professionals—including risk officers,financial officers, and internal auditors—play a key role in supporting the organization’s riskmanagement philosophy by promoting compliancewith its decisions on risk appetite and managingrisks within their areas of responsibility. Afterdetermining risk appetite, the organization mustassess identified risks and opportunities anddecide on a response to capitalize onopportunities and mitigate risk.

Assessing Risks & Opportunities

Previous Management Accounting Guidelinesemphasize the importance of assessing risks, bothin terms of the cost if they materialize, and thebenefits flowing from appropriate risk response.Of particular relevance to understanding,measuring, and managing opportunities and risks isthe capability to quantify their potential benefitsand impacts.

Often when risks are well managed, opportunitiesthat formerly appeared too risky will be seen asmore attractive. In addition, an organization maycome to see that developing a greater capacity toidentify and mitigate risk allows it to captureopportunities that the competition cannot. Evenwithout an apparent opportunity to seize, riskmitigation practices bring risks back within thetolerance boundary of the organization’s riskappetite and are still important to undertake.

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Assessing Opportunities

Traditional methods can usually be applied whenassessing the potential benefits of opportunities.These assessment methods can include 1) assessing the increased market share that canbe captured, 2) calculating the likely profit fromthe innovation, 3) quantifying the number of newcustomers, 4) calculating the potential salesgrowth that could stem from capturing theopportunity, or 5) measuring the residual income(accounting income – capital charge) to calculatevalue added as a result of capitalizing on theinnovation. Calculations of this sort make it easierfor managers to include potential opportunities inROI or other calculations and thus to assess if theidentified innovation is worth pursuing.

Assessing Risks

Measuring risk can be done in five steps:

1. Quantify the magnitude of the impact of the risk.

2. Assess the probability that the risk will emergeand affect the company.

3. Quantify this impact on the company.(Magnitude) x (Probability)

4. Analyze the cost/benefit of taking action tomitigate risk.

5. Prioritize various risks in a ranking tounderstand which are most critical.

For example, a video/DVD rental company beginsto get weak signals that the Internet is playing anever-increasing role in retailing goods ranging fromclothing to groceries. Executives suspect thatvideo rentals may be affected by the availability ofmovies from online sources and estimate thatthere is a 15% chance that DVD rental via theInternet will emerge and cannibalize its business.Is this an underestimation? An overestimation?Analysis of other markets that have lost businessto online sales may help to confirm the estimation.Lost sales from a potential online presence areestimated at $2 million when calculating lossesfrom customer migration; this includes losses ofmembership dues, DVD rental charges, andoverdue fines.The expected lost revenue for atraditional video/DVD rental

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company to an Internet-based rental company isvalued at:

Expected Lost Revenue: ($2,000,000) x (0.15) = $300,000

Does this justify a response? How does thispotential loss stack up against other identifiedrisks?

All of the risks outlined in Risk ClassificationScheme (Exhibit 6) can be quantified andmonetized, even if only by a rudimentary estimate.In fact, risks should be monetized for inclusion inROI or other calculations, thereby improvingresource allocation and investment decisions.Like other estimates used in financial analysis,these estimates are often imprecise.The assignednumbers may vary significantly, depending on theassessment of the market and conclusions variousdecision makers draw from this analysis. However,through proper estimation and disclosure, theseestimates certainly aid decision making and arerelevant to management discussions.

Managing Risks

Effective risk management practices and tools arenecessary for companies to seize opportunitiesand gain competitive advantage over companiesthat do not know of these practices and tools, orcannot effectively implement them. Often, taking aportfolio approach to risk is valuable—managingsome risks well creates the opportunity to takerisks in other areas.

Establishing rigorous risk management capabilitiescan decrease project risk and spur the process ofcapitalizing on strategic risk and opportunity.Sometimes companies can take on initially risky-seeming projects by applying risk mitigationtechniques, thereby reducing the project risk level.

So, instead of increasing risk appetite (moving therisk appetite line out in Exhibit 9), mitigationstrategies lower the level of risk and move theproject within an acceptable range, as illustrated inExhibit 10.

Some of the techniques to move the projectwithin an acceptable risk range include traditionalrisk mitigation strategies such as sharing,transferring and reducing risk, as well as lessconventional ones described below, such asbecoming more agile, double betting, and viewingrisk through a difference lens.




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}

UNMITIGATED RISK

High

RIS

K IM

PAC

T C

OST

Low

Reject

Accept



MITIGATED PROJECT RISK

High

RIS

K IM

PAC

T C

OST

Low

Reject


The star represents the project’s risk, shiftedthrough traditional means like sharing or

transferring, or others like increased agility, etc.

Exhibit 10:Altering Project Risk32

Accept

✽

✽

24

Sharing Risk

This method of risk mitigation distributes thepossible consequences of risk among two ormore parties. Risk sharing can be accomplishedwith a joint venture partner. For instance, whenDanone wanted to enter the Chinese market, itestablished a joint venture with Wahaha Food &Beverage, one of China’s most popular brands ofwater, ready-made tea, and fruit juices, hoping toease its transition into this challenging market.Buyback agreements in the book industry areanother example of risk sharing—publishers agreeto buy back unsold books from retailers, thusencouraging substantial purchases and stocking oftitles in bookstores, while ensuring that theretailer does not have to shoulder the entire riskof overstock by itself.

Transferring Risk

Shifting the responsibility or burden for loss toanother party through insurance, contract, orother means, can play a key role in helping tominimize losses from risk. Under such anarrangement the organization passes a risk to an independent, financially capable third party at a reasonable economic cost under a legallyenforceable arrangement. One mechanism for risk transfer is insurance, which is increasingly indemand.The growth in trade investment, theincreasingly visible instances of asset confiscation,soaring prices in global commodities markets,heightened political unrest in certain areas of the world, and trade between emergingmarkets, all contribute to the increased popularityof insurance as an instrument to protect invest-ments.33 Political risk insurance is a progressivelymore prevalent, and expensive, mechanism sought by companies doing business in potentiallyunstable countries.

Another common instrument for risk transfer isnatural hedging, a popular method of reducingfinancial risk through normal operatingprocedures. For example, a company with a highsales volume will have a natural hedge to part ofits currency risk if it also has operations in thatcountry generating expenses in the local currency.Companies may increase natural hedges bychanging sourcing, funding, or operationaldecisions.

