CHAPTER 1

Strategic Risk Management: Competitive Advantage in an Uncertain World

At 4:19 a.m. on January 18, 1978, the roof of the Hartford Civic Center collapsed under the weight of the previous day’s heavy snowfall. Just a few hours before, more than five thousand fans had cheered as the University of Connecticut Huskies men’s basketball team upset the University of Massachusetts Minutemen, 56–49. By 4 a.m. the building was empty, and luckily no lives were lost.¹

Damage to the property proved substantial, and it took two years to bring the building back on line. The disaster forced the building’s tenants to find new homes. Among the disenfranchised were the World Hockey Association’s New England Whalers, who moved thirty miles north to finish the season in Springfield, Massachusetts. Sadly, on the ice they went from a stellar 26–13–3 record before the relocation to a mediocre 18–18–2 after.² Most season ticket holders remained loyal, but the Whalers’ individual game revenue declined because the Springfield Civic Center seated two thousand fewer fans each night.

The Hartford Civic Center seems like the perfect introduction for a book about strategic risk management. But it’s not. We have a hazard (the snow event), a loss event (the roof collapse), risk transfer (the City of Hartford certainly had insurance on the building), and loss mitigation (the Whalers moved to Springfield). Nonetheless, the collapsed roof represented an operational risk, not a strategic one. Operational risks threaten an organization’s ability to deliver products and services and short-term earnings. Strategic risks, on the other hand, are actions or events, and the uncertainty they generate, that foundationally threaten or enhance a company’s competitive advantage, its pursuit of strategic aspirations, or its viability as a going concern.

Operational risks, like excessive snowfall and the attendant damages, follow a known probability distribution. Storms of varying intensity occur annually, which enables actuaries to estimate the likelihood of excessive snow events and to price hazard coverage accordingly. Likewise, executives can choose from a menu of well-known options to control weather-related risk and to minimize or mitigate its effects. Strategic risks, on the other hand, don’t reduce to a set of probabilistic outcomes; they incorporate and reflect fundamental uncertainty about potential outcomes.

Operational risks create tactical difficulties and financial losses. Strategic risks encompass more than just financial losses, however. These risks put a company’s fundamental competitive advantage and their future viability in play. The events in Hartford impaired the Whalers’ operations and revenue stream but did not affect their strategic advantages. The team survived the 1977–1978 season and finished second in the World Hockey Association playoffs that spring. They returned to Hartford in 1980 and would play another eighteen years as a member of the National Hockey League before moving to North Carolina to become the Hurricanes, where they continue to compete.

Our book makes a simple argument: when executive teams link strategy and its risks, they’ll better create new—and protect existing—business value in an increasingly uncertain world. That value arises from two sources. First, the strategy–risk link invites a systematic, future-focused assessment of threats and opportunities, which we’ll refer to throughout this book as “driving while looking out the front windshield.” Second, that link closes the gap between strategy formulation and its execution as executives focus on who manages strategic risks and how they respond to them.

For one employee of the Whalers, the collapse of the Civic Center roof created strategic risk. Bill Rasmussen had been the Whalers’ director of communication for nearly four years. Rasmussen loved sports, having played baseball at DePauw University and for the U.S. Air Force. He cut his business teeth working in Westinghouse’s advertising department and subsequently founded, grew, and sold his own advertising fulfillment firm. Rasmussen then returned to his first love, but this time in the role of broadcaster and entrepreneur. In one venture, he assembled a mini network of small, rural Massachusetts stations to broadcast University of Massachusetts football and basketball games, doing the play-by-play at night and selling advertising by day. That venture failed, as did others, and Rasmussen eventually landed with the Whalers, in 1974. When the Whalers’ revenues tanked, the team decided that a director of communications was a luxury. The owner fired Bill over the Memorial Day weekend of 1978.³

The forty-five-year-old broadcaster and entrepreneur met with a group that hoped to use the emerging medium of cable TV to broadcast Whalers games, sports news, and other local entertainment to Connecticut households. Rasmussen added to the idea and envisioned a network that would broadcast University of Connecticut men’s basketball games across the state. He, along with his son Scott, named their idea Entertainment and Sports Programming Television, or ESP-TV, and went to work. Rasmussen threw his indomitable energy into the venture, and it would have been hard to find anyone with a stronger résumé in entrepreneurial, small-market sports broadcasting.

