CO - Finnovation

Risk Management Concepts

Risk Management Concepts

Risk Management Concepts - a practical approach.

  • History, the Persians and risk management, an example.

The crossing of the Hellespont, when the Persian armies resolved to invade the Greek city states, is a historical turning point. The defeat of the Persians by the Greek, marked a turning point for the Hellenistic culture. What we know from the writings of the Greek historian Herodotus is that the Persian king was aware of the risks, but chose to ignore them for his certitude in the advantage of the resources and skills of his armies. The veracity of the conversation between the Persian king and his advisors on the wisdom of his decision can be put to test, but the outcome is almost certain. We use this event in history to make two arguments; the negative consequences of risk can be mitigated or balanced if risk is properly identified and managed, and if such, risk can be an overall net positive for business. As such >ISO 31000 defines risk as "effect of uncertainty on objectives" and takes into consideration that there may actually be positive impacts of uncertainty. This seems counterintuitive. Isn’t absolute certainty more desirable? True, but absolute certainty is never absolute (unless the saying goes, it is with death and taxes), and therefore risk avoidance should never be confused with willful risk myopia, but rather it should be the awareness of and utilization of risk to better plan for the unknown (i.e. real risk management). In the following paragraphs, we will discuss some of the tools available for risk quantification and management, the benefits digital transformation can have on integrating risk across the organization, and the type of individual mindsets companies should cultivate for their risk management programs. 

The trouble with lessons from history is that we learn them best right after we fall on our chins. We learn to selectively manage our attention and ignore the majority of the risk around us. This is necessary for us to function on a daily basis, but large organization with significant public stake must possess a more refined outlook on risk. In mining for example, failure to address risk can result in negative outcomes for many stakeholders, as we have seen in the recent dam failures in Brazil. Along with the tragic loss of life, the negative repercussions on the reputation of the industry in general will be felt for many years to come. Both authors have experience in managing critical risk in mining operations in high stake environments. Our believe is that recognizing the existence of risk is the required first step in developing robust mitigation plans that strengthens the business to negative unforeseen outcomes. Integrating risk into business planning should from the on-set and continue throughout the planning cycle and during operation. The development of the risk management plan is a cross-functional enterprise that requires close collaboration unimpeded by silos. In order to fully account for it, the risk management team needs to be fully imbedded into the business planning process.

As an example in mining and mine planning, risk is imbedded in the resource and the reserve model through the uncertainty in orebody characteristics. When uncertainty is factored into the reserve and resource model, a more realistic view of the mine plan can be developed. Companies must still maintain an operating risk profile and register (more on that later) which must feed into the daily operating model, but a shift from a deterministic to probability-based mine planning is a fundamental first step.

Quantifying risk begins by understanding how to effectively measure uncertainty. Douglas Hubbard, in his book How to Measure Anything, offers a few insights to help overcome the initial analysis paralysis. First, Hubbard states, don’t attempt a massive study to measure something if you have a lot of uncertainty about it now. Instead, Hubbard continues, there is greater value to start by quantifying a few unknowns, thereby removing some uncertainty. By studying past predictions and iterating we can become better adept at utilising the optimal amount of information we have available to quantify risks and impacts. On the other hand, focus on the critical risks. Think about what if disaster strikes, what are the Black Swan events that can cause harm, to the people, the environment, to your business. In his book "The Black Swan: The Impact of the Highly Improbable" Nassim Nicholas Taleb makes the point that we are hardwired not to truly estimate risk. We oversimplify. So how do we put the two ideas together - on one hand we need to simplify in order to measure on the other hand we need to consider complexities and improbable events.

Risk Assessment and Management Tools - how to actually do it: The tools are varied for risk assessment. Quantitative risk assessment tools, such as Monte-Carlo simulations are common in the industry, but surprisingly they are not routinely applied to large value-impacting decisions with great uncertainty. Hubbard identifies this phenomenon in the industry as the Risk Paradox, where it has been observed that most organizations utilizing quantitative risk analysis, mostly do so for routine operational decisions, ignoring the most risky decisions. One of the tools we used in our past roles for risk management is the Risk Assessment Matrix, which ranks identified risks according to likelihood and consequences. In our example each functional area was responsible to manage their own assessment matrix, a consolidated and condensed form, managed by each site, was presented weekly for the company’s senior leadership embedded in a standard performance review presentation (known in this case as BPR). These tools were not the only ones available, but they were adopted to standardize risk management across the organization. Business Plan Reviews were central and enormously successful in shifting the company mindset in our past experience. These weekly comprehensive reviews had several key purposes. Most importantly, they helped gather all key business units under a single collective decision making tent, where information can be more easily disseminated. It had also as a significant benefit that the whole organization was aligned on what the management team thought were the companies most significant risks to address and by whom. Transparency is key to mobilize required resources for the implementation of risk management plans. In organization activities compete for resources and having a common view on risks and its impacts helps align those resources.

