Risk management and scenario planning
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Risk Management and Scenario Planning. By James Joseph Wasil Senior IT Strategist Ohio BWC January 9, 2014. Organizations such as ISACA and PMI are taking on governance. Governance seeks to ensure that strategies in the organization are working toward its mission and goals.

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Risk management and scenario planning

Risk Management and Scenario Planning

By James Joseph Wasil

Senior IT Strategist

Ohio BWC

January 9, 2014


Why is risk management poised to take on scenario planning

  • Organizations such as ISACA and PMI are taking on governance.

  • Governance seeks to ensure that strategies in the organization are working toward its mission and goals.

  • Risk Management is becoming more and more important and strategy must be a function of risk appetite in an organization.

Why is Risk Management Poised to take on Scenario Planning?


Why is risk management poised to take on scenario planning1

  • Faith is waning in traditional strategic planning efforts that generate forecasts that are usually wrong.

  • The most likely weakness in most strategies is underestimating risk.

  • Risk Management is evolving!

Why is Risk Management Poised to take on Scenario Planning?


The evolution of risk management

The Evolution of Risk Management

From “Forging a Collaborative Alliance, RIMS & IA, 2012


Conjoining strategic planning function and risk management

  • Risk Management is in the business of developing and sustaining an organizational capacity for foresight (Maree Conway), and

  • The traditional business areas need to be incorporating this type of thinking into their strategic planning.

  • One way to incorporate foresight is through scenario planning.

Conjoining Strategic Planning Function and Risk Management


The context of business is changing

  • “Traditional strategic planning models are increasingly viewed as not producing strategy that can deal with complexity, uncertainty and rapid change in the external environment.”*

The Context of Business is Changing

*Maree Conway - Swinburne University of Technology, and Thinking Futures


Complexity

Ashby’s Law:

If a system is to be stable the number of states of its control mechanism must be greater than or equal to the number of states in the system being controlled.

Complexity


Complexity1

Ashby’s Law Restated:

The only way to destroy variety is through variety.

Variety (Complexity)   Variety (Flexibility))

Complexity


Strategic flexibility

Strategic Flexibility

is the optimum combination of

strategic robustness and

strategic responsiveness

Strategic Flexibility

Concept from Lindgren and Bandhold


Robustness

Robustness is defined as “the potential for success under varying future circumstances or scenarios.” More specifically,

The likelihood that the organization will not need to change in order to meet the challenge is called the “robustness of the organization.”

Robustness

Concept from Lindgren and Bandhold


Responsiveness

Responsiveness is defined as the ability to

  • rapidly sense change in the environment,

  • conceptualize a response to that change, and

  • reconfigure resources to execute the response.

Responsiveness

Definitions are from Lindgren and Bandhold


Ooda loops

Planning:

Decision

Orientation

  • Faster cycling trend

  • Need to fly by the wire by balancing stability and instability

Action

Observation

OODA Loops*

* From John Boyd


Agility rate of change

  • Just as in IT, strategy research has recently focused on the need for agile strategies, able to change upon the wind of a mere scent just blowing by.

  • Scenario planning has been identified as a method for accommodating rapid change

Agility - Rate of Change


Bolstering strategic planning

Strategic planning does consider the future since strategy involves the future, however it typically does not consider the future in a systematic way.

Bolstering Strategic Planning

From Maree Conway


Risk management and scenario planning

UNCERTAINTY

RISK

SCENARIO

PLANNING


What is uncertainty

Uncertainty is the lack of complete certainty - that is, the existence of more than one possibility (scenario). The “true outcome / state / result / value is not known* (perhaps until some future time)

What is Uncertainty?

* Douglas Hubbard. Parentheses by Wasil


Uncertainty

  • Uncertainty is “local”, i.e., my uncertainty is different from yours.

  • There are more uncertain things than certain things.

  • All statements regarding the future are uncertain to some extent.

  • It is better to accept and recognize uncertainty. (this is the basis for scenario planning)

Uncertainty

From Lindely, Understanding Uncertainty


Uncertainty1

  • Approach to uncertainty involves setting up beliefs – a way to organize you beliefs in a reasoned way which leads to a reasoned action.

  • We use a normative (prescriptive) approach

Uncertainty

From Understanding Uncertainty, Lindley


Great news life is uncertain

  • We have free will, therefore we can decide more or less what we want to do!

  • When we get to certainty…then we are dead!

Great News! Life is Uncertain


Types of uncertainty

  • Unknowable uncertainty - the event cannot be imagined.

