The New Face of Enterprise Risk

Article excerpt

The old model of basing corporate strength on industrial might and production capacity is becoming a thing of the past.

In the last three years, managing threats has become at least as important as managing investment opportunities for most companies. The collapse of the new economy, corporate governance failures, terrorist attacks and a series of costly natural disasters are all high-profile events that have focused senior management's attention on risk mitigation. Enterprise value is usually not destroyed through these kind of spectacular events, however, but through more mundane, more common organizational risks.

The last ice age favored big animals with large weight-to-surface area ratios. As things warmed up, however, these big creatures became easy prey for the smaller, faster-moving carnivores of the open field. Many firms find themselves in a similar transition today, from managing stable, fixed-asset businesses to more fluid, knowledge-based organizations that bring their own set of dynamic risks.

The industrial revolution was the age of big capital, in which the most productive resources were efficient factories that used technical breakthroughs, new sources of energy and abundant, cheap labor to take advantage of growing consumer markets. Scale and competitive advantage were integrally linked by cost advantage, thus motivating ever larger and more specialized production facilities. These industrial platforms were not economically nimble, however, and were sensitive to demand fluctuations. Profits quickly evaporated when revenues dropped, since costs were largely fixed. Like receding glacial ice, however, these types of industrial risks have quietly shifted. Only 15 to 20 percent of employees produce goods in the industrialized world, and the remaining capital asset risks of most companies have been transferred through lease arrangements, securitization and interest hedges.

Creative, intelligent, team-oriented people are now the critical resources that generate wealth and risk today. An organization's "cultural platform" has replaced the capital platform as that which drives profits and determines success or failure in business. Or, according to renowned management theorist and business writer Peter Drucker, "Knowledge has become the central economic resource. The systematic acquisition of knowledge has replaced experience as the foundation for productive capacity and performance."

Hard facts support Drucker's assertion. Nearly 75 percent of the Dow 30's value is now in intangible, people-based "assets" including knowledge, business processes and intellectual property that is not yet adequately reflected in financial statements. Various studies from consulting firms such as Marsh show that the leading causes of collapsing shareholder value, whether externally or internally driven, are strategic and operational in nature. Analyzing these findings in more detail, one finds that most collapses are directly or indirectly the result of human resource failures. Managing personnel risks therefore demands top management's utmost attention.

The value of harnessing the power of an organization's intellectual capital is many orders of magnitude greater than the incremental productivity gains from process improvements during the industrialist era. 3M's legendary success with the chance invention of the Post-it note, and Microsoft's Windows computer operating system monopoly are just two examples of the value growth potential of well-managed knowledge organizations.

A New Breed of Risk

Corporate cultures are slow to change following 250 years of successful industrialist tradition. Only now are they realizing the risk management implications of the knowledge organization. The key concern is whether corporate leaders recognize the growing importance of such people-related risks and what steps are being taken to mitigate them.

Personnel risks can be broadly divided into a few categories. …