Other popular methods of risk transfer includehedging risk in the capital markets, sharing riskthrough joint venture investments or strategicalliances, outsourcing arrangements accompaniedby a contractual risk transfer, and obtaining riskindemnities through contractual agreements.34

Reducing Risk

Actions to reduce the likelihood of risk, its impact,or both, can take several forms. Risk avoidance—ceasing the activities that give rise to risk—is themost radical of these, and can deliver the bestresults when trying to mitigate a risk that is takenwithout a commensurate possibility of reward.Barring this radical move, engaging in internalhedging—by diversifying products or location—can also reduce risk. Increasing organizationalresilience by creating and testing businesscontinuity plans is another approach to reducingrisk. Such planning is based on identifying risks tooperations and creating pre-emptive solutions.These risk-reduction activities are undertaken inorder to seize opportunities for growth or tomaintain risk from ongoing operations atacceptable levels.

The increase in global terrorism and the recentoutbreak of the avian flu pandemic have focusedattention on high-impact risks to companies andthe need to prepare for them. However, moremundane risks such as data loss, fires, or IT failures can also wreak devastation on a company.According to recent studies, 25% of U.S.companies that experienced an IT outage of twoto six days went bankrupt soon after.35 In additionto planning for major incidents, thoroughlyunderstanding and establishing sound internalcontrols for day-to-day operations is critical. In aworld where increased supply chain efficiency hasmeant establishing highly complex networks ofsuppliers and partners in a host of geographiclocations, even minor disruptions can cause majorimpacts. Understanding the critical components of ongoing business operations, and planning fordisruptions in these processes increases organi-zational resilience. For instance, many companiesbased in lower Manhattan had back-up work sitesand data storage facilities in New Jersey, just a few miles away, and were able to switch theiroperations to these locations just following theterrorist attacks that devastated their financialdistrict offices on September 11, 2001.

Becoming more agile in responding to risks:Organizations that develop plans before a riskemerges can act more nimbly if the riskmaterializes.This makes the risk response moreintegrated and allows the company to be morecomfortable with taking on greater risk, becausethere is a plan in place to deal with it. In theprevious example of UPS and the Louisvilleblizzard, the fact that the company had a tried-and-true method to deal with disruptions in itstransportation fleet and overcapacity in its system

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meant that it could deal with the risk it faced andbe confident in taking on future risks, eithernatural or man made.

Double Betting:This practice hedges the bets ofinvesting in a product by putting money into twoor more outcomes, thereby improving the odds of a payoff. It allows companies to invest sometime, effort, and money into alternative, non-coreinnovations based on weak signals from themarketplace.This is what IBM did at the height of its domination of the calculator market in the1950s. Recognizing the potential impact (as yetundeveloped) that the computer could have onthe business,Tom Watson Jr., the CEO’s son,convinced his skeptical father and the board ofdirectors to invest research dollars in bothcalculating machines and computers.Within adecade, the computer industry had grown andIBM was able to secure the leadership of this newindustry.36 Double betting is based on a premisesimilar to Markowitz, Miller and Sharpe’s portfoliotheory. Following portfolio theory, investorsdiversify their portfolios to maximize return andminimize risk based on the portfolio’s overallrisk/reward balance, rather than on an individualsecurity’s risk/reward characteristics.This is donebecause the risk on a well-diversified set ofinvestments tends to fall below the risk of eachindividual component.

Viewing Risk through a different lens: Studies havefound that people evaluating risk have differentattitudes towards gains and losses. According toDaniel Kahneman and Amos Tversky—two of the most influential researchers on how peoplemanage risk and the conceptualizers of ProspectTheory37—“loss aversion” guides most decisions.People generally care more about potential lossesthan about potential gains. In addition, theirresearch found that valuing a risky opportunitywas far more dependent on the point at whichthe possible gain or loss would occur than on thefinal resulting value of the assets. For example, agroup was surveyed on the issue of high employ-ment and high inflation versus lower employmentand lower inflation.When the issue was framed interms of a 10% or a 5% unemployment rate,accepting more inflation to decrease unemploy-ment was heavily favored. However, whenrespondents were asked to choose between alabor force that was 90% employed or 95%employed, low inflation was more important thanraising the employment rate by five points.Therefore, when an organization assesses risk,shifting the risk appetite can be accomplished bychanging the reference point at which the risk isbeing evaluated.

In addition to these methods of risk mitigation,innovation is a critical component of mitigatingrisk and creating value. Creating an innovationstrategy and the management control systems fordeveloping this innovation is part of the processthat balances defensive risk mitigation withoffensive opportunity capture.

Managing Innovation38

Companies that can identify and seizeopportunities (often where others only see risk)often do so through innovation. Innovation caninclude a breakthrough idea that leads to awinning product, like the iPod; a new model ofdoing business in a seemingly saturated marketlike Kinepolis or Cirque de Soleil; partnering withthe right firm in an unstable market; or manyother iterations of inventiveness that optimize thevalue of strategic opportunities related to risk.

Financial professionals contribute to managinginnovation by creating the techniques to managethe structures, systems, reward mechanisms,and evaluation methodologies that underpininnovation systems. In addition, financialprofessionals develop and maintain the keyperformance indicators that keep innovationsystems on course.




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An innovation system fulfills five critical roles:

• Efficiency• Communication• Coordination• Learning• Alignment

The first role of an innovation system is toincrease efficiency, swiftly moving great ideas fromconcept to commercialization with minimal use of resources.The second role of the system is tofacilitate communication within the company andwith outside constituencies. For instance, thetechnology development team will need to knowwhat customers want; this knowledge will guide itseffort.The manufacturing team will need to informthe technology development team about what ispractical and cost-effective in terms ofmanufacturing, etc. Coordination between variousteams and projects is the system’s third role.Thiscoordination creates efficiencies across theorganization, particularly those that span the globeand depend on harmonization between timezones and various locations to keep projectsflowing efficiently.The fourth role of the system islearning—allowing for information capturethroughout the innovation process.This can leadboth to improvements to the current project andto the innovation process itself. Finally, theinnovation system enables alignment of objectives,helping everyone in the organization tounderstand the strategy and its implications foroperations.With such a system, the right peopleand ideas can converge to generate innovation.

Exhibit 11 illustrates the five roles of an innovationsystem.

Exhibit 11:The Five Roles of anInnovation System

Although an innovation system is critical totransforming creativity from an exercise in“herding cats” to strategic alignment withcorporate objectives, also important to the

process of capturing opportunities is assessing thevalue of the potential project, investment, orinitiative.

Innovation is based on three significant ideas that,when applied by senior managers, transforminnovation from a fortunate accident to arigorously applied business skill.

