Traditionally, finance and strategy teams have been tasked with working together to promote corporate growth. Now, new research suggests they need to enlist a third partner—risk management—to achieve sustainable long-term growth.
A study conducted by CEB (now Gartner) of the Fortune 1000 and S&P Euro 350, found that just 60 companies have consistently outgrown their industry peers while simultaneously making margin improvements over the last 20 years. The biggest differentiator of these “efficient growth” companies was their ability to allocate capital to bigger, riskier bets. For example, their R&D portfolios were disproportionately slanted toward transformational innovation, their M&A deals were 40% larger on average as a percent of revenue, and they were quicker to reintroduce capital expenditure through the cycle. These riskier bets allowed them to become the “first-movers” in their industry while not spending any more on R&D or acquisitions than others.
But taking such risks does not come naturally for most companies. In fact, in 2016, 77% of CFOs reported that the amount of risk aversion from executives in their organization rose from the previous year. What these executives do not understand is that, like cholesterol, there are good and bad kinds of risk. Bad risks are more obvious and distinguished by recklessness and wrongdoing. These are what the risk management function is normally associated with—putting controls in place to keep bad things from happening. But companies need to take risks to grow, and there is a role for risk management to play in helping with that.
There is also a real benefit to using the enterprise risk management (ERM) program to combat risk aversion. In fact, the CEB study found that the companies that are best at taking smart, riskier bets to grow generate a total shareholder return premium of 7% over their industry peers.
To get this right, finance, strategy and risk management teams need to join forces. This presents risk management with an opportunity to demonstrate its value by enabling senior leaders to make high-risk growth decisions. Risk leaders can help companies change their approach to new growth opportunities by taking three key steps:
- Coordinate risk and strategic planning. At most organizations, risk management is not involved in strategic planning conversations. For risk leaders to have a good understanding of the company’s growth ambitions, having a seat at the table during these discussions is critical. From there, risk leaders can communicate any associated risk implications to the strategic planning group, including finance. The risk profile that ERM generates from these exchanges can help the organization recognize what types of risk-taking make the most sense—which big-growth bets are most likely to succeed and which of the potential impediments are most critical to address.
- Discuss risk appetite within the appropriate context. Risk managers also need to consider how they talk about risk appetite with stakeholders on the risk committee and the board. Too often, risk appetite is discussed using generalizations and jargon that do not give managers and employees a clear understanding of how to consider risk in their roles. Discussions of risk appetite are also typically conducted separately from discussions about growth.
The better approach is to explicitly align risk conversations with annual discussions about strategy and growth. This establishes the organization’s definition of risk appetite in the context of its overall strategy.
- Develop an active risk appetite. When developing or reviewing their risk appetite, risk leaders should base the discussions on where the company wants to go and what needs to change in order to reach those objectives. Instead of asking what level of risk executives are comfortable with, risk managers should ask, “Where do we want to see management taking on more (or less) risk, and in what way?” For example, one option is to use a “flexible risk appetite.” This strategy sets guardrails for risk-taking in areas like reputation or market entry, but also gives managers the flexibility to move quickly in cases where compelling strategic opportunities create short-term deviations from the established risk appetite. By taking a more cross-functional approach to their role, ERM leaders can help build risk appetites centered on the company’s growth ambitions. This approach helps risk management take a central role in promoting growth, allowing it to become a strategic partner.