PL 864: Managing Risk An Overview

PL 864: Managing RiskAn Overview Kenneth J. Hatten Spring 2010

The Premise: Risk is the By-Product of Change • The fundamental premise of this course is that although the future is unknown, to quote Herodotus, “the only constant is change.” • No change, no risk, and so, of necessity, no opportunity. Change, when it occurs, is typically accompanied by threats and opportunities. • Why? It is because even when we think we recognize the harbingers of change, we rarely know its shape, timing, or even its direction.

The 864 Objective To learn more about Recognizing Change and the Risks that attend it, how to Prioritize Threats and Opportunities, how to Mobilize Organizations to Act in Their Own Interests. • RECOGNITION – PESTS N’ STEPS & PETS • PRIORITZING – FOCUS ON STRUCTURAL CHANGE AND SHIFTING POWER; eliminating what is impossible • MOBILIZATION (PREPARATION) - SCENARIOS

Vioxx & the Sumatra Tsunami • The evidence is that managing risk is neither easy nor appreciated by many who are exposed to those same risks. • Making the case for changes that might help us prepare for economic or natural disasters is difficult and the earlier you are the more difficult it is, even though, the earlier you move the greater the benefit will be. • The issue is how to convince others. Pascal’s famous bet about what he saw as the low probability of the existence of God and benefits of living a moral life, even so, because of the eternal consequences that inevitably follow if God is, illustrates the quandary of every seer who sees risk ahead.

Vioxx • Until late 2004, Merck was one of the pharmaceutical industry’s leaders. Then, in March 2000, Vioxx, a Merck product, was associated with fatal heart attacks in a study of 8000 users. It showed 0.5% of the group taking Vioxx suffering heart attacks, compared with 0.1% of the group taking naproxen. Five times the risk of a heart attack but a low overall risk. • Later studies focused on the 18 month plus Vioxx users suffering from a genetic polyp disease showed twice the risk of heart attack or stroke to non-users. • Once the news was made public Vioxx was pulled from the market. Merck’s stock price dropped over 30%. • Shortly later, Pfizer’s Celebrex was similarly ‘labeled’ but kept on the market. Pfizer’s stock also dropped. • Now people generally are becoming aware that familiar pain killer drugs such as Asprin too have risks attached to them. • Taking Asprin to prevent heart attack puts the user at a 40% higher risk for hemorrhagic stroke according to Tara Parker-Pope, writing in the Wall Street Journal, January 4 2005 (p. D1). She points out that there is one additional stroke over five years for every 1000 patients taking Asprin although Asprin may have prevented 14 fatal heart attacks in the same population. Asprin and older painkillers block two enzymes that are involved in inflammation and pain. It is the blocking of the Cox-1 enzyme that leads to serious gastrointestinal bleeding that kills as many as 17,000 US patients a year.

The Sumatra Tsunami • Smith Dharmasaroja, a sidelined and recently a retired meteorologist, but in 2005 the newly installed Vice Minister to the Office of the Prime Minister of Thailand. As a senior meteorologist Dharmasaroja had focused his spare energy on earthquakes and tsunamis although they had never been regarded as a major problem in Thailand. His appreciation of the history of Pacific tsunamis and Thai records led him to believe that Phunket could be exposed to tsunamis triggered by 7.4 and greater quakes on the fault lines to the west of the Indonesian archipelago. • He first alerted local officials to the tsunami threat to Phunket and other Thai beaches in 1993 but nothing was done. The tsunami that hit Papua in 1998 concerned him more because it occurred on the same fault line that extended towards Thailand. So with only a year to go before his retirement as chief meteorologist he went public with his concerns. His warnings caused panic and outrage. Tourist panicked. Local officials were irate. He was ridiculed in Bangkok. Even after the news of the December 26 earthquake broke, but before the tsunami hit, he tried to warn the Thai Meteorological Department, but was unsuccessful. Now he is responsible for a the creation of new tsunami warning system – but his problem is how to warn people without frightening the tourists off and how to create, maintain, and ensure a system that may not be put to real use for another generation.