1. Innovation is a management processnecessitating particular tools, rules, anddiscipline—it is not a mystery. Afterimplementing formal processes and establishingtools such as strategy, organizational design andstructure,management systems, performanceevaluation, and rewards, the payoffs frominnovation can be dramatically increased.(The innovation management system isdiscussed in a later section.)

2. Measurement and incentives arerequired to deliver sustained,high yields.Metrics and incentives at the various stages of innovation from idea generation tocommercialization can be used to effectivelymanage and capitalize on innovation.

3. Companies can use innovation toredefine an industry by combiningbusiness model innovation and technicalinnovation. Innovation is not restricted tocreating a new product through research anddevelopment, also known as “technicalinnovation”. Innovation can also manifest ininventing a new way of creating, selling, ordelivering value to customers.

Three types of innovation can help companiescapture opportunities:

• Incremental innovation results in smallenhancements to existing products,services, or business practices.

• Semi-radical innovation results in significantshifts in either the product or the businessmodel.

• Radical innovation leads to new products orservices that are delivered to customers ina completely new way.

Although capturing opportunities often focuses onradical innovation, semi-radical and incrementalinnovation also allow organizations to mitigaterisk and create offerings that beat thecompetition. For example, incremental innovationsin computing—issuing a new version of software,or in the food industry—launching a new versionof a soft drink or snack food, can help companiesstay ahead without investing as heavily as would berequired to come up with a radical new product.

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Learning

Efficiency Communication

CoordinationAlignment


27

Implementing an InnovationManagement System

Innovation is a key part of capturing opportunityfrom risk. After an opportunity has beenidentified, moving the idea to market requires aninnovation system. Contrary to popular belief,innovation is not just having a good idea at theright time, it is a system to improve the likelihoodthat these ideas will flourish within the organi-zation and lead to market success. Innovationsystems are aided by established policies,procedures, and information mechanisms thatfacilitate innovation within and across theorganization.

When pursuing opportunities, it is critical to havean innovation system to manage the process ofdeveloping these ideas and bringing them tomarket.

The six components of an innovation system are:

• Identification of potential innovations• Structure• Measurement• Incentives & Rewards• Learning systems• Alignment

Identification of potential innovations

In addition to innovating around risks usingmethods mentioned earlier—including customersensitivity, seeing the gaps, and idealized design—itis important to understand why your competitorsare avoiding risks and to consider what yourorganization can do to accept these risks.Thismay involve examining whether the competitionlacks the characteristics that contribute to a highrisk appetite mentioned above—agility, learningfrom the organization’s experience with risk,sound financial health, or strong risk mitigationtools. If the competition lacks these characteristics,your organization can capitalize on its ownstrengths in these areas. For instance, thecompetition may decide not to invest in a countrythat is becoming more oriented towardssocialism, like Venezuela or Bolivia, for fear ofproperty expropriation. However, if your companyhas access to insurance, or to members of thegovernment who can alert you to radical policychanges that the competition does not have,you may capitalize on their weakness and yourstrength, deciding to take the investment riskbecause of your better risk mitigation tools andrecognition of opportunities. Innovation andopportunity management depend on realizing thatsomething is missing somewhere in the network

that produces value for customers—the key to identification is figuring out your strengths(sometimes by pinpointing the competitions’weakness, sometimes by identifying gaps in themarket) and capitalizing on this systematically.Innovation is not a one-time activity, rather it is a longer process of effective management ofrisks and opportunities as they arise, and includesa mechanism for monitoring the market evenwhen the decision is made not to capitalize on a market gap.

Structure

Creating an organizational structure and cultureto encourage innovation and opportunitymanagement is critical. Although there is somedebate in the academic literature about the beststructure to foster innovation within companies,39

sustained innovation excellence is predicated onbuilding innovation platforms and networks ofindividuals who can 1) share ideas with eachother, 2) be managed, and 3) grow. Innovationplatforms are people networks nestled within acompany that direct resources toward specificareas of innovation.These people networkscontribute to different aspects of innovation—idea creation, selection, development, andimplementation—that span the range of businessand technical challenges. Such networks ensurethat innovators are not divorced from the realitiesof operations, markets, and finances, which couldlead to novel, but unmarketable, ideas.

Measurement

Research has found that measurement is one ofthe most critical elements of successful innovation.What is measured, however, must be aligned withthe innovation strategy or managers lose a keysource of information.This translates into lowerperformance and decreased pay-offs frominvestments in innovation. Measurement playsthree key roles:

1) Planning: It helps to define and communicatestrategy and facilitates agreement withininnovation teams, streamlining day-to-dayactivities and enabling people to understandwhere their contribution adds value to themission.

2) Monitoring: It helps to measure progress anddeviation from the plan that might requiremanagement intervention.

3) Learning: It facilitates an ongoing dialogueamong people within the organization, andgalvanizes thinking about better innovationsand execution of strategy.

28

In this Guideline we concentrate on the role ofmeasurement at the project level to seizeopportunities and drive value creation.This isdiscussed in further detail in an upcoming section.

Incentives & Rewards

Motivating employees to 1) succeed, throughincentives and rewards, 2) capture opportunitiesand 3) thrive within the innovation system arepowerful management tools that drive originalthinking.Understanding the various components ofmotivation is critical to formulating an incentivesand rewards program that reinforces theorganization’s innovation strategy. People aregenerally motivated by four factors: economicincentives that encourage an activity; their passionfor the activity; the belief that they will berecognized for accomplishing the endeavor; and a vision that provides a clear sense of purpose.

Incentives link performance measures to rewards,and are generally planned before innovationefforts begin. For example, informing a team thatthey will receive bonuses if they meet a product’starget release date is an incentive. Recognition,on the other hand, rewards the outcome of theproject. Striking the right balance betweenincentives and rewards is important in motivatingteams and individuals to work together toaccomplish innovation. Distinct goals for eachproject, performance metrics, and defining theactual rewards are other significant factors of aneffective incentives system. Such incentives andreward structures must also be aligned with thecorporate culture.

