Nobel prize winning psychologists, Amos Tversky and Daniel Kahneman, suggested in their “prospect theory”, first published in 1979, that how a decision is framed impacts the choice we make. Small changes in frames or how a decision is worded can have a substantial impact on our propensity to take risk, with a loss seen as more significant, and therefore worth avoiding, than an equivalent gain.
Frames define problems, diagnose causes, make moral judgements or suggest opportunities – all through the process of making certain information more noticeable, meaningful or memorable to the audience making the decision.
In terms of framing, strategy is all about opportunity and a potential loss if a given opportunity is not realized. We use optimistic frameworks such as blue ocean strategy and cash cows to signal their upside. By contrast, risk is marked by pessimistic language – risk identification, assessment and mitigation. As long as we keep the world of strategy separate from risk and don’t examine the same decision from different angles, we may bias the decision-making process right from the start.
When strategists, for instance, use the term Global Signals – the indicators that help you make sense of the events or trends shaping business – they often focus on the opportunities firms could be missing out on, making executives more willing to take risks. In risk management, the equivalent would be a Gray Rhino – a highly probable threat that is neglected despite its high impact, and that often occur after a series of warnings.
The Chief Strategy Officer, often an optimist, will look at the whole business in its context, assessing the industry dynamics, market, competitors and resources before making a decision. The Chief Risk Officer or the board risk committee is, by nature, more likely to be a pessimist who needs to prepare the organization for the worst possible scenario and ensure that the company survives. One trap organizations often fall into, however, is failing to consider the risk of inaction.
As board members can easily flip from risk aversion to risk-seeking behaviour as a result of framing, the use of language matters hugely- Bettina Büchel
Although risk management is not the sole responsibility of the board and is an institutional responsibility, it is often seen as a discipline independent of strategy. This is a mistake. Instead, companies should ensure there is a common understanding or conviction on how much risk they are willing to take.
One way to integrate the two is by carrying out scenario analysis – a process of analyzing future trends by considering different possible outcomes. This way it allows optimistic and pessimistic perspectives to be integrated into a single framework and ensures a common framing is adopted across the board.
Consider the aforementioned fertilizer company. The board could be tasked with predicting the future of agricultural systems in a sustainability driven world. This might involve scenarios that lead to different production systems ranging from conventional agriculture to indoor farming, regenerative agriculture, organic agriculture and vertical farming. The level of risk can be evaluated from multiple dimensions such as the market size, barriers to entry, and execution capabilities. The board risk committee should provide guidance on risk appetite which would enable the framing of risk to inform strategic dialogues but not be the deciding factor. At the same time, the risk committee agenda item would no longer just be a compliance and check box exercise, but would allow the two discussions – strategy and risk – to be integrated at the board level.
If the board uses scenario analysis to inform its strategic and risk discussions, it can address the following questions:
“Although boards face intense time pressure, the thoroughness of strategic dialogues should take priority”- Bettina Büchel
Particularly in highly dynamic and uncertain situations where new information is emerging on an ongoing basis, the board needs to meet regularly to update the drivers of the scenario analyses. This way they can ensure that a certain context is not cast as a problem, threat or opportunity too quickly and avoid making hasty recommendations without having a robust dialogue and debate.
Too often board members have a strong opinion and will push their frame onto others leaving no room for alternative viewpoints. Having an open discussion and allowing everyone to make their assessment of the situation will ensure that a range of perspectives and options emerge. A more diverse set of board members will also lead to alternative viewpoints.
Over thousands of years, humankind has learned to use storytelling and metaphors to convince others and guide decisions. Yet at the same time these metaphors and stories can strongly push people in a certain direction and allow implicit assumptions to surface. These often taken-for-granted assumptions are what causes a specific frame to be dominant. As board members can easily flip from risk aversion to risk-seeking behaviour as a result of framing, the use of language matters hugely. Going back to Tversky and Kahnemann, we know that executives act rigidly when faced with risks, tending to follow routines and procedures, rather than looking at a situation in new ways. This threat rigidity is the key issue that a combination of scenarios and use of language offering multiple perspectives can avoid.
By defining the same situation in different ways, you are given alternative perspectives – this is where the use of scenarios is powerful. Although boards face intense time pressure, the thoroughness of strategic dialogues should take priority. Boards may need to revisit how much time they allocate for these essential activities, especially given these decisions don’t only have an impact on day-to-day operations but increasingly on multiple stakeholders and society at large.
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