Why managing risk is the noblest science in business
02 January 2015 -
The problem with risk is that most people don’t understand it enough to have sufficient respect for it, writes a leading expert
Professor Ian Reeves CBE
I remember the call coming at the end of the day. “Congratulations on winning the M40,” said the dry voice down the line. “Is your chief estimator there?” “No, he’s away from his desk.” “Well, when he comes back, ask him if he has found the mistake that has won you the contract!” Our competitor hung up.
In those days, the chief estimators of all the major contracting firms would ring each other with such messages, and this giant government contract to build a large section of the new motorway between London and Birmingham was no different. The call was chilling. I knew in my heart that our rival was going to be right. “Okay,” I said. “No one is going home until we work out our mistake.”
Our competitor was quite right – it turned out with the M40 job we’d miscalculated how much the capping on the road would compact, so had underestimated the amount of materials we would need. Pricing construction work was – and is – a big part of business success. And a major element of the construction estimating process is the key ability to calculate risk.
One of the best pieces of advice I was ever given was that there is no such thing as a simple profit. What you are charging the client is a margin to cover a premium for the risks being taken and a yield on the capital employed. Risk calculation is a noble science, a crucial branch of applied experience and mathematics that is undervalued – and widely misunderstood – by most of today’s leaders. Too few managers routinely identify and quantify risk, never mind handle it. The banking crash is evidence of this, as are many other capital project and corporate failures.
So what to do? The first key stage is risk identification – and the one that many managers miss, usually by not challenging optimistic assumptions. Much of what we assume or are told to be correct turns out to be wrong. My approach to any investment project is to spend a great deal of time and energy in the formative stages probing and testing each of the assumptions and items in the risk register.
Is the client creating an environment to enable success? I research the potential client, meet them and talk to them. I look for signs. Are they honourable? Do they have the financial and management resources to undertake the project? Do they themselves grasp the mathematics and the risks of the project that they are proposing? Will the people in their team have the necessary skills and experience to enable the scheme’s success? I’d go into as much detail as possible, assuming nothing. Information is at the heart of successful risk calculation.
The second step is to take counsel from others. Few project leaders are best placed to know every facet of the programme. I once witnessed the grand demise of a chief executive who listened but did not hear. His team had diagnosed the situation correctly, they had furnished him with the clues, but he did not allow his brain to accommodate them. His lack of emotional intelligence was his undoing. It is impossible to calculate risk and to develop a strategy for managing the risks without being abreast of the facts, and the operational and economic dynamics and priorities.
Few risks occur in isolation. Major capital project and business failures usually result from the cumulative impact of many risks occurring simultaneously or at least in close succession. The number, nature, sequence and timing of events will change the scale and volatility of the risks being quantified.
Even with the facts at our disposal, and a real understanding of the project’s environment, we will sometimes make mistakes. Yet the key with mistakes is to learn from them and never make the same ones twice. Risk, like stone or tarmac when building a motorway, is a commodity that has to be identified, quantified and managed. Leaders, who will not, or cannot, do this, are on a road to failure.
Professor Ian Reeves CBE CCMI FCInstCES FRSA is senior partner at Synaps Partners LLP. He is visiting professor of infrastructure investment and construction at Manchester Business School, University of Manchester.
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