With Rasmussen’s connections to Connecticut’s sports community, from the Whalers and the University of Connecticut Huskies to the smaller colleges and minor leagues sprinkled throughout the Constitution State, finding programming content appeared doable. The real challenge lay in distribution. Rasmussen’s original plan called for ESP-TV to produce five hours of programming each night. Using satellite transmission, a new technology, the company would beam content to local providers, who would then send it over coaxial cable to subscribers’ homes. But when Bill and Scott sat down with Al Parinello, the RCA sales executive in charge of selling satellite transponder time, their plans changed.

RCA priced its transponders to encourage continuous transmission, to prove the value of the nascent model and recover the sunk cost of their satellite. Parinello laid out the pricing model: ESP-TV could pay $250 per hour for five hours of transmission each night, or $38,750 per month. Alternately, it could pay $48 an hour, or $35,712 per month, for continuous, 24/7 transmission.⁴ Bill recognized a good deal when he saw one. ESP-TV mushroomed from a small venture serving a few thousand Connecticut Yankees into a nationwide sports network.

ESP-TV exemplifies our notion of strategic risk, in that it was a de novo venture full of opportunity, threat, and uncertainty. Uncertainty on the demand side arose because ESP-TV represented a radical new, untried product. National sports programming consisted of a few hours of live events on Saturday and Sunday afternoons, and a rare weekday game. By 1979, the Big Three broadcast networks (ABC, CBS, and NBC) aired 1,356 hours of sports programming. While that sounds like a lot, it worked out to a little over eight hours per week for each network.⁵ Local sports programming might include local event broadcasts, but the bulk came in two to three minutes of sports segments during the nightly news. ESP-TV would offer 168 hours per week, seven times the combined networks’ current coverage. No one could estimate how many viewers would watch sports all day, every day—or even for part of a day that wasn’t a weekend.

Could two thousand or so fragmented—and primarily rural—cable companies attract enough viewers each day, week, and month to make ESP-TV attractive to sponsors? Advertisers paid good money for slots on major network broadcasts because the scarcity and elite matchups that characterized sports programming guaranteed millions of eyeballs in the prime eighteen-to-forty-nine age demographic. But all sports, all the time? Such an extreme level of programming had never been offered, and demand was completely uncertain.

On the supply side, ESP-TV faced similar strategic uncertainty. How would they fill 168 hours each week? How would they pay for that much content? The Big Three spent almost a billion dollars for broadcast rights, spread across college sports, which was controlled through the monopolist National Collegiate Athletic Association, and every major professional league: the National Football League, Major League Baseball, the National Basketball Association, the Professional Golfers’ Association, and even the Professional Bowlers Association. Despite all this available content, though, each network only broadcast eight hours each week, and scarcity translated into huge profits for the sports divisions. ESP-TV needed to fill seven times that much time with whatever scraps the major networks let fall from their table. Also, ESP-TV, with hardly any cash on hand, had to pay as little as possible. If ESP-TV couldn’t fill the time, the consequences were obvious and dire: no viewers, no advertisers, and the venture would die a quick and unremarkable death.

Round-the-clock programming represented substantial downside strategic risk, but with huge upside potential competitive advantage. If ESP-TV could fill those hours, attract viewers, and garner advertising dollars, it would become the only network of its kind. More importantly, they had a product that, from the perspective of the Big Three, couldn’t be replicated. For the networks, sports telecasts represented a very profitable side business, but only a side business. Sports could never dominate the schedule, since the networks had too many audiences—men, women, and children— who enjoyed other types of programming. The Big Three would always fill their days with soap operas, serials, newscasts, and movies, and to do otherwise would alienate core audiences and advertisers. Practically speaking, 24/7 sports programming represented economic suicide for the Big Three.

Rasmussen had almost no control over viewer behaviors, but a lot of control over content. By the summer of 1979, he and son Scott had secured a contract with the NCAA to broadcast “nonpremier” sporting events, the scraps the networks didn’t want. They also negotiated an initial advertising agreement with Budweiser and garnered a $10 million investment from an unlikely source, Getty Oil. Getty had found itself awash in cash after the oil price hikes of the late 1970s, and Getty vice president Stuart Evey, a huge sports fan and future-focused investor, saw the seed of competitive advantage in ESP-TV.⁶ Rechristened ESPN, the venture prepared to debut on air with its own in-house sports report: SportsCenter.

