November 2017
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Kaplan and Norton: Ignoring Risk Is Not An Option

Kaplan and Norton correctly assert that management all too frequently ignores risk as a factor in managing their firms. They explain that part of the reason for this failure is the lack of good measurement tools to quantify “rare, or black swan, events”, but this is no excuse. The inability to quantify these risks does not absolve management from the responsibility to manage them. That something is difficult, does not make it less necessary.

Their suggested solution is essentially straight forward: identify the primary risk factors, estimate their impact, and sum up the risk exposure in a visible way, so it can be used to manage the firm. Executing it is not always so straight forward. One reason is that quantifying risk is often substituted for managing risk – and often with disasterous consequences. The tiny odds of a “black swan” event occuring often obscure the vulnerability to that risk – and subsequently minimize the urgency of managing the risk.

Using scenarios can make the problem easier to approach. Scenarios are useful tools for managing risk, because they can help reveal interdepencies and cumulative risk. Something as simple as the depiction of a process flow can often suffice as the basis for a scenario-based risk assesment.

In a manufacturing process, for example, simply adding 20% to the cost of your overseas suppliers could reflect the effect of a potential currency risk. Similar variations could be used to reflect financing risk, legal risk, and so on, ultimately giving a picture of the total risk. The same flow can be used as the basis for depicting several different risk scenarios, allowing the risk – and the possible reactions – to be compared and contrasted.

No matter the tool, Kaplan and Norton’s conclusion offers little hope to executives trying to avoid tough decisions. Quantifying risk does not eliminate the need to manage risk.

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