Context, Questions, and Caveats • So, how can we prepare and stay alert and do better? • Acknowledge that strange things can happen. We have problems because the world it seems to be just a little more mathematical and regular than it is – “its inexactitude is obvious but its inexactitude is hidden and its wildness lies in wait” (Bernstein, 1996, quoting the English writer G. K. Chesterton, well known too for his Father Brown mysteries). • Recognize that long-lived stable relationships deplete the capacity of people to imagine anything different. Nothing suggests they should even try! Rather than being conceivable, improbable calamities become “unthinkable.” Still, it’s inconceivable that we can assess what we can’t conceive. • Remember, Jack Sparrow the ‘Pirate of the Caribbean’, separated the improbable from the impossible – don’t worry about the impossible. • Recognize that people generally over predict the short-term and under shoot on the long.

Synthesis • Synthesizing a world view is not easy • But once in a while someone comes along succinctly stating their world view. Winston Churchill’s “Iron Curtain” and Dwight Eisenhower’s “Military Industrial Complex” come to mind as visions with long-term impact – each presents the risks of an unfolding situation and simultaneously alerts us to “why” it is so. • Essentially Churchill and Eisenhower described emerging scenarios. • Few businesses have such clear visions to encapsulate their risks and guide their decisions. • The most useful scenarios are those with memorable and meaningful names

Complicating matters for every decision maker, and a great frustration, is the clear “wisdom” that comes with hindsight. One example of literature of this ilk is “Here is New York” by E.B. White, written at beginning of the Cold War in 1948 and resurfacing after 9/11: “The subtlest change in New York is something people don’t speak much about but that is in everyone’s mind. The city, for the first time in its long history, is destructible: A single flight of planes no bigger than a wedge of geese can quickly end this island fantasy. Burn the towers, crumble the bridges, and turn the underground passages into lethal chambers that cremate the millions. The intimation of mortality is part of New York now: In the sound of jets overhead, in the black headlines of the latest edition. “All dwellers in cities must live the stubborn fact of annihilation; in New York the fact is somewhat more concentrated because of the concentration of the city itself, and because of all targets, New York has a certain clear priority. In the mind of whatever perverted dreamer might loose the lightning, New York must hold a steady, irresistible charm. “This race – this race between the destroying planes and the struggling parliament of man – it sticks in all our heads. The city at last perfectly illustrates both the universal dilemma and the general solution. This riddle in steel and stone is at once the perfect target and perfect demonstration of nonviolence, of racial brotherhood. This lofty target, scraping the skies and meeting the destroying planes halfway; home of all people and all nations; capital of everything; housing the deliberations by which the planes are to be stayed and their errand forestalled.”

“So what?”Whenever we see a future oriented article that seems important, it’s worth placing its author in the context of his or her own times and thinking carefully about the critical experiences he or she has had. Placing in Time EG., • White’s statement was circulating in Boston within one or two days of the attack on the World Trade Towers in September 2001. • Amazing that someone could locate it so quickly. • Prophetic, perhaps, but given when it was written -- after its author had time to appreciate the significance of the bombing of London, Dresden and Berlin, Tokyo, Nagasaki, and Hiroshima in World War II, and as the intensity of the Cold War with Russia became clear – possibly a simple and accurate statement of the facts of (city) life at the time and always.

Recognizing Change and Risk, Prioritizing & Mobilizing Action • “Managing Risk” is about recognizing changes, prioritizing the few that seem likely to impact us, appreciating the risks they bring; then, focusing on those we need to attend to and getting others to act in their own interests while they have time to choose -- before they have no choice. • The hurricane Katrina which devastated New Orleans in 2005 was neither unexpected nor unheralded. But, most of the authorities with responsibility for preparations in New Orleans were found wanting.

