ACCT5919 -
Business Risk
Management
Lecture 3 – Aligning Strategy and Risk
What is Strategy?
Strategy can be defined as a high-level plan or approach formulated to achieve specific
objectives or goals. It involves making deliberate choices and decisions regarding
resource allocation, competitive positioning, and actions to effectively navigate an
organisation or individual towards a desired outcome.
Strategy encompasses a range of activities, including analysing the internal and external
environment, setting goals, formulating plans, implementing actions, and evaluating
results, all aimed at gaining a competitive advantage and maximising long-term success.
Why is Strategy Important?
1. Direction and Focus: Strategy provides a clear direction and purpose for an
organisation. It helps align efforts, resources, and activities towards common goals,
ensuring that everyone is working towards a shared vision.
2. Competitive Advantage: A well-defined strategy enables organisations to differentiate
themselves from competitors and gain a competitive advantage. It helps identify unique
value propositions, market positioning, and distinctive capabilities that set them apart.
3. Resource Allocation: Strategy guides the allocation of resources, including financial,
human, and technological resources. It ensures that resources are invested in the most
effective and efficient manner to achieve desired outcomes.
4. Adaptability: Strategy allows organisations to anticipate and adapt to changes in the
business environment. By continuously assessing and adjusting their strategies,
organisations can respond to evolving market conditions, customer needs, and
technological advancements.
.
The Strategic Environment
FIRM
CAPABILITIES
• Political/ legal
• Economic
• Social
• Technological
• Environmental
• Vision
• Mission
• Values
• Culture
• Goals
• Markets and
channels
• Customers
• Competitors
• Suppliers
• Assets and
resources
• People and
management
• Systems and
processes
• Capabilities
Strategy
COMPETITIVE
ENVIRONMENT
PURPOSE
GENERAL
ENVIRONMENT
External
Environment
Internal
Environment
Source : G Kiel 2015 Directors at Work: A Practical
Guide for Boards
The Strategy Process
The strategy process typically involves several steps:
1. Environmental Analysis: Assessing the internal and external environment to
understand opportunities, threats, strengths, and weaknesses. This includes analysing
market trends, competitors, customer preferences, and the organisation's capabilities.
2. Goal Setting: Defining clear, measurable, and achievable goals that align with the
organisation's vision and mission. Goals should be specific, time-bound, and relevant
to the overall strategy.
3. Strategy Formulation: Developing a strategic plan based on the analysis and goals.
This includes identifying strategic options, evaluating alternatives, and selecting the
most appropriate strategies to pursue.
The Strategy Process (Cont.)
4. Implementation: Translating the strategic plan into action by allocating resources,
assigning responsibilities, and setting performance targets. This involves developing
action plans, establishing key performance indicators, and monitoring progress.
5. Evaluation and Control: Continuously monitoring and evaluating the effectiveness of
the strategy. This involves tracking performance, gathering feedback, and making
necessary adjustments to ensure the strategy remains relevant and effective.
.
The Strategy Landscape
Source Why Do So Many Strategies Fail? - Leaders focus on the
parts rather than the whole. by David J. Collis
Harvard Business Review (July–August 2021)
Strategy Tools - SWOT
Strategy Tools - PESTLE
Theory - Courtney’s Strategy and
Uncertainty
Courtney Strategy is a strategic approach proposed by Charles Courtney that focuses on
decision-making under conditions of high uncertainty. It recognises that traditional strategic
planning methods may not be effective in situations where the future is unpredictable and
volatile.
Courtney’s Strategy emphasizes adaptability, learning, and flexibility in response to
changing circumstances. It suggests that instead of trying to predict and control the future,
organisations should focus on building resilience and agility to thrive in uncertain
environments.
Underestimating uncertainty can lead to implementing the wrong strategies. According to
research by the Harvard Business Review (1997) at least half of all strategy problems fall
into levels 2 or 3, while most of the rest are generally level 1 problems. The level of
uncertainty can have a profound impact on the success of a strategy.
Effectively dealing with uncertainty is an important determinant of the success of a
strategy. This is the fundamental premise of Courtney’s analysis.
Courtney’s Strategy and Uncertainty
(Cont.)
Key principles of Courtney’s Strategy include:
1. Probe-Sense-Respond: Instead of relying on rigid plans, organisations should take a
more iterative and experimental approach. They should conduct small-scale probes or
experiments to gather data and insights, sense the implications and patterns that
emerge, and respond by adjusting strategies and actions accordingly.
2. Options Thinking: Emphasizes creating a range of strategic options rather than
committing to a single course of action. This approach allows for flexibility and the
ability to capitalise on opportunities or adapt to changing conditions.
3. Strategic Resilience: Organisations should build resilience by developing the
capability to quickly detect and respond to signals of change. This involves
continuously scanning the environment, engaging in scenario planning, and being
prepared to adjust strategies as needed.
Courtney’s Strategy and Uncertainty
(Cont.)
4. Learning Orientation: Encourages a culture of learning and experimentation.
Organisations should embrace failures as opportunities for learning and adjust
strategies based on new insights and feedback.