SportsCenter cost only a fraction of what was required to produce a live sporting event. Production costs were also kept to a minimum by using a permanent set and a single camera, or two at the most. A skeleton crew of anchors, a director, camera operators, and a few production assistants were hired. ESPN paid only production costs, without the rights fee it paid to broadcast sporting events. If SportsCenter cost little to produce, it cost almost nothing to reproduce. For the cost of a few videotapes and an operator, ESPN could rerun the original broadcast to fill dead spaces throughout the day.

SportsCenter launched on Saturday, September 7, 1979. Longtime broadcaster and ESPN new hire Lee Leonard proclaimed salvation to starved fans everywhere with his opening line: “If you’re a fan, if you’re a fan, what you’ll see in the next minutes, hours, and days to follow may convince you you’ve gone to sports heaven.” He then anointed tiny Bristol, Connecticut, home of the fledgling network, the center of the sporting universe.⁷

Leonard’s opening words proved prophetic on both counts. ESPN struggled to find its foothold, but as the years went by, millions of American sports fans tuned in to SportsCenter, often multiple times each day, to get their piece of sports heaven. Tiny Bristol became the center of the sports universe, ESPN grew into one of the most valuable brands in entertainment, and the network generated profits that eventually made it the crown jewel of the Walt Disney Company, its corporate parent.⁸

A New Age: VUCA and a World of Strategic Risk

The launch of ESPN illustrates what we mean by strategic risk. Television broadcasting had been a bucolic business in the three decades since the advent of the medium in the early 1940s. NBC and CBS began as national radio networks in the 1920s and had successfully incorporated the new technology into their existing business model. ABC got its start when the U.S. government required NBC to spin off some of its radio holdings in the 1940s. Networks enjoyed the protection of the Federal Communications Commission, which limited the number of stations in each market and the overall number of broadcast frequencies in exchange for the networks providing free programming, news reporting, and other services to the entire nation. In 1976, 78.2 million people, or 92% of the viewing public, tuned in to the Big Three for their evening entertainment.⁹

The year 1976 also marked the beginning of the industry’s transition from idyllically calm to hellishly turbulent. The cause was technological and regulatory changes in the early 1970s that allowed two additional broadcast platforms, cable and satellite, to flourish and prosper.¹⁰ The industry in short order exemplified what staff at the U.S. Army War College would later term VUCA—volatile, uncertain, complex, and ambiguous. In just under a decade, the Big Three saw its share of viewers fall to 75%, and then to just 50% by the early 1990s. Bruce Springsteen memorialized the chaos in his classic 1992 song “57 Channels (and Nothin’ On).”

Today, every business in every industry faces a rapidly accelerating VUCA world, and the trend line indicates more of this, rather than less, in the future. Technological advances alone account for increasing amounts of VUCA and are responsible for waves of disruptive innovation confronting executives. At one end of the scale is escalating VUCA wrought by global conditions, such as geopolitical instability, interconnected financial markets, regulatory responses to the climate change debate, and renegotiated international trade agreements. At the other end are microeconomic considerations of equal intensity: more sophisticated and nontraditional competitors entering markets, big data analytics, and constantly shifting consumer preferences. These elements combine to surround far too many decisions with uncertainty, and ambiguous signals from communities, customers, investors, and suppliers make differentiating signal from noise a difficult ongoing task.

VUCA elements reinforce each other in a virtuous circle/vicious cycle sort of way. For example, the actions of more competitors lead to more volatile outcomes, and so on. Volatility, complexity, and ambiguity—as well as the underlying actions and events that engender them—create and magnify uncertainty, or the inability to predict the future with any sense of accuracy. Uncertainty runs the gamut from minor and temporary worries (How will forecasted weather swings impact this season’s deliveries?) to significant concerns (How will tariff and trade wars impact investments in global supply chains?). Uncertainty around these significant concerns gives rise to strategic risk.

Risk Versus Uncertainty

Uncertainty differs from risk, and that difference sets strategic risks apart from the way executives and experts traditionally think about risk. The work of Frank Knight, an early twentieth-century economist at the University of Chicago, helps us understand this crucial difference. Knight pioneered the study of entrepreneurship, one of the riskiest and most rewarding types of business activity. For Knight, the potential entrepreneur faces many potential challenges in setting up shop. Some challenges represent risk, others uncertainty.

