Risk, uncertainty and strategy

Dr. Unang Mulkhan

Categories of risks facing organizations
Risk Category Examples Endogenous/exogenous to the
organization
Strategy Changing patterns of demand Mostly exogenous
Competitor actions Mostly exogenous
Changing markets Mostly exogenous
Business/government relationship Endogenous and exogenous
New disruptive technologies introduced Exogenous
Operations Manufacturing/process system Endogenous
Financial/accounting controls Endogenous
Regulators Exogenous
Economic Poor cash flow Mostly exogenous
Changes in interest rates Exogenous
Currency exchange Exogenous
Poor credit Endogenous and exogenous
Hazards Natural disasters such as earthquakes or Exogenous
volcanoes
Terrorist attacks Exogenous
Criminal activity Endogenous and exogenous
IT Failure Exogenous
Organizational Characteristics
risk factors

Complex- simple Complexity corresponds to industry size as well as the number and
environment heterogeneity of competitors. Simple environments, such as oligopolies, have
institutional rules of behaviour. Is likely to lead to blind spots, making it
difficult for organizations to calculate risk or prepare for the responses of
rivals since not all are understood or even known.

Scarcity – Munificence refers to the abundance of resources, which include human,

munificence financial and capital. Abundance provides a context in which greater risk can
be tolerated more easily. For example, mergers are tolerated to a greater
extent in periods of growth rather than periods of economic closure. The
reverse is true of scarcity, when firms face less risk as they all look inward to
tighten controls and to reduce costs.

Dynamism Dynamism refers to the stochastic characteristics of the environment. These

include, for example, discontinuities caused by the introduction of new
technologies or novel products from competitor organizations.
Managerial risk Characteristics

z
Aspirations and Aspirations are used to judge the quality of actual performance. Expectations indicate the level of anticipated
expectations future performance. Higher aspirations induce higher risks. Higher expectations mean better performance is
more likely and this will induce lower of risk taking. The framing of a situation as either a gain or a loss may also
influence propensity to take risk. For example, when managers/ decision makers are faced with the likelihood of
failing to meet their objectives, they are likely to accept greater levels of risk in order to try to reach their
objectives and to avoid losses. When managers/decision makers are faced with the likelihood that they will
achieve objectives, they are likely to favour safer options and avoid risk.
Top-team High levels of heterogeneity in top teams are likely to promote greater risk taking. Managers with varied
characteristics backgrounds (educational, international, other companies) will bring different perspectives and interpretive
schema to bear upon decisions. Such groups are more likely to consider and take action on more risky, uncertain
and non-routine decisions. High levels of homogeneity will induce a greater tendency to preserve the status quo
and only take action on less risky decisions.
z Managers/decision makers who do not hold an equity stake in their organizations are less likely to take risky
decisions than managers/decision makers who do hold a stake. Equity ownership prompts owner-managers to
make decisions which are in line with sharehoider goals through carefully calculated risk taking. Other things
being equal, equity ownership mitigates the risk aversion of managers who hold risk-neutral preferences held by
diversified shareholders. Non-owner-managers may feel that taking risks puts their employment at risk, because
gambles which do not succeed can result in them being fired or, in the extreme, firm bankruptcy. They also have
a less strong interest in the outcomes of successful risky decisions.
Slack Slack means an organization has spare resources which can buffer it against fluctuations in environmental
conditions. It acts to absorb shocks which could otherwise harm performance. Slack allows managers/decision
makers to avoid risky decisions and major strategic changes. Low levels of slack induce more risky decisions. This
'hunger-driven' view of risk taking is shared by some authors and not by others. For example, Wiseman and
Bromiley (1996) provide evidence that supports the argument. On the other hand, Singh (1986) found a positive
relationship between slack and risk taking by managers. Firms do not necessarily have to be hungry for
managers to take risks in this perspective. palmer and Wiseman (1999), however, found evidence in favour of
the hunger-driven view of risk taking, showing that organizations which have greater levels of slack take fewer
risks
Environmental uncertainties Industry uncertainties Firm uncertainties
Political Input market Operating
War Quality uncertainty Labour unvertainties
Revolution Shifts in market supply Labour unrest
Coup detat Changes in quantity used Employee safety
Other political turmoil Input suppy
Raw materials shortages

