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Kaplan and Norton: How To Measure Your Company’s Risk in a Downturn

Harvard professors Robert S. Kaplan and David P. Norton, creators of the balanced scorecard, have written a superb article arguing that far too often management has ignored risk as a factor in managing their firms.

How To Measure Your Company’s Risk in a Downturn

http://blogs.harvardbusiness.org/kaplan-norton/2008/12/how-to-measure-your-companys-r.html

Some excerpts:

“Traditionally, we have advocated two methods to drive shareholder value: revenue growth and productivity improvements. The third method for sustaining shareholder value, missing in many companies’ strategies, should be risk management. We’ve asked many companies why this method is missing in their plans, and consistently we hear back that their challenge is to find valid metrics of risk management, a key driver of sustainable value creation.”

“All financial institutions have metrics related to risk exposure, such as “value at risk.” But almost all the financial institutions, and almost certainly the ones that failed, treated risk management as a regulatory and compliance function, somewhat like internal controls for Sarbanes-Oxley, and not as a strategic issue.”

They argue that companies usually fail to do this because the lack the right tools to measure what is hard to measure, and suggests they start by taking the following three steps:

“1. Start by attempting to identify the macro-economic variables that have the greatest potential to put your strategy at risk”

“2. Estimate the impact on profitability from potential changes in these macro-economic variables”

“3. Aggregate the risk exposure onto the company’s BSC to stimulate discussion at monthly strategy review meetings about the risks of the current strategy.”

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