Hedge Right

Taking calculated risks and avoiding others is an intrinsic part of an firm’s agenda. A vital decision facing all company managers is choosing what risks to take and which ones to avoid — and then how to hedge against the potential consequences of risks that are taken. Recognizing that careful analysis takes time and money, how methodical should the firm be in becoming more resilient when facing potential disruptions and adverse events?

It is evident that protective measures have become more essential as risks have attracted far more public attention and concern in recent years. Media references to risk rose worldwide from 1990 to 2016 by a factor of twenty-five —  and in the United States double that. Risk has entered the lexicon of virtually ever company manager. Headlines with the word “crisis” and the name of one of the top hundred companies ranked by Forbes appeared 80 percent more often in the 2010s than in the management-- has become one of the essentials for almost everybody in business.

The growing importance of the concern is evident in influential business gatherings. The World Economic Forum, with which the two of us have been collaborating for over a decade, provides a barometer. In the 1990s, the Forum devoted only a few of the sessions in its annual meeting in Davos, Switzerland, to risk issues. Of its nearly 250 sessions at the 1997 annual gathering, for instance, just a dozen were explicitly focused on the topic. By the mid-2000s, however, a third of its sessions touched on risk, and by the 2010s, nearly half. Recent discussion has centered on how to manage these risks more effectively to foster a culture of resilience.

Understanding, reducing, and managing risk are no longer the province of just technical specialists, but involve the entire enterprise. Catastrophic risk has even entered boardroom deliberations as directors have come to appreciate that cyberattacks and cyclones can depress their firm’s performance and their own reputations as much or more than a floundering strategy. Yet there is also an obvious upside: well-managed, calculated risk-taking is one of the drivers of value creation and profitability in any competitive market.

Calamity, catastrophe, or crisis; adverse event; a low-likelihood but high-impact shock. A host of words and phrases capture the central focus of this book. We apply them interchangeably but consistently with reference to moments or events that could dislocate the normal business functions or operations of a firm, or cause major financial or reputational damage to it. We use the terms risk and disruption to characterize company threats and their impacts.

This is an extract from Howard Kunreuther's Mastering Catastrophic Risk published by Oxford University Press