Learning systems

The organizational ability to learn faster, better,and more cheaply than the competition is criticalto market success, particularly when it comes tocapturing opportunities. Organizations that canmake mistakes and learn from them 1) save thefrustration of repeating the same errors and 2) can continue to seek out opportunities,decisively mitigate risk, and innovate. On the otherhand,“non-learning” organizations often stagnatewhen it comes to these skills. Establishing a systemthat enables people to learn quickly at relativelylow cost is the key to organizational learning thatefficiently drives projects to capture opportunities.According to studies, this type of learning iscritical to innovating and seizing opportunities.Systems to capture information on innovationperformance throughout the life of the initiativecan be used to identify problems and potential

solutions. For instance, when Toyota was workingon the design of the Prius, managers from themanufacturing plant gave input to the design teamabout what could create glitches in manufacturing.This information was then immediately factoredinto the designs, saving critical time in taking thePrius from idea to market. Beyond the specificproject, capturing information about the innovationsystem itself can then inform the next innovationproject.This helps organizations to retain theknowledge that they develop throughout theinnovation process and enables more efficientproduction when the next opportunity is identified.

Alignment

Through a system of clear messaging, a companycan ensure that people in the organization areaware of the link between innovation strategy andoperations, and their contribution to the process.This can serve as an incentive as well as reinforcingthe link between opportunities, innovation, andcorporate objectives. For instance, new hires atone Fortune 500 company are taken on a tour,shown some of the “innovation labs”, and told thatalthough the company values new ideas, it is onlyinterested in those that are truly marketable.

Exhibit 12 summarized the components of aninnovation system.

Exhibit 12: Components of anInnovation System

Financial professionals play a critical role in thecreation, implementation, and smooth operationof an innovation system.They are charged withcreating structures, measures, and incentives andrewards systems that keep the innovation systemstreamlined and goal oriented rather than allowinga diversion into innovation for its own sake.Financial professionals are also in the uniqueposition of including both risks and opportunitiesin financial calculations for more rigorous projectplanning and corporate strategy.

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Components of an Innovation System

Identification of potential innovations

Structure

Measurement

Incentives & Rewards

Learning systems

Alignment


29

3. EVALUATING RISK &OPPORTUNITY THROUGH ROIAND OTHER METHODS

After an opportunity has been identified as bothaligned with corporate strategy and viable withinthe organizational structure, it is important toevaluate it. Some evaluation methods can be moreinformal than others, yet we believe it is critical toevaluate opportunities for inclusion in financialcalculations.This can be done in a variety ofways, including calculating expected profits orexpected value added (profits minus the cost ofcapital involved in developing and running theopportunity project), or using more commonmeasures such as ROI.

We propose putting numbers to the assessmentof risks and opportunities.Measurement, althoughit may lack precision, forces decision makers toaddress their underlying assumptions, identify thevariables that can impact a project, and weigh therisks of their assumptions when considering theopportunities of a particular investment. Betterforecasting of both risks and opportunities canlead to improved decisions on process, product,and capital investment. Financial professionals cancontribute greatly because of their ability toundertake such measurement, thereby making riskand opportunity management more rigorous.

We suggest using ROI, including NPV calculations,modified to include real options theory.Thisallows for flexibility in investment appraisaloptions and for the inclusion of the costs of riskmitigation actions, both of which can be central tocapitalizing on opportunities. Real options are acomplement to, and an extension of, traditionalNPV calculations and should be included as a stepin applying the ROI method.

Real options

An option is a right, but not an obligation, to takean action—like buying, expanding, or deferring—ata predetermined price for a predeterminedperiod. Real options embed an option value inotherwise static NPV calculations, thereby addingflexibility to the calculations necessary fordecision making.Traditional discounted cash flowevaluation assumes that after decisions are madeabout a project, these plans are fixed and will befollowed, regardless of additional information,changes in the market, or newly presentedopportunities. In addition, traditional methodsassume that investment is a one-time choice,rather than an ongoing process informed by newinformation and ongoing evaluation. By contrast,real options allow for the uncertainty andcontinuous learning inherent in project planningand successful business strategy. Real optionsthinking forces decision makers to explicitlyconsider the value of a new investment and theoptions it creates. It also allows for an initialinvestment with a longer time horizon for areturn on that investment, and builds in thepossibility of a variety of outcomes and responsesto information as it unfolds.The traditional ROImethod, on the other hand, might yield a negativeresult and a decision not to invest because itcaptures a different type of return using a fixedtime horizon.

Exhibit 13 illustrates a catalog of some realoptions.

It is easy to see how real options apply to anumber of industries in which it is important toinvest in an array of products, knowing that manyof them will fail.These industries includepharmaceuticals (where money is invested inresearch and development for a host of drugs,many of which will never enter the market) andthe oil and gas sector (where it is critical toexplore for product, yet often locations do notyield fruit). Such industries invest in a portfolio ofoptions that have different risk-returncharacteristics for all of the reasons discussedearlier (Double betting).




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A lot of evidence suggests that financial optionsare being applied heavily throughout the financialindustry (using methods such as Black-Scholes),and that real options theory affects thinking. Notmuch evidence exists, however, that real optionscalculations are being used in the non-financialsetting. Rather, when real options are included,it is often done using ranges or as a discussion ofunderlying assumptions rather than by includingpoint estimates.41

Real options thinking allows for more nuancedanalysis and flexibility for decision making as newinformation emerges that static NPV calculationlacks. In addition, real options incorporate financialinsights at the strategic stage of project planning,rather than as an afterthought. Financialprofessionals can add greatly to corporatestrategy by contributing their insights, using realoptions thinking at the early stages of evaluatingopportunities and risks.

A modified ROI calculation that includes realoptions is a seven-step process that includes:

1) Generating options using real options thinking

2) Estimating the opportunity benefit

3) Evaluating the costs of capturing theopportunity (including required risk mitigationactivities)

4) Estimating the probability that the risks needingmitigation will actually emerge

5) Calculating the expected impact/value of therisk

6) Calculating the NPV of the opportunity andthe risk

7) Calculating the expected value of the ROI

Like other estimates used in financial analysis,these estimates are often imprecise. However,through proper estimating and disclosure, theycertainly aid decision making and are relevant tomanagement discussions. Often, decision makerswill estimate ranges of costs and choose a pointestimate for use in the analysis.The ranges, alongwith the measurement techniques used in the ROIanalysis, would then be included as a footnote orappendix to the ROI calculation. Discussion ofthese ranges, and decisions on a certain pointestimate, assists personnel in thinking about andcommunicating opportunities and risks. Althoughthe output of this practice is important, just ascritical, ultimately, is the process for deciding onthe appropriate issues, their associated costs, andthe probabilities of occurrence. Ultimately, it isthe board, the CEO, or the CFO, who mustchoose the appropriate metric.The quantitativeanalysis, ranges, point estimates, and ensuingdiscussion are critical elements in decision making.The assumptions, decisions, and measurementtechniques that lead to quantification of risks andopportunities and risk mitigation techniques musttherefore be included as a footnote or appendixto the modified ROI analysis. This seven-stepmodified ROI calculation, the last of the threesteps in the process described in Exhibit 5 andthroughout this Guideline, is illustrated in Exhibit 14.