Certain challenges involve potential hazards. Will inventory be damaged by flood or fire? What interest rate will I pay to finance that inventory? Others provide opportunities for gain, as in the case of a hard-bid project taking less time to complete than anticipated, the difference creating profit. Knight defined both challenges as risks because the likelihood of the outcomes was volatile, given that interest rates fluctuate and projects run into snags, but they do so in largely predictable ways. Based on past experience, an entrepreneur could calculate the probability of fire or flood, or that work would be done in a compressed time frame. “Risk” means that an event follows a known probability distribution. A wise entrepreneur estimates the likelihood of a risky event and plans accordingly through traditional methods such as insurance or risk mitigation programs.

But entrepreneurs face uncertainty as well as risk. Will the company solve the technical challenges of getting a new product to market? Will customers like it? Will enough of them pay enough to turn a profit? Uncertainties, like risks, exhibit volatility because they have multiple potential outcomes. However, the entrepreneur has no historical data from which to predict the likelihood of any outcome, and the more radical the innovation, the more uncertain the outcome. Uncertain events can’t be estimated from known probability distributions, so the only way to reduce uncertainty is to act and enter the business.

Strategic risks arise from, and center on, uncertainty. A new business will either pay off or not, but because of the unique nature of the situation, neither entrepreneurs nor actuaries can estimate the outcome in advance. Entrepreneurs succeed to the extent that they manage and master uncertainty.

ESPN certainly did so. Bill Rasmussen assumed that viewers had not reached their saturation point for sports, although uncertainty hung over this assumption because no one had ever offered 24/7 programming. ESPN’s team embraced uncertainty, jumped in, and then figured out ways to manage and reduce uncertainty. They did so in a way that created a significant and sustained competitive advantage.

Uncertainty, Competitive Advantage, and Strategy

Put simply, strategic risk concerns strategy. A firm’s strategy is the set of resource allocation decisions that help a firm create and sustain a competitive advantage over its rivals in the pursuit of its strategic ambitions. A firm with a competitive advantage generates more profit that its rivals; captures greater market share; commands greater loyalty and respect from customers, employees, and other stakeholders; or capitalizes on market changes more rapidly. Competitive advantage allows a firm to win. Strategic risks are those that threaten—or amplify—a firm’s competitive advantage over rivals. It turns out that the tool kits available through TRM and ERM prove inadequate to cope with the nature of uncertainty that impacts competitive advantage.

Much has been written about strategy and strategic management. Indeed, a search for book titles containing the words “strategic management” returns more than ten thousand hits on Amazon. For us, winning strategies in a VUCA world come as leaders answer four questions and allocate resources based upon those answers. We’ll briefly describe those questions here, and readers who want a deeper dive will find more in appendix A. Two of the questions focus on the development of strategy, and the other two on its deployment.

The primary question of developing competitive advantage is what unique value will we offer customers? Why will we win? Customers engage products or services because they have work they need to do, or jobs to be done. Competitive advantage accrues to those companies that can help customers do jobs in unique ways through differentiated product features and benefits, or by doing those jobs more cheaply than other options. ESPN focused on helping customers do their “sports entertainment” job. SportsCenter provided a clear answer to ESPN’s unique value question. The show offered viewers quantifiably more sports news—thirty minutes compared to three minutes—and a qualitatively different experience, one that covered a broader range of sports and featured longer pieces with greater depth and insight.

After executives know what their unique value will be, they focus on the next question: How will we create that unique value? Firms create value by configuring their assets (resources) and processes (capabilities) to support activities (such as manufacturing, sales, or service) that deliver that value to customers. Cable TV provided one answer to the question of how ESPN would deliver value, since it defined the distribution channel.

A second answer to that question gets at the core of SportsCenter’s enduring advantage. In the earliest days, when reruns were many and viewers few, the show’s anchors adopted a philosophy of innovation: “No one is watching anyway, so try something new.” SportsCenter developed a culture in which the hosts mattered. They did more than just read the news; they injected commentary, humor, and often satire into the show to make the value of SportsCenter truly unique. Humor contributed greatly to an iconic brand that viewers loved.

