Risk Management: Innovate or Die

One of the classics in business literature is former Intel CEO Andy Grove’s “Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company,” published in 1996. In the book, Grove coined the term “strategic inflection point,” which he defined as “a time in the life of a business when its fundamentals are about to change.”[1]

That a company can be the subject of a strategic inflection point but can also be the cause of one is a sobering market reality. Now, 20 years later, Grove’s premise is as applicable today as it was before the turn of the century, if not more so. As he so eloquently observed, “The ability to recognize that the winds have shifted and to take appropriate action before you wreck your boat is crucial to the future of an enterprise.”

Key Considerations

Today, it’s fairly common knowledge that we’re facing disruptive change to business models and even entire industries. Whereas disruptive innovations may have once taken a decade or more to transform an industry, research shows that the elapsed time frame has compressed to half that time. More importantly, it continues to shrink, leaving very little time for reaction. Sustaining a business model in the face of digitally enabled competition requires constant innovation to stay ahead of the change curve. And eventually, the business model itself runs out of steam and the status quo has no future.[2]

To get and stay ahead of the disruption curve, an organization first must quickly discern the vital signs of change. This is not a matter of luck, but rather a capability in which the company is able to do four things really well:

1. Understand the critical assumptions underlying the business model. Management’s assumptions about markets, customers, competition, technology, regulatory and other external factors are fundamentals that shape the organization’s strategy. Because the organization’s business model is typically designed to function within the business environment envisioned by management, a dramatic shift in any of these drivers would likely require an evaluation of the validity of the model.
2. Apply scenario analysis capabilities to evaluate situations in which an event or combination of events could invalidate one or more of the critical assumptions. Scenarios help management understand what can happen that can impact the failure or success of the business model. They help focus attention on the potential sensitivity of changes in any of the fundamental business model assumptions. For example, industries that lack strong entry barriers may be especially susceptible to technological shifts and, as a result, are likely to face new and unexpected sources of competition.
3. Conduct competitive intelligence activities aligned with the most important drivers evidencing that scenarios of greatest concern are either developing or have occurred. To facilitate the timely recognition of change, the competitive intelligence function ensures there are mechanisms in place that enable managers to take a fresh look at the organization’s processes and customer interactions and re-examine and challenge assumptions underlying the business model. The function aligns its activities with the most critical strategic assumptions by offering appropriate quantitative and qualitative measures that provide relevant perspectives and insights about evolving conditions and trends in the business environment affecting those assumptions. Thus, competitive intelligence creates valuable information for decision-making by seeking out nontraditional information and data that may offer executives and directors a contrarian view.
4. In a timely manner, distill information about assumptions, scenario analyses and intelligence gathering and report insights obtained to decision-makers. For example, prior to the financial crisis, some financial institutions were able to identify the sources of subprime risk 12 to 14 months ahead of their competitors. As a result, they had more time to evaluate the risks and formulate options for divesting their subprime portfolios and hedging their exposure. These institutions paid attention to what was happening in the marketplace and acted decisively on the insights they obtained.

Time to act is a precious asset in a dynamic environment. It arises from timely recognition and enables management to capitalize on critical opportunities and risks arising from disruptive change. In essence, it provides a gift of being able to evaluate the emerging trends and formulate options to act with confidence.

Recognition is made possible through transparency. However, there are two “transparency killers” that can lead to strategic error: (1) unduly relying on the past in predicting market behavior and (2) allowing silos to constrain the depth and breadth of communication up, down and across the enterprise. If hierarchical and silo organizational structures compartmentalize information or filter information moving up the management chain, delays and distortions of the message are likely to occur.

As important as recognition is to managing disruptive change, this alone isn’t enough. Timely reaction must follow. Having knowledge of an emerging opportunity or risk without converting that knowledge into hard choices and actionable plans to innovate processes and offerings or adjust strategies is as useless as having no knowledge at all.

To ensure timely reaction, management must:

• Foster an organizational culture that facilitates consideration of the impact of changing market realities on critical business model assumptions. Continuous dialogue among business areas, alignment of compensation and other incentives with the goal of balancing short- and long-term performance, senior management involvement and an active board help shape the desired culture. When trending metrics signal the warning signs, it helps to engage a diverse group of stakeholders who understand the customer, the company’s markets and its critical strategic assumptions to evaluate the signals, formulate ideas and determine how to proceed, including triggering exit and contingency plans.
• Incent managerial ingenuity to translate altered assumptions into actionable revisions to strategic, business and product plans. Compensation arrangements that skew incentives to maximize revenues without fostering sensitivity to changing market realities can create serious blind spots in an organization. To illustrate, if signs of vulnerability begin to arise – such as next-generation innovations offering diminishing improvements – and are ignored, that’s a problem. If process and product owners have difficulty identifying new ways to enhance offerings, that’s another sign of trouble. If feedback from customers indicates they are considering alternative offerings that are increasingly acceptable to them, then trouble is brewing. If there are no incentives to question the durability of the business model, then the road traveled leads to that dead end where obvious market pressures and declining financial results force acknowledgement that the business model is in trouble. By that time, it’s either too late to salvage it or the change process becomes much more painful than it needs to be.
• Seek organizational resiliency. The ability and discipline to act decisively on revisions to strategic, business and product plans in response to changing market realities are the hallmarks of a resilient organization. We often hear the trite observation that management needs to ensure that the right information is given to the right people at the right time. In order to position the organization as a resilient early mover, this simply means that decision-makers must be in direct contact with the unvarnished truth. Armed with the truth and supported by the board, they can apply the right tools to analyze information for decision-making with a bias for the action needed to sustain superior longer-term performance.

Insulation from reality in a rapidly changing environment is lethal. When companies don’t respond to disruptive change, it’s usually because they don’t have a clear view of what’s happening or a single version of the truth. This dysfunction can arise from incentives that do not encourage resiliency and from management being out of touch with the customer.

In business environments exposed to disruptive change, adaptive processes are needed to rapidly alter underlying assumptions to reflect newly changed circumstances. Disruptive change is a double-edged sword, simultaneously presenting one of the biggest opportunities and risks a company can face. What separates the winners from the losers in managing disruptive change is the ability to recognize the vital signs and act on them with confidence.

In summary, the following are three questions executive management teams and boards of directors should consider about their organizations:

1. Are we periodically evaluating changes in the business environment to assess the related impacts on assumptions inherent in our business model? Is there a process for challenging the durability of our business model?
2. Do we monitor key factors that provide insight regarding the continued validity of the key assumptions underlying the business model and the potential for disruptive change?
3. Do we have adaptive and experimental processes to address the opportunities and risks associated with disruptive change and drive innovation in our core processes and offerings?

Change presents an opportunity to take a business to another level. Conversely, it can be a sign of the beginning of the end. Whichever side of the change curve management and the board find themselves on, few would disagree that disruptive change itself cannot be taken lightly. The key is embracing it as inevitable and organizing to manage it.

[1] Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company, by Andy Grove, 1996.

[2] Big Bang Disruption: Strategy in the Age of Devastating Innovation, by Paul Nunes and Larry Downes, 2014.