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Exhibit 13: Catalog of Real Options40

Type of Option Description

Enter & Exit Exit investment at a market low and re-enter when market conditions have improved

Delay or Defer Delay or defer investment expenditure until it is deemed more profitable

Abandonment or Shut-down Cease use of an asset or shut down operation if deemed unprofitable and capture salvage value

Growth Capitalize on earlier investments or enter into related projects

Adjust Adjust or modify input mix or outputs in response to demands, costs, or price

Staged investment Make investments in successive stages as information unfolds, retaining the right to abandon the project


31

Exhibit 14: Modified ROI calculations

1. Generate options using Real Options thinking

2. Calculate Benefit of After a potential opportunity has been identified, calculating its potential benefit to theseizing the opportunity company is the first step in evaluating whether or not to fully invest in the innovation.

Calculating the benefit should include monetizing any gains the company could make as aresult of pursuing the opportunity.These could include, among others:

• Increased market share ($ of added revenue) • Increased price premium • Savings resulting from locating in less expensive location ($ of operating costs saved)• Other reduced costs• New products• New markets• New channels• More efficient operations

Since some of these benefits would appear over time, a net present value (NPV) of each issue should be calculated.This can be done in step 5 when risk NPV is also calculated.

3. Calculate Costs When the opportunity’s benefits have been estimated, the next step is to estimate the costsinherent in capturing the opportunity and mitigating its associated risks.The fact that thecompany sees an opportunity means that likely it has superior knowledge or access to riskmitigation tools that the competition lacks.This knowledge and access, however, comes with aprice tag,which should be listed and monetized.

4. Estimate Probability After calculating the potential costs of each risk to the company, the potential likelihood, inpercent, that each risk would occur and cause damage to the company, is approximated.Thisnumber is the estimated probability. (Later we calculate the impact on the company inexpected value.) However, a footnote can be included to the ROI analysis that indicates thatthese numbers are midpoints (which would most likely settle within a range). An estimatedprobability should be assigned to each identified risk.

5. Calculate Expected After approximating the estimated probability, the expected value for each risk is calculatedRisk Value by multiplying the estimated impact (cost) of the risk by the percent estimated

probability of its occurrence. For example, if the costs of sub-par quality leading to lost sales are estimated to be $1 million, and the likelihood that this risk would materialize isestimated 25%, then:

Expected Valuesales loss = ($1,000,000) x (25%) = $250,000

6. Calculate NPV After steps 1-5 have been completed, the NPV of each opportunity and risk is calculated.Note that each issue has opportunities and risks that emerge at different times. NPV iscalculated on the outcome of:

Opportunity

NPV benefits – PV[(gain1) x (% likelihood1) + (gain2) x (% likelihood2)…OpptnN] = cost of opptn.

Risk

NPV benefits – PV[(cost1) x (% likelihood1) + (cost2) x (% likelihood2)…RiskN] = cost of risk

NPV calculations for opportunities and risks are completed in the same way as traditionalNPV calculations.Therefore, companies can use a table to input the cost that the risk willincur, and the year that it will arise. Discounting back, using a set discount rate, is done in thetraditional manner.These calculations are carried out for each identified opportunity and risk.

7. Calculate Expected Once all NPVs for the opportunities and risks have been calculated, they should Value of ROI each be added together.The aggregate opportunity NPV and risk NPV should then be

inserted as line items in the normal ROI calculation. Schedules should be provided that showthe calculations of benefit, expected value, likelihood, and costs. It is critical that seniormanagement see both the process and the output of doing these calculations.

net

expected value

calculate NPV of issue

netcalculate NPV of issue

expected value

32

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An Example

An example of integrating real options intotraditional ROI calculations could play out asfollows:

A company wants to enter South America becauseit sees this part of the world as a potentially goodmarket.However, the company is not familiar withplaces, profiles of customers who would beinterested in their products, the range of productsthat could succeed, or suppliers in the region.Instead of investing large amounts of money tobuild a factory immediately, company leadershipwould like to spend $1 million to open an office inBuenos Aires, Argentina, engage a workforce, andlearn more about the market.The companybelieves that it is important to penetrate theSouth American market and would like to positionitself for the long term. It expects that after a year it will have a much better idea of location,customers, market size, and suppliers. If, however,an ROI calculation was done on this $1 millioninvestment, it would likely be significantly negativebecause most of the output for the first yearwould be learning about the market rather thansales.Therefore, the project would not qualifyunder any ROI calculations. In such a case, ROIcalculations are inadequate.The $1 millioninvestment could not be treated using a traditionalROI appraisal; it has to be evaluated as a realoption that allows for market assessment, marketpenetration, and organizational learning.Depending on what is learned in the first year,decision makers in the company may request $20 million, $50 million, or $100 million forexpansion into South America.

Four scenarios could emerge using real optionsthinking:

Scenario 1:The company invests $1 million in year zero to develop a sales force, exploreproduction facilities, suppliers, get a betterunderstanding of customers, and evaluate if SouthAmerica is a good option. After the first year, thesituation is deemed a disaster and the companyrealizes it can’t make any money in South America.

$1 millionTotal = $1 million

Year 0

Given that the company has decided SouthAmerica is not a good option, it lost only $1 million, as opposed to having built a factory and losing much more money.

Scenario 2:The company decides to invest $1 million in year zero to explore the market.

After the first year, the information collected leadsthe company to believe that South American is aterrific market, so it decides to invest $50 millionto build a factory and begin manufacturing.Although this is a simple staged investment, anROI of the initial $1 million would have beennegative, potentially resulting in a decision not toinvest.Through real options thinking, the initial $1 million investment preserved the option forthe ensuing $50 million investment, withoutcommitting the company.

$1 million $50 millionTotal = $51 million

Year 0 Year 1

Scenario 3:The company decides to invest $1 million in year zero to explore the SouthAmerican market. After the first year, thecompany sees great opportunity and decides tobuild a factory.While feeling confident that this is agood prospect, decision makers are not willing toput in the full $50 million in the early stages.Rather, they design the factory in such a way thatgives them the option to build the first part for $9million and then possibly expand, depending onresults of the first year.This expansion will dependon the confidence level about how much growthis needed, and is affected by risk appetite. If resultsafter year one are as expected, $10 million will beinvested in a factory expansion in year two and$30 million in year three, for a total investment of $50 million.

