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HR: Why Broaden Your Risk Perspective?

Posted by Mark Bennett on November 18, 2009

2552346073_069722ec21_bStrategy is founded on risk and risk is inherently subjective to the views of the people involved, including employees and management. As a result, HR has a great opportunity to improve the way in which risk impacts strategic success for the business, going beyond the more tactical or operational perspective HR has previously taken.

All economic activity is by definition “high risk”. And defending yesterday–that is, not innovating– is far more risky than making tomorrow.
Peter Drucker

HR and Risk Up to Now

Although it might be over-generalizing, for quite some time, HR has mostly focused on risk in terms of how to identify and address workplace risk items such as harassment claims, EEOC violations, health and safety liability, etc. These are all vital areas to be risk-managed, but to be more strategic, HR needs to broaden that perspective to include how it can positively impact business risk.

Risk is frequently misunderstood and mismanaged[i]. This misunderstanding and mismanagement can have unexpected, even dire consequences due to people’s varying comfort with risk and the complex ways that people in general react to it. Here’s a sobering real-life example of just how that can happen[ii]:

Blowing It on Business Risk and People – an Example

In oil & gas exploration, the odds are high against finding anything, let alone a find suitable for extraction. People working in this field apply their diverse expertise towards figuring which locations are most likely to be profitable. In addition, there is the added pressure to locate larger, more profitable reserves, which are even harder to find.

The decision on whether to bid on a lease and then drill is based on “pessimistic/low, likely/medium, and optimistic/high” estimates[iii] for how much can oil or gas can be extracted. If the “likely” estimate is large enough, then a bid is made and if that succeeds and drilling is approved and the actual output is on track to meet that large estimate, the folks behind that estimate are very happy as they can expect some kind of bonus.

However, it’s easy for a manager to only see the “optimistic” estimate and let that “frame” their expectations. Then, when in fact the more realistic “likely” value does result instead, the manager perceives a “loss” and they can end up taking it out on the troops. This did happen to a team and they were told they wouldn’t get a bonus because “the company wants those higher outputs” i.e. the optimistic level.

And here’s what happened next. The team then saw that only results that met the “optimistic” estimate get praise, so they naturally became more conservative in their estimates. They lowered their “optimistic” estimate to be closer to what they normally would have given as the “likely” estimate. In turn, the “likely” estimate was lowered as well. Because of these more conservative estimates, when budgets were decided, the allocations didn’t go to that team as much because their estimates are now lower than those of other teams. With a lower budget, that unit couldn’t bid as much on the leases (especially the riskier but higher potential ones – remember that the competition is bidding higher because they have higher, non-distorted estimates) so they missed out on more of the big finds.

Since there were fewer large finds returns were lower for the whole company. Investors were expecting higher returns when they chose the company, since they already understood it was higher risk. As a result, lower earnings and less capital were available for the company, it couldn’t compete, and eventually it was acquired.

What HR Can Do

All of this happened because management didn’t understand the relationship between the company business risk and the incentives and motivation of the people working there. If HR had an understanding of the strategic impact (e.g. company survival) of this relationship and had a role in making sure that managers understood it and practiced it as well, this poor management decision could very well have been avoided.

This was just one example from oil & gas exploration, but the same scenario plays out in a multitude of “high-risk” businesses ranging from software development and airplane manufacturing to drug development. However, the difficulty that management in particular has with dealing with the interaction of risk and incentives can even disrupt the competitiveness of “low-risk” enterprises. HR’s ability to apply its expertise with people coupled with a broader, strategic perspective of risk can bring huge advantage to a company.

Photo by hellolapomme

[i] The definition of risk is not well agreed upon, but we will use the following: the existence of more than one possible outcome where some of them are undesirable (e.g. loss or catastrophe). Risk only has real meaning when a decision must be made and human decision makers are decidedly not “risk neutral.” That is, they will not simply choose the highest “expected values” with cold logic, but will favor certain choices over others depending on factors such as current wealth, level of possible loss, gain, framing, ownership, etc.

[ii] Credit goes to “Why Can’t You Just Give Me the Number?” by Patrick Leach, an excellent, succinct book that shows executives how to manage risk and make better decisions using probabilistic thinking. Also recommended is “The Flaw of Averages” by Sam Savage and as previously mentioned, “The Failure of Risk Management” by Douglas Hubbard.

[iii] The medium or likely value has about a 50% chance of finding at least that amount. The high or optimistic value has only about a 10% chance of finding at least that amount. In other words, they might happen occasionally, but not on average.

6 Responses to “HR: Why Broaden Your Risk Perspective?”

  1. Nice one!

  2. Mark – I agree. Like you articulate so well in this post, we have to be mindful of looking at both the risks of moving forward with each initiative and the business risks of not moving forward with the initiative.

    One of the real keys to HR success is understanding your company’s philosophy and strategies in regard to risk.

    You don’t want to just dive in and say — “I’m going to start taking more risks – for the good of the company!” However you can do some digging and discover the CEO, Senior Leaders, BOD’s and other important players’ expectations and tolerance in regard to risk. They are the ones that should set the tone and you in HR should follow their lead.

    We have a tricky role in HR in this regard because some leaders who love risk rely on their HR leaders (and sometimes their finance leaders) to prevent them from going over board when it comes to risk. It’s not unusual for a CEO to say to their HR SVP – “Why did you let me do that?”

    Thus the HR balancing act.

    Therefore, it’s important that we examine each situation carefully, apply the appropriate measure of risk based on our company’s level of risk tolerance and provide our recommendations and caveats.

    Nice post, Mark!

    • Excellent advice to HR, Beth. You put it perfectly as being a balancing act for HR. You also reminded us of how CEOs and other senior managers can intentionally put HR and Finance in the position of appearing as the roadblocks to risk while they can appear as the risk-takers. Thanks!

  3. […] HR has a great opportunity to improve the way risk impacts strategic success for the business with HR: Why Broaden Your Risk Perceptive?.   They also add their support for the American Cancer […]

  4. […] HR: Why Broaden Your Risk Perspective? […]

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