The first question about the deployment of a strategy is where will we compete? The traditional answer has been to think in terms of industries or markets, but life in a VUCA world invites another answer: jobs to be done. ESPNs original business plan focused on a narrow market niche (Connecticut sports fans); however, Bill Rasmussen leaped at the opportunity to compete nationally. Over time, ESPN expanded its customer reach into new programming, such as SportsCentury and 30 for 30, a set of documentaries about sports stars, into print media (ESPN Magazine), and even into restaurants (ESPN Zone). Each of these moves deepened competitive advantage as the network helped customers do jobs such as dining out in sports-related ways.

Strategy’s final question—Why can’t competitors imitate or create a substitute for our competitive advantage?—ensures that competitive advantage persists over time. Unique value creates immediate competitive advantage and profits, but when it is easily copied by competitors, unique value transforms into a commodity yielding competitive parity. ESPN enjoyed a durable advantage. It didn’t face serious competition until the Fox Broadcasting Company (another upstart network) founded its own sports network fifteen years later, in 1994. Rasmussen and his successors employed competitive judo against the Big Three; ABC, CBS, and NBC couldn’t match ESPN’s all-sports offering without alienating their core audiences.¹¹ Breadth, depth, and edginess created a powerful connection with viewers of ESPN that other networks, and even Fox, couldn’t match. ESPN was, and for a long time remained, the undisputed leader in sports television.

We live and hope to compete in a VUCA world, where uncertainty abounds. Some of that uncertainty gets at the heart of strategy and competitive advantage, and it can impact, for better or worse, a company’s current answers to strategy’s four questions. Such is the reality of the world we live in. Living in a VUCA world, however, creates a problem for both individuals and organizations, because we all hate uncertainty and do our best to eliminate or avoid it.

An Old Problem: Uncertainty Avoidance and Absorption

Hate is a strong word, and we’re sure that people don’t truly hate uncertainty. We would bet, though, based our own experiences and those of our students, colleagues, and executive clients, that most people strongly dislike uncertainty. When it comes to individual decision making, uncertainty doesn’t mesh well with a seemingly hardwired desire of our brains for solid anchors to our decisions. Individual aversion to uncertainty gets amplified when we come together in an organizational setting. Indeed, the gears of collective decision making grind to a halt when the question “What do we expect to happen?” gets answered with “We don’t know.” We’ll briefly examine the drivers of individual and organizational responses to uncertainty.

Individuals and Uncertainty Avoidance: The Illusion of Certainty

Dislike of uncertainty stems from two of its most prominent features: the lack of predictability and the lack of control it signifies.¹² Both of these create mental stress, which has two effects. First, stress reduces our effectiveness in making decisions. Under conditions of high stress, our cerebral cortex, the seat of rational thought and the part of our brain that makes us different from animals, gives way to the hippocampus and amygdala, the parts of the brain that generate emotion. When stressed, we replace reasoned decision making with fear and aggression.¹³ Most of us realize that these two attitudes don’t lend themselves to good decisions, leading to the second effect: we engage in mental gymnastics to replace real uncertainty with an illusory, yet believable, assertion of certainty. We replace a range of equally likely potential outcomes with a single-point estimate.

Humans employ a powerful tool to craft that estimate: the past. We scan our history for events similar to the current state and its potential futures, and then we invoke the assumption that the past predicts the future. What happened last time becomes our default belief about what will happen this time around.¹⁴ We fail to think critically about the past and gloss over two questions: How similar to the past is the current situation? On what dimensions do the two situations differ? When looking out the front windshield causes too much stress, we look in the rearview mirror in the vain hope that it will illuminate the road ahead.

An example illustrates this behavior and its impact. A few days after the horrific and shocking events of September 11, 2001, one of us visited our aging mother to check in. As you might expect, the conversation turned to the attacks, and mother warned of a country at war and an economy transforming to wartime production, which would include rationing of essential items and the reassignment of people and assets to weapons manufacturing. Mom was seven years old when the bombing of Pearl Harbor took place, in 1941, and the similarities between the two attacks—a surprise attack on U.S. soil and the use of airplanes—fueled her predictions. She failed, in the stress and fear of that intense moment, to identify differences between the two situations. For example, the nation-state of Japan initiated Pearl Harbor, whereas the non-nation-state terrorist group Al Qaeda struck in 2001. Also, note the massive difference in the size and scale of the U.S. economy sixty years after Pearl Harbor. Looking in the rearview mirror encouraged her to make a set of dire predictions, none of which turned out to be correct.¹⁵

When the past generates a false sense of certainty, we eliminate perceived unpredictability, and that gives us the illusion of control. In our example here, our teammate was encouraged to stockpile foods and prepare for a world with limited gasoline, butter, and chocolate. Had he done so, resources would have been allocated around a future that never materialized. He chose not to listen to his mother in this case, and with all due respect, and to eschew actions based on illusory certainty.