The Administrative Problem • Some people make change difficult, others make it possible. • How can you separate one set from the other? Search See Sell Sign

Question Your Theory of Your Business: Is it a Risk? Is there a better way? • Peter Drucker who died in 2005 wrote …you'll know you're in trouble when you work and invest yet your competitive position and results simply don't improve; and, you'll know you are really in trouble when companies with fewer resources take market share from you, no matter what you do. • He warned, "Whom so ever the gods wish to destroy, first they give forty years of success." The turnover in the companies in the Dow Index and in the Fortune 500 lists is evidence that there is no guarantee of a prosperous tomorrow. • Apparently, the longer we enjoy success, the more perilous our hold on reality and the harder we must work to be alert to change, to discriminate about its nature, and develop the capacity to adapt ahead of need. • We have to recognize the change that can tip the world upside down and shift power within organizations, industries, countries….even families, from one stakeholder to another, that is, STRUCTURAL CHANGE. • When things change structurally, the counsel of this course is, CHANGE! • The greatest risk is not having the wrong theory, per se, but to ignorantly and energetically reapply yesterday’s (logic) when its time has passed. • This course is, therefore, ultimately about identifying and testing your own and other people's current "theories” of the world and their business" Remember, no change, no risk, but no opportunity!

Will the United States be able to safeguard nuclear waste for 10,000 years? • Throughout my study of this project I am constantly reminded of the Valley of the Kings in Egypt. The Pharaohs created the Valley of the Kings in 1526 B.C. to serve as personal tombs for their journey to the afterlife. These tombs were created at an enormous expense, but were viewed as vital for the Egyptian elite. They were buried in their tombs along with a great deal of their wealth in gold, gems, and other artifacts that were believed to needed to survive in the afterlife. Their afterlife was the most important thing to the pharaohs. It was no secret where the valley and its riches were located, so the living pharaohs always ensured that the tombs had the best guards to protect them against grave robbers. One thing they did not adequately plan for was the eventual downfall of their Empire and their inability to guard the tombs forever. According to their religious beliefs, if their tomb was disrupted, individuals would be unable to survive in the afterlife. The pharaohs abandoned the Valley of the Kings after 450 years (1070 BC) due to excessive robbery of the tombs -- violations they were unable to stop. The pharaoh’s weakness was brought about by an extreme famine that crippled Egypt economically and militarily. Will the United States be able to safeguard nuclear waste for 10,000 years?

Disruptive Technologies & Technological Substitution New Established Performance Question: Who feels the change first and where – who in the established market? How can a market leader recognize the importance of any change and the urgency of any threat? Time

Question: Who feels the social change first and where – who in the market for ideas? How does mind share shift? Can leaders appreciate the implications of such changes and the urgency of any threat? The Social Issues Life Cycle Management Discretion Societal Weight Time

The Social Issues Life Cycle Number of Committed Stakeholders Whose Perceptions and Beliefs Converge Management’s Freedom to Choose Its Own Path If an issue wins support and support continues to build, organizations of every type begin to lose the discretion to make their own choices Seers News Political Legislation Administrative Events Action Law

The Agenda RECOGNIZE • To think critically and develop a reliable methodology for understanding the forces shaping the evolving future – their power and direction; PRIORITIZE • To separating what is important to us from the spurious and, to prioritize (our) response to them. MOBILIZE • To sort out how to bear grim news or tidings of great joy -- so that, whether we are seers, or convinced by a seer that the sky is about to fall, we’ll know how to prudently initiate the selling process and survive.

Will the United States be able to safeguard nuclear waste for 10,000 years? • Throughout my study of this project I am constantly reminded of the Valley of the Kings in Egypt. The Pharaohs created the Valley of the Kings in 1526 B.C. to serve as personal tombs for their journey to the afterlife. These tombs were created at an enormous expense, but were viewed as vital for the Egyptian elite. They were buried in their tombs along with a great deal of their wealth in gold, gems, and other artifacts that were believed to needed to survive in the afterlife. Their afterlife was the most important thing to the pharaohs. It was no secret where the valley and its riches were located, so the living pharaohs always ensured that the tombs had the best guards to protect them against grave robbers. One thing they did not adequately plan for was the eventual downfall of their Empire and their inability to guard the tombs forever. According to their religious beliefs, if their tomb was disrupted, individuals would be unable to survive in the afterlife. The pharaohs abandoned the Valley of the Kings after 450 years (1070 BC) due to excessive robbery of the tombs -- violations they were unable to stop. The pharaoh’s weakness was brought about by an extreme famine that crippled Egypt economically and militarily. Will the United States be able to safeguard nuclear waste for 10,000 years?

