Published 21 August 2024 in Governance ⢠6 min read
In todayâs highly interconnected and increasingly complex world, one thing is certain: dealing with uncertainty is a topic boards must tackle head-on.
The tangled web of relationships between nations and economies, growing geopolitical tensions, complex supply chains, and massive technological change are increasing the incidence of âBlack Swanâ events â a term coined by Nassim Nicholas Taleb for low-probability events that catch us off guard and have far-reaching consequences. Think of the global financial crisis or COVID-19. Worryingly, even ordinary events are becoming increasingly challenging to predict and quantify.
Against this backdrop, how can boards effectively govern and cushion their organizations from the far-reaching consequences stemming from risk and uncertainty?
Firstly, itâs important to differentiate between risk and uncertainty.
Risk typically involves known and measurable probabilities. For example, the impact of currency fluctuations on an organizationâs international operations, changing regulatory requirements that could lead to fines, a data breach that compromises sensitive information, equipment failures that disrupt the production processes, or severe weather events that trigger drought or flooding and disrupt operations.
Uncertainty, on the other hand, involves ambiguity, unknown probabilities, and unpredictable outcomes. It is beyond the limits of our knowledge, and past events donât bear any relationship to future shocks. Take, for example, the rapid advancement in new technologies that may render your products or services obsolete, political instability and trade disputes that impact global supply chains and markets, or a social media backlash that damages a companyâs brand and reputation.
Even though we live in a world where we are inundated daily with vast amounts of data and information, itâs important to recognize that there are things we cannot know and understand. While it might be possible to forecast the impact of inflation and interest rate fluctuations on your business, itâs harder to predict when the next financial crisis, natural catastrophe, or political uprising might strike.
This means boards must balance two contradictory trends. On the one hand, ever more sophisticated analytics tools are at their fingertips, raising the expectation that all decisions will be made based on rational, evidence-based justification. Yet, equally, they face a growing number of unpredictable events and challenges, with the outcomes often unknown and seemingly unmanageable.
âBoards should demonstrate strategic foresight by recognizing, assessing, and preparing for future trends to ensure that organizations are not only prepared to face the challenges thrown up by risk and uncertainty but also equipped to capitalize on new opportunities. â
Most major companies have established comprehensive, enterprise-wide risk management frameworks to cushion their organizations. They may even have elevated a Chief Risk Officer to their C-suite to try to control and mitigate risk.
Strategies include diversification, hedging, and using complex mathematical models to manage risks in financial markets. They may purchase cybersecurity software or conduct employee training to guard against phishing attacks. To manage the ongoing risk of supply chain disruption, they might diversify their supplier base to ensure their factories keep humming or invest in insurance that protects against financial loss during a production outage.
Managing uncertainty, on the other hand, requires more flexibility and adaptability. It involves systematically monitoring trends and developing contingency plans. Boards must work with senior management to conduct scenario analyses and stress tests to assess the organizationâs resilience. They need to recognize that traditional risk management approaches wonât cut it and that, even when making decisions, they will need to consider factors that remain truly uncertain and hard to predict. Rather than trying to predict when events might happen, they should consider the consequences and adapt accordingly. For example, to tackle the uncertainty of shifting consumer preferences or emerging competitors, NestlĂŠ has revamped its portfolio and is investing heavily in product innovation focused on health, wellness, and sustainability.
Though risk and uncertainty are not the same, in practice, they are related and connected, necessitating holistic strategies that take both into account.
Boards should demonstrate strategic foresight by recognizing, assessing, and preparing for future trends to ensure that organizations are not only prepared to face the challenges thrown up by risk and uncertainty but also equipped to capitalize on new opportunities.
Sequoia is an interesting case study of how companies are adapting their strategies to tackle the uncertainty arising from geopolitical tension. In 2023, the Silicon Valley-based venture capital firm announced it would split into three separate entities based on geography: China, India/Southeast Asia, and the US/Europe. The firmâs managing partners noted that running a decentralized global business had become increasingly complex amid rising tension between the US and China, especially on tech issues.
Another example is Holcim, one of the worldâs largest cement producers, which announced in January 2024 plans to spin off its North American business. Holcim is convinced that an all-American company can best serve the fast-growing US market, while the remaining part of Holcim will be positioned as a European leader in sustainability, decarbonization, and recycling building materials. This reorganization prepares the company for an increasingly multipolar world and aims to immunize it from geopolitical uncertainty while capitalizing on regional growth opportunities.
While only a few organizations have taken steps to overhaul their organizational structure along geographical boundaries and evolving spheres of influence, these moves underscore how increasingly strained relations between nations are becoming a growing preoccupation for boards.
This extreme uncertainty is generating a difficult strategic and operating environment that requires a greater tolerance of ambiguity and a culture of constant refinement, revision, and adoption. Traditional and often rather rigid planning systems and processes fail in times of uncertainty. Boards, therefore, need to work with management to prepare more flexible, responsive ways to adjust to the new requirements quickly.
The ability to distinguish between risk and uncertainty is crucial for boards to make effective decisions. While the two often blur and overlap, adopting the right mindset, tools, and strategies to navigate both is essential. On the one hand, establishing a clear framework for risk management and governance is paramount. On the other hand, boards must prepare for âunthinkableâ scenarios and foster diverse perspectives, and new ways of working to respond to uncertainty and unexpected events.
Working with the CEO and executive management team, board directors can provide valuable oversight, guidance, and accountability by asking questions about the organizationâs strategy, structure, and capabilities that will assess its ability to deal with risk and uncertainty.
Strategy questions focus on the companyâs long-term direction, including market positioning, competitive advantage, investment policies, and new business models.
Risk-focused questions:
Uncertainty-focused questions:
Structure questions circle around a companyâs governance framework, organizational configuration, and planning infrastructure.
Risk-focused questions:
Uncertainty-focused questions:
Capability questions focus on culture, skills, talent, and technologies.
Risk-focused questions:
Uncertainty-focused questions:
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