Organizations and Uncertainty: Absorption at Every Level

Nobel Laureate Herbert Simon, the 1978 prize winner in Economic Sciences, and his colleague James March thought a lot about how uncertainty impacts organizational, as opposed to individual, decision making. Their research led them to identify a clear pattern they named uncertainty absorption. Uncertainty absorption represents a rational response by those who gather and process information about unfolding events. In this light, they perceive executive decision makers’ aversion to uncertainty and their desire to make decisions based on point forecasts, no matter how tenuous, rather than to consider a wide range of possible and unpredictable outcomes.

Simon and March wrote that “uncertainty absorption takes place when inferences are drawn from a body of evidence and the inferences, instead of the evidence itself, are then communicated.”¹⁶ Decision makers often don’t work with facts or the on-the-ground reality. Instead, they work with the interpretations and inferences made about meaning and trajectory by those gathering and analyzing facts and data. They also don’t usually want to know what might happen, preferring to focus on what someone thinks will happen. This phenomenon takes place at every organizational tier, from the supervisory to the executive. Managers have little desire to tell the boss “I really don’t know.” It makes them sound like they either haven’t done the work to figure out what’s going on or lack the courage to make the tough calls good leaders have to make. In either case, prospects for promotion may in reality sink as the truth of “I don’t know” leaves their lips.

At each step of the managerial hierarchy, inferences and interpretations, the carriers of the illusion of certainty, move future outcomes from possible to plausible to probable. Wide ranges of potential outcomes reduce to point forecasts. Inference and interpretation act as a VUCA-neutralizing agent, scrubbing the following from facts and reality: the volatility and magnitude differences between potential outcomes and the fundamental uncertainty about which outcomes are more likely than others, the complexity of the fundamental interrelatedness among different elements and the nuances that account for specific contexts or admit the fuzzy nature of the facts, and ambiguity, as multiple meanings and interpretations give way to a single narrative.

Organizations, like individuals, invoke the past as a framework to create an illusion of certainty. But organizations, compared to individuals, have more potential pasts to draw on. They might draw on the histories of individual members, the institutional memory of the organization recorded in formal documentation and informal narratives, and the experiences of any number of key stakeholders such as competitors, suppliers, or investors. Analysts and managers get to choose which rearview mirror to look out of as they create the illusion of certainty.

Pressure for certainty, or at least predictability, exists at every level of an organization. It usually increases as information escalates. Senior executives rarely have enough contact with day-to-day markets and operations to see emerging uncertainty, so as this information progresses upward, more and more uncertainty gets absorbed. What began on the sales floor as a range of potential outcomes contingent on multiple factors becomes a neat and tidy point forecast when it arrives at the C-suite. Unfortunately, this dramatically narrowed forecast means that the final decision maker “is severely limited in his [or her] ability to judge [the inferences’ and interpretations’] correctness.”¹⁷ They know neither the facts themselves nor the uncertainty that littered the path as the interpretation moved upward.

Uncertainty absorption has another deadly consequence for organizations, in that it helps to create and perpetuate the gap between strategy and its execution. Successful execution requires that those making strategy and resource allocation decisions have a solid understanding of the on-the-ground reality. However, uncertainty absorption means that strategy gets made by people with a curated version of reality. As executives are further detached from the day-to-day reality, the gap between strategy’s objectives and the actions that realize them becomes wider. Illusions of certainty lead to poor answers to strategy’s four questions and to misguided implementation processes that affect strategic plans, capital and operating budgets, mergers and acquisitions, or hiring and training protocols.

We may not truly hate uncertainty, but we do dislike it and the stress it generates in our own lives. We don’t check that disdain at the office door; we just fold our personal uncertainty avoidance into an elaborate bureaucratic ritual of uncertainty absorption. We hope for stress-free lives of predictability and control; however, the realities of a VUCA world crash that party and leave decision makers in a difficult situation.