5. Distributed Decision-Making: Recognises that decision-making should not be
concentrated solely at the top of the hierarchy. Instead, decision-making authority
should be distributed across the organisation to leverage diverse perspectives and
promote agility.
Courtney Strategy acknowledges that uncertainty is inherent in complex and dynamic
environments. By embracing adaptability, continuous learning, and strategic flexibility,
organisations can position themselves to navigate uncertainty more effectively and seize
opportunities as they arise.
Courtney’s Four Levels of
Uncertainty
Level 1: A Clear-Enough Future
At level 1, managers can develop a single forecast of the future that is precise enough for
strategy development. Although it can’t be 100% accurate because all business
environments are inherently uncertain, however, the forecast will be sufficiently narrow to
point to a single strategic direction. In other words, at level 1, the residual uncertainty is
irrelevant to making strategic decisions. Example - aviation.
Courtney’s Four Levels of
Uncertainty (Cont.)
Level 2: Alternate Futures
At level 2, the future can be described as one of a few alternate outcomes or discrete
scenarios. Analysis cannot identify which outcome will occur, although it may help
establish probabilities. Most important, some, if not all, elements of the strategy would
change if the outcome were predictable.
Many businesses facing competition, and major regulatory or legislative change confront
level 2 uncertainty.
Courtney’s Four Levels of
Uncertainty (Cont.)
Level 3: A Range of Futures
At level 3, a range of potential futures can be identified. That range is defined by a limited
number of key variables, but the actual outcome may lie anywhere along a continuum
bounded by that range. There are no natural discrete scenarios. As in level 2, some, and
possibly all, elements of the strategy would change if the outcome were predictable.
Companies in emerging industries, facing technological disruption, or entering new
geographic markets often face level 3 uncertainty.
Courtney’s Four Levels of
Uncertainty (Cont.)
Level 4: True Ambiguity
At level 4, multiple dimensions of uncertainty interact to create an environment that is
virtually impossible to predict. Unlike in level 3 situations, the range of potential outcomes
cannot be identified, let alone scenarios within that range. It might not even be possible to
identify, much less predict, all the relevant variables that will define the future.
Level 4 situations are quite rare, and they tend to migrate toward one of the other levels
over time.
Theory – Luehrman’s Real Options
Analysis (ROA)
Luehrman Real Options Analysis (ROA), named after Tim Luehrman, is an analytical
framework used in capital budgeting and investment analysis to evaluate projects that have
significant uncertainty or flexibility. Traditional capital budgeting techniques, such as
discounted cash flow (DCF) analysis, assume that investment decisions are irreversible and
projects are evaluated based solely on their expected cash flows.
However, in real-world scenarios, managers often have the ability to make strategic choices
or have flexibility in adapting to changing market conditions. ROA attempts to capture this
flexibility by treating investment projects as a series of options that can be exercised or
abandoned based on future events and new information.
Theory – Luehrman’s Real Options
Analysis (ROA) (Cont.)
The key concept behind real options analysis is that certain project characteristics resemble
financial options, such as the option to expand, delay, defer, switch, or abandon an
investment. By considering these options explicitly, managers can make more informed
investment decisions and capture the additional value created by having the ability to react
to changing circumstances.
Theory – Luehrman’s Real Options
Analysis (ROA) (Cont.)
Luehrman uses two metrics to measure options and plot them comparatively on a
rectangular field he calls an “Option Space”. The metrics are:
Value-to-cost metric – the value of the underlying assets we intend to build or acquire
divided by the present value of the expenditure required to build or buy them. This is the
horizontal axis.
If the value-to-cost ratio is between zero and one, it means the cost of this option is more
than the value we will generate from it.
If the value-to-cost ratio is greater than one, it means the value generated is greater than
the cost.
Volatility metric – measures how much things can change before an investment decision
must finally be made. This is the vertical axis.
Theory – Luehrman’s Real Options
Analysis (ROA) (Cont.)
Luehrman likens his “Option Space” to a tomato garden; the thought being that in a tomato
garden not all the tomatoes are ripe at the same time, some are ready to pick right now,
some are rotten and should be discarded, and some with the proper attention will be ready
to harvest at a later date.
The same holds true for evaluating your investments. In traditional evaluation of
investments, the decision has been limited to yes/no “ripe or rotten” based solely on net
present value. The argument here is that an investment with a negative net present value
may still be good, but perhaps it’s just not the right time, or you don’t have all the
information you need to make the proper decision. If you can delay until the proper time,
you avoid the possibility of discarding a good investment because of incomplete
information.
Theory – Luehrman’s Real Options
Analysis (ROA) (Cont.)
Aligning Strategy and Risk
Aligning strategy and risk is crucial for effective strategic management. Risk is the
effective of uncertainty on objectives. To align strategy and risk, organisations need to:
1. Identify Risks: Conduct a comprehensive risk assessment to identify potential risks
that may hinder the success of the strategy. This includes both internal and external
risks, such as market volatility, regulatory changes, operational failures, or
cybersecurity threats.