Governmental policy Product/market

Fiscal and monetary Quality changes
Price controls Changes in consumer tastes
Trade restrictions Spare parts restrictions
Nationalization Availability of substitutes
Government regulation Production uncertainties
Barriers to earnings Scarcity of complementary goods
Inadequate provision of public services Machine failure
Repatriation

Macroeconomic Competitive Liability

Inflation Rivalry among competition Product liability
Changes in relative price New entrants Emission of pollutants
Exchange rates Technological uncertainty
Foreign exchange rates Innovation
Interest rates

R&D Credit
Terms of trade Problems with collectibles
Uncertain results of R&D

Social
Social unrest
Riots
Changing social concerns
Demonstrations
Small-scale terrorist movements

Natural uncertainties
Variations in rainfall
Hurricanes
Earthquakes
Other natural disasters
 Summary
All organizations and all managers face uncertainties. The effects are to increase the degree of risk faced by
strategic decision makers. Most techniques of strategic decision making under uncer tainty (e.g. tisk analyses)
assume that the returns from a decision are arranged on a probability distribution conditional on the choices
made. In general, decision makers are assumed to have a preference for alternatives which have higher
expected values, but at the same time, they consider the riskiness of other alternatives. Decision makers seek
an appropriate trade-off between risk (variance) and return (expected value)
Risk itself is a variable concept. In the consideration of alternatives, risk taking is correlated to the risk takers
changing fortunes (March and Shapira, 1999). For example, if risk is perceived to be life-threatening, then
individuals, it seems, will either take highly risky decisions or will be traumatized to take very risk-averse
decisions and play safe. We currently know these are the polarized choices decision makers may take, but we
do not yet know enough to predict when and under what circumstances they will opt for high risk or will play
safe.
Higher levels of organizational slack seem to encourage experimentation and innovation and encourage risk
taking (probably because of a relaxation of controls). Lower levels of organizational slack (or when slack
becomes negative) mean tighter controls, and efforts to improve efficiencies and procedures encourage lower
levels of risk taking, Decision makers’ aspiration levels are also not fixed. Over time they will vary, often
considerably, and therefore the degree of perceived risk will vary depending on where the aspiration level is
fixed. This is because risk-averse behaviour will be defined as being below the aspiration threshold and risky
behaviour will be defined as being above it. Equally, individuals’ self-confidence changes over time. Past
successes can breed confidence and sometimes overconfidence) in taking risky decisions. Overconfidence can
occur when decision makers wrongly assume they were wholly responsible for past successes (and do not
attribute success to exogenous factors, such as errors by competitors or a munificent macroeconomy where
resources are easily available).
Risk itself is subject to varying interpretations and definitions. Risk can be viewed as
something totally exogenous to organizations and therefore out of managers’ control. Equally,
risk can be seen as wholly endogenous. Even seemingly external events and threats (such as
terrorist attacks) can be attributed ultimately to the actions, or inactions, of individuals and
groups. From this perspective, all risk is argued to be ultimately man-made. Typically, decision
makers will face some level of uncertainty between these polarized views. There will always
be earthquakes, flooding and volcanoes and there will always be man-made disasters. A key
question for strategists is how to manage risk and how to craft strategic decisions in the face
of risk Stulz (2007) argues that risk managers routinely make six fundamental mistakes:

1.relying on historical data:

2.focusing on narrow measures,
3.overlook knowable risks:
4.overlooking concentrated risks;
5.failing to communicate:
6.not managing in real time.
Many empirical models of risk have been developed and some of the main
ones have been mentioned in this chapter. The limitation of all these
approaches is that they are essentially short to medium term in their time
horizons. In order to build in a longer-term time dynamic, scenario analysis
can be beneficial to strategists, enabling them to plan future decisions based
on a contingent view of what a plausible future (or set of futures) may be.
This chapter has described in some detail one way of dealing with scenarios,
both to develop strategies and to help make decisions in the face of
uncertainties. Finally, the chapter returns to the level of analysis of the
organization, since the ability to implement such strategies depends very
much on the capacities and capabilities built into the organization's
infrastructure. In particular, we have highlighted the role of core
competences, effective governance and ensuring the organization can
undertake strategic change and continue to learn. Each of these topics and its
influence on strategy implementation is developed in the following chapters.