Types of Uncertainty

From Heijden


Types of uncertainty1

  • Risk uncertainty - Risk is a state of uncertainty where some of the possibilities involve a loss, injury, catastrophe, or other undesirable outcome

Types of Uncertainty

From Hubbard


The history of risk er and erm

Frank H. Knight (1885-1972)

American economics scholar

University of Chicago

Classic work on Risk (1921) set its definition based in the context of uncertainty:

If we cannot quantify outcome probabilities we have UNCERTAINTY.

If we can quantify outcome probabilities then we have RISK.

The History of Risk, ER and ERM


Heinrich s dominoes

H.W. Heinrich was the Assistant Superintendent of Engineering and Inspection Division of the Travelers Insurance Company

Heinrich’s Dominoes


Hubbard s definition of risk

“The probability and magnitude of a loss, disaster, or other undesirable event.

That is, “Something bad could happen”

Risk Management - “The identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events.

That is, “Being smart about taking chances.”

Hubbard’s Definition of Risk


What is risk risk management

  • International Standard ISO 31000 on Risk management – Principles and guidelines.

  • This is the latest source on risk management

What is Risk? Risk Management?


What is risk and risk management

Risk is the effect of uncertainty on objectives where

  • an effect is a positive and/or negative deviation

  • Objectives an have different aspects (financial, S&H, environmental) or a combination

  • Risk is often referenced to potential events and consequences or a combination

  • Risk is often expressed in terms of the consequences of an event and the associated likelihood of occurrence.

What is Risk and Risk Management?

From ISO 31000:2009


Risk management is an evolving field

Balanced Scorecard is the prime Strategy Execution Framework among the Fortune 500

Risk Management is an Evolving Field


Risk management is an evolving field1

Robert S. Kaplan now venturing into Risk Management

Three Kinds of Risks:

Category I – Preventable Risks

Category II - Strategy Risks

Category III - External Risks

Risk Management is an Evolving Field


Erm definitions from rims and iia

RIMS:

“Enterprise risk management is a strategic business discipline that supports the achievement of an organization’s objectives by addressing the full spectrum of its risks and managing the combined impact of those risks as an inter-related risk portfolio.”

ERM Definitions from RIMS and IIA

From “Forging a Collaborative Alliance, RIMS & IA, 2012


Erm definitions from rims and iia1

IIA:

“Enterprise risk management is a structured, consistent and continuous process across the whole organization for identifying, assessing, deciding on responses to and reporting on opportunities and threats that affect the achievement of its objectives”

ERM Definitions from RIMS and IIA

From “Forging a Collaborative Alliance, RIMS & IA, 2012


Both erm and ia use similar tools

Both ERM and IA Use Similar Tools


Strategic planning uses forecasts

A forecast is like a vector in that it has direction and magnitude

Strategic planning uses Forecasts


Scenario planning uses scenarios

Scenarios cover, or envelope two or more axes of uncertainties

Scenario planning uses Scenarios


For two axes of uncertainty

Axis of Uncertainty “Y”

Scenario A

High Y

Low X

Scenario B

High Y

High X

Axis of Uncertainty “X”

Scenario C

Low Y

Low X

Scenario D

Low Y

High X

For Two Axes of Uncertainty


Definitions of scenarios

  • An internally consistent view of what the future might turn out to be - not a forecast, but one possible future outcome.

    Michael Porter

Definitions of Scenarios


Definitions of scenarios cont d

  • A description of a future situation and the course of events which allows one to move forward from the original situation to the future situation. Two major categories:

    • Exploratory - starting from past and present trends and leading to a likely futures;

    • Anticipatory or normative - built on the basis of different visions of the future to be desired or feared.

      Michel Godet

Definitions of Scenarios (cont’d)


Definitions of scenarios cont d1

  • “narrative stories that follow particular paths into the future based on research, trends, and key concerns of the managers who will use them.”

    - Korte and Chermack

Definitions of Scenarios (cont’d)


Important distinction on scenarios

Scenarios are not about predicting the future, rather they are about perceiving futures in the present.

Schwarz

Important Distinction on Scenarios


Scenario planning methodologies

  • Intuitive Logics - SRI, Pierre Wack, Ralston and Wilson

  • Trend-impact analysis - Futures Group

  • Cross-impact analysis - Battelle

-Scenario Planning Methodologies


General scenario planning using intuitive logics approach

Identify the central question / problem (Decision Focus)

Using executive peer groups, gain a consensus on what the key strategic decision is that the organization is facing. This will be your decision focus, and the scenario planning context.