It is critical to understand the organisation’s risk universe
2. Evaluate Risk Impact: Assess the potential impact of each identified risk on the
organisation's strategic objectives. This helps prioritise risks and allocate resources
accordingly.
Aligning Strategy and Risk
(Cont.) – Risk Universe
External
Factors
Internal
FactorsBrand /
Reputation
StrategicFinancial
Operational
Legal /
Regulatory
Cashflow
management
Funding
Exchange
Rates
Financial
Management
Legislation
Safety Ethics
Environmenta
l
Cyber
Geopolitical
Contractual
Stakeholders Government
Policy and
priorities
Span of
control
Sustainability
/Resilience
Competition
Macroeconomic
Conditions
People and
Culture
Operating
ModelTechnology
Business
Disruption
Performance
Management
/ Delivery
Asset
Management
Aligning Strategy and Risk (Cont.)
3. Risk Mitigation: Develop strategies and action plans to mitigate or manage identified
risks. This may involve implementing risk controls, developing contingency plans, or
diversifying business operations to reduce exposure to specific risks.
4. Risk Monitoring: Continuously monitor and reassess risks throughout the
implementation of the strategy. This ensures that any emerging risks are promptly
identified and addressed.
.
Risk Appetite and Risk Tolerance
Risk appetite refers to the amount and type of risk an organisation is willing to accept in
pursuit of its strategic objectives. It reflects the organisation's risk tolerance and
willingness to take risks. Risk appetite influences the selection of strategic initiatives,
resource allocation decisions, and risk management strategies. A well-defined risk appetite
statement helps guide decision-making by providing a framework for evaluating and
balancing risks and rewards.
RISK APPETITE
The amount of risk exposure
the organisation is willing to
pursue to meet its goals.
RISK TOLERANCE
Organisation’s readiness,
after risk treatment, to lose
what it already has to
achieve its objectives.
An organisation’s risk
appetite
is ultimately revealed by
its major decisions.
Different Risks – Different Appetite
Source Slywotzky, 2004
Hazard
risk
Financial
risk
Operating
risk
Organisational
risk
Strategic
risk
• Asset management
• Safety
• Environmental
• Regulatory
• Currency
• Interest rate
• Commodity prices
• Credit
• Fraud
• Inventory
• Supply chain
• Production system
• Information
systems
• Governance performance
• Organisation structure
• Talent / morale
• M&A integration
• Technology
• Brand erosion/
collapse
• Disruptive
competitor
• Industry economics
collapse
• Customer shift
• New project/
investment
• Stagnation
• Obsolete business
model
Decreasing quantifiability
Strategy and Risk Appetite
Aligning strategy and risk appetite involves ensuring that the organisation's strategic
objectives and the level of risk it is willing to accept are in harmony. Here are some steps
to achieve alignment:
1. Define Risk Appetite: Start by clearly defining the organisation's risk appetite. This
involves establishing the level of risk the organisation is willing to take in pursuit of its
objectives. Risk appetite should consider factors such as the organisation's risk
tolerance, desired return on investment, industry norms, and regulatory requirements.
2. Link Risk and Strategy: Evaluate the potential risks associated with the
organisation's strategic initiatives. Assess how these risks align with the defined risk
appetite. Determine if the organisation's risk tolerance allows for the level of risk
inherent in the chosen strategies. Consider both upside risks (opportunities) and
downside risks (threats) when linking risk and strategy.
Strategy and Risk Appetite (Cont.)
3. Risk Assessment: Conduct a comprehensive risk assessment to identify and
analyse potential risks that may affect the achievement of strategic objectives.
Evaluate the likelihood and impact of each risk and determine if they fall within the
organisation's risk appetite.
4. Risk Mitigation: Develop risk mitigation strategies and action plans to address
identified risks. These strategies should align with the organisation's risk appetite.
Consider implementing risk controls, contingency plans, or diversifying business
operations to manage and reduce exposure to specific risks.
5. Risk Monitoring and Reporting: Establish mechanisms to continuously monitor and
report on risks and their alignment with the organisation's risk appetite. Implement
regular risk assessments and update risk profiles as the business environment
evolves. Ensure that key stakeholders are kept informed about the risks being
undertaken and their alignment with the strategic objectives.
Strategy and Risk Appetite (Cont.)
5. Governance and Decision-Making: Integrate risk management into the
organisation's governance structure and decision-making processes. Ensure that risk
considerations are taken into account when making strategic decisions and that risk
management practices are embedded throughout the organisation.
6. Communication and Training: Foster a culture of risk awareness and understanding
among employees. Clearly communicate the organisation's risk appetite and how it
aligns with the strategic objectives. Provide training and support to help employees
make informed decisions within the defined risk appetite.
Regularly reassess and review the alignment between strategy and risk appetite as the
organisation's objectives and risk landscape evolve. This iterative process ensures that the
organisation maintains a balanced approach to risk-taking while pursuing its strategic
goals.