Models to Master • Although there is one core model in this course, in fact, this course employs several different models • Students will have to make their own selections as to which model to employ in what circumstances • Learning more about model use and the implications of their limits is a lessons to be learned.

Core Model: PESTS N’ STEPs & and PETS • (Acronyms based on Political, Economic, Social and Technological Change) • PESTS – change can be a pest but you have to deal it so why not seek the upside. • Watch out for Natural Disasters – “N” – uncontrollable, but you can prepare • Consider stakeholder interests and power • Take STEPs to seize the opportunity and prosper; and, • Be prepared to give up your PETS – pet ideas and preconceptions so you and your organization can change

Principal Delivery Strategy • Using Scenarios to explore the possible future, create executive awareness of those possibilities, and identify and even create networks of informed and possibly expert decision makers.

Morgan Stanley uses a simplified structure to help its mangers develop useful scenarios for their planning sessions – we can use it too. • What is important to you? • Who adds (to) the uncertainty?

Find what can be expected and what could be a surprise: Tell the story that explains how far out along each of the 450 lines the situation can evolve? Importance + Uncertainty - Uncertainty + Importance -

First identify the most important issues facing the company, Ask what are the most important forces likely to shape the future – its driving forces (typically one or more interacting PESTS). • Then assess who is likely to generate uncertainty (Know the Stakehodlers). • The driving forces are typically evidenced by HARD data while the uncertainties are evidenced by SOFT data

Challenge • Mastering the conceptual tools for assessing the likely future and the payoffs of alternative strategies. The quest is to identify and formulate a robust strategy for an ever changing world – a strategy that affords you and your organization a competitive advantage.

Explicit Models • PEST N’ STEP and PETS • Stakeholder Analysis • Scenario Development • Cross Impact Analysis – Where are Structural Changes likely to Emerge? • The Payoff Matrix: What are the robust and dominant strategic options

Cross Impact Analysis What could happen? What Events? What Changes? Where are Structural Changes likely to Emerge? High Impact Low High Low Probability

The Payoff MatrixExample: What is the Investor’s payoff under each strategy in each ‘state of the world’?What if the investor is 30? What if he or she is 65? One can maximize the upside or minimize the downside or seek a robust, that is, dominant strategic option but usually the financial and temporal position of the beneficiary matters Alternate Future States of the World Deep Recession Stagflation Boom Hold Cash Alternate Strategies 50%: 50% Buy Stock Now

Subsidiary Models for Risk Recognition, Prioritization, & Mobilization • Recognition: Distinguishing patterned, stepped, discontinuous and structural changes; recognizing dissonance within any organization (or community), identifying strategic inflections and understanding intra-organizational and inter-organizational dissonance. Identifying what is ‘competitive about technology change and appreciating just how sudden the ultimate collapse of a long established competitive advantage can be. • Assessing Country Risk: Consider rule of law, distribution of wealth and political power, normal and abrupt political successions, corruption, educational priorities, national crisis management, and the history of nations’ relationships with international agencies and multinational corporations. • Stakeholder Power Changes: Facing the real cost of action and inaction where uncertain impacts may shifting power among stakeholders -- particularly if those with veto wielding status are threatened. Dealing with customer and employee resistance to change. • Placement in Time -- Placing political or business leaders, and the eminent authors of (allegedly) prophetic scenarios, in the flow of history and considering how their lifetime personal experiences have shaped their attitudes and biases and, so, their critical decisions and opinions. • Using Systems Analysis as an Analytical Tool to identify likely non-linear effects (over time), their likely causes , as well as the use of causal maps, strategy maps, and competitive maps, to abstract high impact factors from the chaos of reality.

PL 864: Managing Risk An Overview