$1 million $9 $10 $30Total = $50 million

Year 0 Year 1 Year 2 Year 3

Scenario 4:The company decides to invest $1 million in year zero to explore the SouthAmerican market with an office in Buenos Aires.Through this initial investment the companyrealizes that South America is a terrific market andbegins to invest aggressively, first with $9 million inyear one, followed by $10 million in years two andthree and $50 in year five for a total investment of$80 million.

$1 million $9 $10 $10 $50Total = $80 million

Year 0 Year 1 Year 2 Year 3 Year 5

After generating options using this real optionsthinking, financial managers should do an NPV ofeach option so that senior leadership deciding ona strategy has a better idea of the potential gainfrom investing $1 million. A traditional NPVcalculation would be negative, and the assumptionwould be that it is unwise to invest in SouthAmerica.The option value, however, converts theevaluation of the initial $1 million proposal from


33

negative to positive, and preserves the right andability to enter the market. After calculating anNPV for each option, financial managers should doan ROI calculation as illustrated in Exhibit 14 andinsert the calculated projected revenues.

CONCLUSION

Integrating risks and opportunities into projectplanning through modified ROI or other calcula-tions enables managers to better understand 1) the full range of risks their operations face andthe opportunities available to them, and 2) theircosts. Although the output of the analysis isuseful, the analysis process itself also allowsstrategizing for risk and opportunity management— to develop ways to avoid risk, to create riskmitigation plans, and to capitalize on opportunities.After risks and opportunities have been fullyexplored and calculations made, it is important tointegrate these processes with a managementcontrol system, which serves as the backbone tomitigating risk and pursuing opportunity.

Moving beyond the traditional view of risk as avalue destroyer to seeing risk as a potential valueenhancer requires creativity and vision, as well asa management control system within which thiscreativity can flourish and lead to market success.

A management control system helps to:1) more thoroughly identify and assess risks andopportunities,which are often linked, and 2) improve the company’s ability to accept risksand pursue opportunities. Such a system includesa mechanism to:

1. Review the strategy: Establishing a strategy toidentify and manage risks and opportunities—large and small, glaringly obvious and on theperiphery.The approach to these issues mustbe revisited periodically to review whetherthese methods continue to be aligned withoverall corporate objectives.

2. Review and, if necessary, alter the appetite forrisk: As organizations mature and expand,often the risk appetite shifts. It is important toreview risk appetite to ensure that it continuesto keep pace with changes in the company, itsstrategy, and its presence in various locations.A mismatch between risk appetite andorganizational size, scope, or project plans canoften stymie innovation.

3. Assess and review the costs and benefits:Although opportunities and innovation canpresent game-winning strategies, it is criticalthat the potential gains outweigh the costs

presented by the risks. Reviewing costs andbenefits at various points in the identificationand assessment cycle can ensure that innova-tion activities are on a course to marketsuccess, not simply generating good ideas forthe sake of it.

4. Accept and manage risks and opportunities:After a risk mitigation and innovation projecthas been accepted, it is critical to ensure thatthe appropriate tools and systems are in placeto manage them.Without sound managementof these processes, even the best idea canflounder and fail to reach the market.

5. Review the innovation structure: As organiza-tions become increasingly familiar with, andadept at, innovating they learn lessons fromtheir experiences. Integrating these lessonsinto future innovation projects ensures thatmistakes and glitches will not be repeated.Reviewing innovation structures and makingcertain that experience is informingmethodology can save time, money, andfrustration.

6. Monitor the environment:Whether or not theorganization decides to pursue opportunitiesor simply concentrate on mitigating identifiedrisks, it is critical to continue monitoring theenvironment for old and new risks andpotential payoffs.This ensures that mitigationstrategies are compatible with the currentenvironment and that pursuing new innovationsis integrated into the organizational fabric.

Financial professionals can add value throughoutthe creation and application of these managementcontrol systems by lending their expertise at eachof the six steps.

In an increasingly complex world, business riskposes threats, but also provides opportunities tocreate new competitive advantage and new waysto satisfy customers.To garner these benefits,however, risks and opportunities must beevaluated and handled within a system thatadequately identifies, quantifies, and mitigatesthem.This robust treatment of risk andopportunity allows for rigorous managementpractices enabling organizations to capitalize ontheir expertise to identify and captureopportunities that can help to beat thecompetition. Measures developed and applied tocounteract business risks can, and often do,illuminate some of the greatest opportunities forinnovation to companies that are ready to see andseize them.

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ENDNOTES1 Rewarded and unrewarded risk is a concept

described by James Quigly, CEO of Deloitte & Touche USA LLP in: James Quigly.“RiskIntelligent Enterprise: Gaining CompetitiveAdvantage Through Smart Risk Management”,Fortune, March 19, 2007: S4-S7.

2 Basic diagram sourced from:“EnhancingShareholder Wealth by Better ManagingBusiness Risk”, International Federation ofAccountants, Study 9, June 1999: p. 9.

3 For more on the role of financial professionals,please see: Hugh Lindsey.“20 QuestionsDirectors Should Ask About Risk”,TheCanadian Institute of Chartered Accountants,2006.

4 Much of the work on innovation in thisGuideline is taken from:Tony Davila, Marc J.Epstein, and Robert Shelton.Making InnovationWork:How to Manage It,Measure It, and Profitfrom It. Upper Saddle River, NJ:Wharton SchoolPublishing, 2006: 120.

5 Charles A. O’Reilly and Michael L.Tushman.“The Ambidextrous Organization”,HarvardBusiness Review,April 1, 2004

6 Ibid, p. 65-67.

7 Marc J. Epstein and Adriana Rejc Buhovac.“Identifying, Measuring, and ManagingOrganizational Risk for ImprovedPerformance”, Risk Management AccountingGuideline.Toronto, Ontario: CMA Canada andAICPA, 2005.

8 Ibid.

9 George S.Day and Paul J.H. Schoemaker.“Scanning the Periphery,” Harvard BusinessReview, November 2005.

10 W. Chan Kim and Renée Mauborgne.BlueOcean Strategy:How to Create UncontestedMarket Space and Make the CompetitionIrrelevant. Boston, MA: Harvard Business School Press, 2005.

11 Adrian J. Slywotzky,The Upside:The SevenStrategies for Turning Big Threats into GrowthBreakthroughs, New York, NY: Random House.2007, pp. 70-84.

