In today’s innovate-or-die business environment, midsize companies must come to grips with the fact that embarking upon new and less familiar initiatives naturally involves assuming some risk. But how much risk is enough to support innovation, and how much is simply unacceptable?
“Innovation and risk management are not diametrically opposed to one another,” asserts James Lam, president of Boston-based James Lam & Associates and author of Enterprise Risk Management: From Incentives to Controls. “They are actually very complementary.” Here are some key considerations when establishing risk parameters for your company:
Create a statement of risk appetite. A clearly articulated statement of risk appetite communicates to internal and external stakeholders the degree of risk the company is willing to take on in order to maintain innovation.
“Without a clear, company-wide definition of risk appetite, you are left dependent upon the judgment of individuals, some of whom may be highly risk-averse, while others may take on more risk than the company is comfortable absorbing,” Lam says.
Developing risk appetite begins with an understanding of what the business is trying to accomplish strategically, and how much risk it needs to achieve its goals before turning to constraints on that risk. It should be both qualitative – emphasizing core values and strategic goals – and quantitative, establishing the share of capital and earnings available to support that risk.
Encourage smart risk across the enterprise. Your risk appetite statement is an indispensable tool for communicating standards across the organization, but it is just the first step. You also have to translate it to the operational level. Part of this process is simply opening channels of communication so that ideas from every source are captured, shared, and evaluated on a more or less formal basis, and employees are encouraged to identify opportunities for improvement without retribution. But another part is providing distinct guidelines and metrics to support innovation. Lam recommends taking a portfolio approach to innovation, assuming, as do venture capital firms, that a certain percentage of projects or products will fail while maintaining an acceptable return on investment overall.
Limit innovation risk with agile processes. Diversifying your innovation portfolio is one way to limit risk, but at the project level itself, you can take steps to limit potential loss without stifling innovation. In particular, you can employ agile project management, which encourages short bursts of activity that result in operable product features or processes that can be evaluated by stakeholders. At each stage, a decision can be made to move forward as planned, pivot to accommodate needed changes, or abandon a project that doesn’t pan out. “Agile thinking means shortening the time period between seeing failure or success, thereby limiting your exposure as you make decisions for further investment,” Lam explains.
Risk can be a scary concept for established enterprises, which can lead to unproductive risk aversion. But by shining the spotlight on risk and its role in innovation, companies can leverage that risk for maximum rewards.
“Think about a cliff whose edge is maximum risk,” Lam concludes. “If there’s a cloud around that cliff, and you’re a person concerned about safety, you’re not even going to get close to it. Having a clear risk appetite—having good risk management and reporting—is like lifting that cloud. And if you lift the cloud, then the person could go all the way up to the edge to enjoy the scenery and still be safe.”