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Figure1 Example Risk Assessment Matrix

Now there are certainly issues in using risk management matrixes, there are authors that go as far as pointing out "The Risk of using Risk Matrixes" as do Thomas, Philip & Bratvold, Reidar & Bickel, J., but being systematic about risk and start managing it proactively in our view is key.

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Then tools used will evolve as the organisation itself gets better in understanding risk. From the small, doing a field risk assessment (FLRA) as the author did quickly mentally (the formal one was done before by the maintenance personnel) before climbing in together with the maintenance manager >Luis Gutierrez into the mill to inspect the liner state - to enterprise risk management (ERM) forming part of a CROMCEN.

Digitizing and Centralizing the Data. One of the stumbling blocks which may be encountered in any organization is the scattering of key information systems. Risk tracking and management is usually a decentralized domain. Duplication, obsolescence and fragmentation of data is common when risk tracking is managed manually and locally on systems such as excel or other similar solutions. Organizations can benefit greatly in eliminating these potentially costly errors by investing in the proper systems and processes to manage risks in a core system or database. In doing so, greater transparency and accountability can be achieved in this key area, while eliminating duplication and scatting of data. However, having a robust regular process already helps to get this improved. Once everybody has to think regularly about risk, the way it is measured, and what he himself has to do, to support managing them, information tend to become more coherent

Investing in the Dissenters. In his less know work Vital Lies Simple Truths: The Psychology of Self-Deception, The Best Selling Author Daniel Goleman argues on the dangers of Groupthink in the corporate family. Goleman states that the dangerous pathology of groupthink, even with safeguards of the bottom-line and the market-place, remains an ever present source of costly mistakes for any organization. Beyond the self-correcting external sources, it is wise for business leaders to develop individuals that can offer dissenting voices. This we believe is especially critical in areas such Risk Assessment and Management, where the wrong decisions can yield significant repercussions. Strong business leaders tend to inadvertently create groupthink, which can be counteracted by encouraging a sense of unity and openness to all relevant information, some of which can be achieved through innovative systems and processes >(See iROC and BPR).

How to mitigate risk.

Risk does not have to be the paralyzing influence on any business decisions. By realigning our view on the matter, and applying the appropriate leadership, systems, processes and procedures, we can transform a perceived disadvantage into a tool for better business planning and to make an organization more robust.

>Quoting Dwight D. Eisenhower in a speech from 1957 "I tell this story to illustrate the truth of the statement I heard long ago in the Army: Plans are worthless, but planning is everything. There is a very great distinction because when you are planning for an emergency you must start with this one thing: the very definition of "emergency" is that it is unexpected, therefore it is not going to happen the way you are planning."

Planning for risk and having mitigating actions in place is required practice. It will also help in case you encounter events you have not planned for as the planning exercises will help you to be able to adapt quicker. It will also highlight weaknesses. As an example: If you plan to extract a victim of an accident or sickness by air, you will realize that sometime flying conditions are not met, especially at high altitude where density altitude changes and high winds exist that make helicopter flights sometimes too dangerous or even impossible.

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The amount of passengers you can carry may be limited. You may need to think of triage and how to bring patients to medical care facilities based on individual graveness of injuries. Of course you will most likely never encounter the exact conditions you planned for, but having planned, having gone through the process will help you to adapt when a critical situation occurs.

Our recommendation - just start doing it.

  • Michael Meding
    Michael Meding
    CFO, Emincar SA Cuba

    Michael is presently CFO of Emincar. Emincar is subsidiary of Trafigura a global mining company. Michael is Trilingual Finance and Operations Executive, Master of Business Administration from Harvard (US and Germany) with postgraduate studies in Argentina and Chile. He Commercially astute, results driven leader specialising in business partnership and alliance building. Prior to this he was CFO of Barrick Gold. As highest-ranking finance officer in Argentina, responsible for Budgeting, Controlling, Accounting, Reporting, Treasury, Tax, Internal Controls and Strategic Planning. He worked with Novartis before.

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