12 Kate Murphy.“What Pilots Can Teach HospitalsAbout Patient Safety”, New York Times,October 31, 2006.

13 George S. Day and Paul J.H. Schoemaker.Peripheral Vision:Detecting the Weak Signals ThatWill Make or Break Your Company. Boston, MA:Harvard Business School Press. 2006.

14 Paul Hansel.“Putting the Napster Genie Back in the Bottle”,New York Times, November 20,2005.

15 Brent Schlender.“How Big Can Apple Get?”Fortune, February 21, 2005.

16 Tom Williams,Wal-Mart spokesperson in: DougDesjardins.“Effects of West Coast PortLockout Expected to Linger”,DSN RetailingToday, October 28, 2002. <http://findarticles.com/p/articles/mi_m0FNP/is _20_41/ai_93917318>

17 Gary Gentile,“Backlog at West Coast PortsStill Maddens Merchants, Exporters”,AP Business Wire.

18 Adrian J. Slywotzky,The Upside:The SevenStrategies for Turning Big Threats into GrowthBreakthroughs, New York, NY: Random House.2007: 108.

19 W. Chan Kim and Renée Mauborgne.“ValueInnovation:The Strategic Logic of HighGrowth”, Harvard Business Review 1997: 2.

20 Kinepolis Group Annual Report.

21 Russell L.Ackoff, Jason Magidson, and Herbert J.Addison, Idealized Design:How to SolveTomorrow’s Crisis...Today, Upper Saddle River,NJ:Wharton School Publishing, 2006.AndKnowledge@Wharton,“Idealized Design:How Bell Labs Imagined — and Created — the Telephone System of the Future”,August 9,2006.<http://knowledge.wharton.upenn.edu/article.cfm?articleid=1540&CFID=16401333&CFTOKEN=72511220&jsessionid=a830544ff4a2635a14e6>

22 Adrian J. Slywotzky,The Upside:The SevenStrategies for Turning Big Threats into GrowthBreakthroughs, New York, NY: Random House.2007, pp. 19-32.

23 Chris Cooper and Naoko Fujimura,“ToyotaSays Worldwide Hybrid Car Sales Top 1Million”, Bloomberg.com June 7, 2007.<http://www.bloomberg.com/apps/news?pid=20601101&sid=atAqPjvDSm4k&refer=japan>

24 Cirque du Soleil CEO Guy Laliberté named Ernst &Young Entrepreneur Of The Year® 2006.<http://www.ey.com/global/content.nsf/Canada/Media_-_2006_-_EOY_National_Recipient>

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25 According to Clay Christensen, Professor ofBusiness Administration at the HarvardBusiness School in:George S.Day and Paul J.H.Schoemaker.“Scanning the Periphery”, HarvardBusiness Review, November 2005.

26 Intuit Company Data <http://money.cnn.com/quote/quote.html?symb=INTU>

27 Chartered Institute of ManagementAccountants. CIMA Strategic Scorecard<www.cimaglobal.com/strategicscorecard>

28 The Committee of Sponsoring Organizationsof the Treadway Commission.“FAQs forCOSO’s Enterprise Risk Management —Integrated Framework” <http://www.coso.org/Publications/ERM/erm_faq.htm>

29 Basic diagram sourced from: Brian Ballou andDan Heitger.“A Building Block Approach forImplementing COSO’s Enterprise RiskManagement – Integrated Framework”,Management Accounting Quarterly.Winter 2005.6:2, p. 9.

30 Yossi Sheffi.The Resilient Enterprise:OvercomingVulnerability for Competitive Advantage.Cambridge, MA: MIT Press, 2007: 190.



33 Russ Banham,“Concern Over Political Unrest:Companies Insure Foreign Investments”,TheWall Street Journal, June 5, 2007, special section.

34 Deloach, J.W. Enterprise-wide Risk Management:Strategies for Linking Risk and Opportunity.London: Prentice-Hall, 2000.

35 Economist Intelligence Unit.“BusinessResilience: Ensuring Continuity in a VolatileEnvironment”, 2007: 4.

36 Adrian J. Slywotzky,The Upside:The SevenStrategies for Turning Big Threats into GrowthBreakthroughs, New York, NY: Random House.2007, p. 99.

37 Amos Tversky and Daniel Kahneman.“Prospect Theory:An Analysis of Theory UnderRisk”,Econometrica. 47:2, 1979.“Advances inProspect Theory: Cumulative Representationof Uncertainty”, Journal of Risk and Uncertainty,5: 1992, 297-323. Peter L. Bernstein. Against thegods:The Remarkable Story of Risk, New York,NY: John Wiley & Sons, 1996: 270-283.

38 This section draws heavily from:Tony Davila,Marc J. Epstein, and Robert Shelton.MakingInnovation Work:How to Manage It,Measure It,and Profit from It. Upper Saddle River, NJ:Wharton School Publishing, 2006.

39 Some organizational structures discussedinclude:A completely separate structure(Clayton M. Christensen.The InnovatorsDilemma:When New Technologies Cause GreatFirms to Fail. Boston: Harvard Business SchoolPress, 1997).A new venture division (Robert A. Burgelman.“Designs for CorporateEntrepreneurship in Established Firms“,California Management Review, 1984, 26(3):154-166), or Within existing divisions (Hollister B. Sykes and Zenas Block.“Corporate Venturing Obstacles: Sources and Solutions”, Journal of Business Venturing,1989, 4:159-167).

40 Sourced from: Chatham Research Alliance.An Introduction to Real Options,August 2003.

41 For more discussion of real options please see:Timothy A. Luehrman.“Strategy as a Portfolioof Real Options”,Harvard Business Review:Sept-Oct 1998, and Timothy A. Luehrman.“Investment Opportunities as Real Options:Getting Started on the Numbers”,HarvardBusiness Review, July-August 1998.

36

BIBLIOGRAPHY

Bernstein, Peter L. (1996). Against the Gods:TheRemarkable Story of Risk. New York, NY:Wiley & Sons.

Davila,Tony,Marc J. Epstein, and Robert Shelton.(2006). Making Innovation Work:How to Manage It,Measure It, and Profit From It. Upper Saddle River,NJ:Wharton School Publishing.

Day,George S.And Paul J.H. Schoemaker. (2006).Peripheral Vision:Detecting the Weak Signals That WillMake or Break Your Company. Boston, MA: HarvardBusiness School Press.

Day,George S.And Paul J.H. Schoemaker. (May 15,2006).“Scanning for Threats and Opportunities“.Harvard Business School Working Knowledge.