The Fundamental Question (and Answer)

Living in a VUCA world is tough, even for those individuals and organizations that manage to thrive in it. Regardless, the tandem processes of uncertainty avoidance and absorption magnify the threats, and dampen the opportunities, of strategic risks to all. Leaders must overcome resistance and learn to accurately assess and manage uncertainty if they hope to survive, let alone thrive, in an uncertain age. This raises the critical question: How can executives and their firms learn to embrace uncertainty? Our answer: by adopting a strategic risk management program.

Strategic risk management is a set of principles, processes, teams, and tools that allow firms to manage strategic risks, which are those uncertainties, events, and exposures that create threats to—or opportunities to expand—their core competitive advantages. First and foremost, SRM embodies an organizational response to uncertainty. The chief risk officer, a position enacted by the Dodd-Frank Act to ensure risk management compliance for large bank holding companies and endorsed by industry standards such as the COSO II framework, leads the SRM team and all other risk functions in the organization. The CRO can’t work in isolation, however. SRM only works when people in all functions at all levels get involved in the process, either providing input about strategic risks or helping to manage them. SRM needs to stand on equal footing with the other critical strategy systems of the firm: budgeting, corporate development, mergers and acquisitions, human capital management, product development, and strategic planning.

The rest of this book outlines how organizational leaders design and implement the principles and processes, staff the teams, and utilize the tools to manage strategic risk. Chapter 2 begins the process by more richly defining what we mean by strategic risk. Before they can be managed, SRM leaders and their teams must understand strategic risks, those critical areas of uncertainty that threaten their firms’ ability to gain and maintain a competitive advantage and that arise from the interaction of three elements: changes in the external or market environment, a firm’s response to those changes, and the development of that change–response relationship over time. Boards, executives, and all organizational leaders need this understanding as well, in order to differentiate strategic risks from the ones they already know about and for which they have oversight responsibility.

Chapter 3 then lays out the fundamental principles that guide SRM. To effectively combine strategy and risk management, boards and executive teams need to adopt, in most cases, a new mental map, which is a set of assumptions, cause-and-effect relationships, and worldviews. These high-level mental maps—we use the metaphor of a thirty thousand–foot perspective—invite leaders to see how SRM complements their existing efforts in risk management and strategy. They also have to see how SRM extends current organizational capabilities related to creativity, environmental scanning, and horizontal and vertical communication within the firm.

Chapter 4 descends to ten thousand feet, where processes guide the daily work of the executive team, including the CRO, CEO, CFO, and chief strategy officer (CSO). Successful SRM programs integrate the work of these executives toward the “strategy complex” of the enterprise. Leaders can’t merely bolt on additional activities called SRM and hope to create long-term value, so we identify the significant touch points where managers can weave the unique threads of SRM into the fabric of the existing strategy architecture. Here is where the link between strategy and risk becomes real and robust.

In chapter 5, we identify the characteristics of the SRM team, a dedicated group, working under the direction of and reporting to the CRO, that coordinates and carries out the work of SRM. These teams systematically search for weak signals in the firm’s market, industry, and broader environment that portend potential strategic risks. As we describe, the team complements their external scanning with rich and frequent interactions with business units or functions potentially impacted by those emerging risks. The team maps those potential strategic risks onto the Strategic Uncertainty Decision Map, a tool unique to our model of SRM. This map gives the SRM team, and the senior leaders to whom they report, a quick and easy way to interpret relevant weak signals and emerging strategic risks.

Chapter 6 provides leaders with more tangible tools to assess and manage emerging strategic risks. We’ll present three tools that, when used in concert, facilitate deep understanding of emerging strategic risks and uncertainties in sensible, action-oriented ways and enable effective management. As risks mature, uncertainty begins to resolve and the nature of the impact becomes more calculable. Scenario planning exercises empower teams to identify potential futures and to outline the general contours of possible outcomes. Scenario plans give decision makers structured space to think expansively about general response strategies, activities that would create value across multiple potential futures.

Wargaming is the second tool in the SRM kit, with the goal of action plan creation targeted at a concrete version of a future scenario. Using stakeholder role-play techniques over several iterations of action–reaction exercises, teams develop a response pattern and observe the consequences of their hypothetical investments for the behavior of others. This type of simulation aids in understanding default mind-sets, fostering trial and error in a low-cost environment.