Note that it will be an agreement on how the scenarios will be used.

(we are only interested in certain aspects of the future, not the future.)

General Scenario Planning using Intuitive Logics Approach

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario planning using intuitive logics approach1

Identify the central question / problem (Decision Focus)

As an example, say you are in the energy business. Energy looks like a mixed bag. Coal and Nuclear becoming harder while fracking, solar, and wind are starting to produce.

Your focus might be

How are we going to be able to deliver energy inexpensively and reliably over the next 30 years?

Form the focus as a explanatory paragraph.

General Scenario Planning using Intuitive Logics Approach

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz

Identify key decision factors (KDFs)

Determine what the key external factors / issues are regarding the future that we want to know more about to improve our understanding.

These KDFs are external, largely uncontrollable conditions.

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz1

Identify key decision factors (KDFs)

Example: How will fracking impact domestic energy production?

How will wind power be incorporated into the grid?

What new security threats /requirements will the grid face?

Will nuclear energy again become promising?

Etc.

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz2

Cluster the key decision factor (KDFs)

Categorize KDFs that fall into groups.

Example: Energy Costs

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz3

Research driving forces and drivers

Since there is no source that predicts the future, the team must analyze the forces that determine the KDF outcomes. These are things like trends, forces, factors, events, areas of uncertainty

This is analogous to the PESTEL analysis strategists perform, but is very rigorous.

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz4

Research and rank key factors and driving forces

Use an impact / uncertainty matrix to accomplish

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz5

Develop scenario logics

Identify the key axes of uncertainty

Example: Say that we identified key axes:

Technology, Resources, Environmental Issues, Cost, Security

As potential axes. We pick the two most important axes of uncertainty.

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz6

Determine Alternate Logics for Each Axis (technology and energy costs)

Scenario A

High technology

Low costs

Scenario B

High technology

High costs

Scenario C

Low technology

Low costs

Scenario D

Low technology

High costs

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz7

Prepare narratives for each scenario, with a descriptive name. These are brief descriptions one or two paragraphs; A narrative of how each scenario might evolve

Example: High Technology High Cost otherwise known as “Responsible Technology Scenario”

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


General scenario approach schwartz8

As the end of the twenties arrives, the landscape is complete with wind farms occupying positions among citizens, who themselves are putting energy back into the grid with their solar energy panels, and even their electric cars. But the cost has been high. The grid is now robust, but costs to secure it have been very high in terms of purchasing multiple access right of ways, thousands of miles of underground high voltage equipment, and smart grid appliances that regulate millions of homes. Even though fusion has not become economical yet, efforts have…

Example: High Technology High Cost otherwise known as “Responsible Technology Scenario”

General Scenario Approach (Schwartz)

Excerpted From Ralston and Wilson, Scenario planning Handbook


After the scenario planning

  • Strategic plans back up the scenarios

    • Some strategies will work in all scenarios

    • Some strategies will be risky in some scenarios

    • Some strategies may pay off big in only one or two scenarios

  • Strategies based on Scenario planning are more effective and offer agility and flexibility.

After the scenario planning


Erm and black swans

Black swans are

  • The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.

  • The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities).

  • The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs.

ERM and “Black Swans”


Recommendations

Risk Management should

  • Ensure that your organization does some form of strategic planning

  • Participate in Strategic Planning Exercises

  • Lead in environmental assessments such as PESTEL and SWOT

  • Work towards forming a Knowledge center and toward becoming a learning organization

  • Start to engage top management into looking into scenario planning (but be careful here….)

  • Start becoming informed on scenario planning yourself!

Recommendations


Risk management is an evolving field2

  • Nassim Nicholas Taleb

Risk Management is an Evolving Field


Scenario planning can prevent black swans

  • Black Swans are most dangerous when “end of tail” operations are likely to occur.

  • Risk Management can gauge if scenarios and ancillary strategies take us there!

Scenario Planning can prevent Black Swans


Scenario planning is an evolving field

Scenario Planning is an Evolving Field


Scenario planning is an evolving field1

Scenario Planning is an Evolving Field


Good scenarios are not enough

To be effective, they must involve management, top and middle, in understanding and anticipating the unfolding business environment much more intimately than would be the case in the traditional planning process.

Pierre Wack

Good scenarios are not enough


Questions and attempts at answers

Questions and Attempts at Answers


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