Day, George S.And Paul J.H. Schoemaker.(November 2005).“Scanning the Periphery“.Harvard Business Review.

Deloitte & Touche USA LLP. (March 19, 2007).“Risk Intelligent Enterprise: Gaining CompetitiveAdvantage Through Smart Risk Management“.Fortune. S4-S7.

Joachimsthaler, Erich. (2007). Hidden in Plain Sight.Boston, MA: Harvard Business School Press.

Kim,W. Chan and Renée Mauborgne. (2005).BlueOcean Strategy:How to Create Uncontested MarketSpace and Make the Competition Irrelevant. Boston,MA:Harvard Business School Press.

Kim,W.Chan and Renée Mauborgne. (January-February 1999).“Creating New Market Space“.Harvard Business Review.

Kim,W. Chan and Renée Mauborgne. (January-February 1997).“Value Innovation:The StrategicLogic of High Growth“.Harvard Business Review.

McGee, Kenneth. (2004). Heads Up:How toAnticipate Business Surprises and Seize OpportunitiesFirst. Boston, MA: Harvard Business School Press.

Mitroff, Ian I. (2005).Why Some Companies EmergeStronger and Better From a Crisis. New York, NY:American Management Association.

Roberto, Michael A., Richard M.J. Bohmer, and AmyC. Edmondson. (Nov 1, 2006).“Facing AmbiguousThreats“.Harvard Business Review. p.106—113.

Sharp, David. (1991).“Uncovering the Hidden Valuein High-Risk Investments“. Sloan ManagementReview. 32:4. p.69—74.

Sheffi,Yossi. (2007). The Resilient Enterprise:Overcoming Vulnerability for Competitive Advantage.Cambridge, MA: MIT Press.

Slywotzky,Adrian J.And Karl Weber. (2007). TheUpside:The Seven Strategies for Turning Big Threatsinto Growth Breakthroughs. New York, NY: CrownBusiness.

Slywotzky,Adrian J.And John Drzik. (April 2005).“Countering the Biggest Risk of All“. HarvardBusiness Review. 83:4. p.78—88.

Tversky,Amos and Daniel Kahneman. (1979).“Prospect Theory:An Analysis of Theory UnderRisk“.Econometrica. 47:2. p.263-291.

Tversky,Amos and Daniel Kahneman. (1992).“Advances in Prospect Theory: CumulativeRepresentation of Uncertainty“. Journal of Risk andUncertainty.Volume 5. p.297-323.

“Weathering any Storm“. (March 19, 2007).Fortune. Retrieved June 2007, from http://www.competeresilience.org/upload/Weathering.pdf

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Bill Connell, FCMAPast Chair, IFAC Professional Accountants inBusiness Committee

Gordon Cummings, MBA, CMA, FCMABoard Director and Business Consultant

Mark Dixon, ACMAEuropean Investment & TOC Finance LeadHewitt

James Duckworth, BA (Hons), FCMA., MIIANED and Chairman of Audit Committee ofControl Risks

Michael Fortini, CPADirector of CompliancePearson plc

John Fraser, CA, FCCA, CIA, CISAChief Risk OfficerHydro One

Jasmin Harvey, B.Comm, B.Econ, ACMAInnovation and Development SpecialistChartered Institute of Management Accountants

William Langdon, MBA, CMA, FCMAKnowledge Management Consultant

Mike Lewis, MSc, FCMA,AMCT, MIRMSenior Vice President and Head of Risk AssuranceEMI Group Ltd

Philip Linsley, BA (Hons), CALecturer in Accounting and FinanceThe York Management School

Nigel Higgs, MA, FCMANJH Consultants Limited

Kenneth W. Witt, CPATechnical Manager, Business, Industry and GovernmentAmerican Institute of Certified Public Accountants

Margaret Woods, B. Comm., MSc., FCCAAssociate Professor in Accounting and FinanceNottingham University Business School

This Management Accounting Guideline was prepared with the advice and counsel of:

The views expressed in this Management Accounting Guideline do not necessarily reflect those of theindividuals listed above or the organizations with which they are affiliated.

38

ABOUT THE AUTHORS

Marc J. Epstein is Distinguished Research Professor of Management at Jones Graduate School ofManagement at Rice University in Houston Texas and was recently Visiting Professor and Wyss VisitingScholar at Harvard Business School. Formerly a professor at Harvard Business School, Stanford BusinessSchool, and INSEAD (European Institute of Business Administration), Dr. Epstein has written previousManagement Accounting Guidelines. He has also written other articles on strategic managementsystems and performance measurement, and over 100 articles and 15 books. In 1999, he wrote theaward winning “Counting What Counts:Turning Corporate Accountability to Competitive Advantage”.He has recently co-edited a four volume series “The Accountable Corporation.”

Tamara Bekefi is Principal of Daedalus Strategic Advising, a firm focused on the strategic management of corporate social and political risk, opportunity and sustainability issues. Until recently she was theManager of Business and International Development Research and a Research Fellow at HarvardUniversity’s Kennedy School of Government. Previously, Ms. Bekefi worked for the oil industry groupIPIECA, ExxonMobil, Phillips-Van Heusen, KLD, a social investment research and analysis firm andOrientation Global Networks, an international telecommunications firm. She received her M.A. from the Fletcher School of Law and Diplomacy and her B.A. from McGill University.

Kristi Yuthas is Swigert Endowed Information Systems Management Chair at Portland State University.Dr. Yuthas has a background in IT consulting, focusing primarily on business process improvement andknowledge management. Her research explores the strategic, organizational and social consequences ofmanagement, accounting, and marketing information systems. Dr. Yuthas currently sits on the editorialboards of accounting information systems journals and has over 100 publications and presentationscovering a broad range of topics in accounting and information systems topics.

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For more information on other products available contact:

In Canada: The Society of Management Accountants of CanadaMississauga Executive CentreOne Robert Speck Parkway, Suite 1400Mississauga, ON L4Z 3M3 CanadaTel (905) 949 4200Fax (905) 949 0888www.cma-canada.org

In the U.S.A.: American Institute of Certified Public Accountants1211 Avenue of the AmericasNew York, NY 10036-8775 USATel (888) 777 7077Fax (800) 362 5066www.aicpa.orgVisit the AICPA store at www.cpa2biz.com

In the United Kingdom: The Chartered Institute of Management Accountants26 Chapter Street London SW1P 4NP United KingdomTel +44 (0)20 7663 5441Fax +44 (0)20 7663 5442www.cimaglobal.comEmail Technical Information Services at [email protected]

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