Our Strategic Risk Ownership Map complements the Strategic Uncertainty Decision Map. As strategic risks evolve, the organization moves from monitor-and-understand mode to manage-and-respond mode. This map identifies which organizational actors have direct responsibility for managing and responding to strategic risks and provides some detail about specific actions and timelines. It offers a snapshot of the internal risk management processes under way at any given point in time, connecting those implementing strategies with those responsible for its formulation. In so doing, we aim to close the strategy–execution gap.

Chapter 7 applies the tools of SRM to an emerging set of strategic risks: the transformational changes taking place in the automobile industry. We focus on three related changes that have the power to fundamentally alter our economic and social lives—the development of autonomous vehicles, the rise of ridesharing as a viable alternative to vehicle ownership, and the shift from petroleum to electricity as a fuel. We consider how these uncertainties create strategic risks for three companies, none of which produce automobiles, and show how the logic and tools of SRM can help them successfully adapt to a radically new world.

There is a hard reality embedded in setting up an effective SRM system: it requires large amounts of time, energy, and human and financial capital. Nonetheless, the potential payoffs far exceed the costs. While establishing an effective system is difficult enough, keeping that system running and contributing to winning strategic outcomes requires sustained effort. Chapter 8 takes on the two biggest obstacles to SRM becoming a meaningful and lasting organizational contributor: culture and communication.

Risk and culture, whether implicitly or explicitly recognized, are inextricably intertwined in organizations. Years of consulting work have shown us that, beyond the processes and committees, cultural attitudes toward risk itself can ultimately make or break an ERM program. Peter Drucker admonished us to remember that “culture eats strategy for breakfast.” It is therefore reasonable to conclude that leaders must weave SRM into the cultural fabric of the organization. Since existing management control processes contribute to circumscribing the full cultural tapestry, this also means interlacing risk considerations directly into those processes. Absent such an assimilation, SRM is destined to have a limited shelf life.

Promoting rigorous and ongoing consideration of uncertainty is a big leap for organizations that normally default to uncertainty absorption habits. Cultures often can impede the serious consideration of strategic risks through a series of cautionary tales and taboos against extolling the potential gains from uncertainty.

Culture also underlies communication, the second important element for creating a truly dynamic system. It instructs workers on what types of information should be shared, and when, and acts as a powerful filter of the flow to senior management. Cultural norms also speak to who should carry messages upward, and they install credibility and legitimacy checks for discerning what’s worth hearing and what’s not. Sustainable SRM programs work within and leverage culture and its norms to embed themselves into the everyday life of the firm. We introduce a final tool, the Risk Reporting Matrix, to frame and guide these efforts.

Chapter 9 presents our concluding thoughts on SRM and the fusion between strategy and risk as we go to press. Much of what we propose is intended to have timeless value. Other elements will serve as timely prompts to move forward and begin the journey to SRM. We have faith that you’ll implement the timely now and find continued value in the timeless.

Conclusion

In the beginning, Bill Rasmussen had no idea whether enough viewers would tune in to make ESPN viable. He felt, along with his investors, that the potential for competitive advantage justified making the attempt. SportsCenter neutralized the greatest strategic risks to the fledgling network through low costs and sufficient programming content to build a solid viewer base. We know now that SportsCenter helped ESPN resolve customer uncertainty in its favor, in a big way. ESPN became the undisputed leader in sports television. We also know, today, that ESPN’s position is anything but secure, due in no small part to the rise of social media and video streaming. Viewers may get for free what they once paid to access. ESPN faces a different set of strategic risks that could undo the network or could open the door to a new level of excellence.

Your company may have much in common with ESPN. You may be, metaphorically, in 1979, looking to neutralize a clear threat to your survival or to capitalize on uncertainty to create a competitive advantage. You may mirror ESPN today and face an emerging set of strategic risks about the viability of your core competitive advantages, brought on by new competitors in the world of online and on-demand media.

Wherever you are, strategic risks abound. We believe that by facing and responding to those risks with the tools we provide in this book, your organization can leverage strategic risks in a way that builds competitive advantage. We’ll begin our study by looking at a company with a long history of facing and mastering strategic risk: the Walt Disney Company.