14 Dec Brexit: the end of the beginning
Whilst the UK is in the last leg on their trade talks with the EU over a post-Brexit trade deal, we look back at our post from 2016 on eight ways in which risk management discipline can help you make a complex decision.
This blog post was first published in June 2016.
The last few months, since the British referendum campaign began in earnest, have revealed some familiar patterns with how I see risk management being pursued in the business world. Companies, like the citizens of the United Kingdom, often face huge decisions which could propel them forward into profit and success, yet simultaneously expose them to disaster. So what can we learn from the practice of Enterprise Risk Management when it comes to facing down a difficult dilemma?
Panic is not a countermeasure
Panic is what happens when we have no choices left. The discipline of risk management helps us to decompress our busyness in order to focus attention when it is needed. Risk management is deliberate decision making when we still have time to control outcomes when the best set of choices is open to us. For many voters being harassed by the competing and contradictory claims of the opposing campaigns, the choice they face is becoming too difficult and has started to descend into a tailspin of irrationality. Burying our collective heads in the sand and accepting the possibility of a terrible outcome, is the antithesis of risk management.
Balance is not the juxtaposition of equal extremes
Politicians on either side of the debate have been warning the British public about the dangers of voting the wrong way on June 23rd. It’s been fascinating to watch the BBC attempt to cover the campaign in an unbiased and balanced fashion. Every day, lines of intelligent people come on to TV screens and social media, passionately offering their dire predictions of the future, their outline of the huge consequences of deciding the wrong way, only to be entirely contradicted in the very same news segment by another intelligent and persuasive person, who argues energetically and enthusiastically in the opposite direction.
This has the effect of rendering the electorate stupid, like a child who has been subjected to vigorous shaking of the shoulders; brain impairment is sure to follow. All we can tell right now is that we can be sure our collective future will involve having the sky and our heads, in close proximity!
Whilst media outlets try to fairly represent opposing views, risk management seeks to understand the relationship between, and legitimacy of, extreme positions and to determine the factors which might sway the outcome in either direction. Risk management is not only about stopping bad things from happening, but also about ensuring consequences of risk events are manageable when they come about. Effective plans can be established as to how best to control or influence critical factors, in order to achieve the most profitable outcomes.
Risks have no meaning without context
One area of the ‘Brexit’ campaign where there does seem to be some accord, is that the decision is an important one. The implications will have a significant effect on the future and those effects will start to be felt almost immediately, as financial markets react to the decisions (some argue that exchange rate discounting effects have already begun) and realign themselves with what they believe the future will become like. No one is pretending this doesn’t matter, so people are trying to make an earnest decision. Great! But how to make such a risky decision when your head is being filled with competing but compelling information?
The International Standard on Enterprise Risk Management (ISO 31000) might offer us some help. It defines risk as to the “effect of uncertainty on objectives”. One of the principal reasons why the risks being set out in the current debate are not providing much clarity, is because no one is precisely saying what greater purpose, what vision of the future is at stake, what objective of the British Islanders is in jeopardy?
Put simply, there may be risks involved, but to what exactly? This is how intelligent people can come to utterly different conclusions about the significance of the same information. It’s the same in business: risks can be written down but they don’t make much sense unless they are related back to what the company is seeking to achieve. I constantly see risks which are poorly defined and devoid of objectives: “Risk of reputation damage if we invest in such and such a market”…
“So what?”,”End of the world”, “Big deal”, “We’ll all be out of a job” – give my head another shake and turn my brain to jelly! Risks make no sense if they become disconnected from purpose.
Bring the best brains together for the final decision
When rationality is undermined, stakeholders typically choose to opt for safety in numbers, or safety behind a strong leader. No matter how significant the decision, human beings have always found it easier to outsource responsibility for tough calls to other people. Politicians fill this fear vacuum with outlandish claims of superior insight and capability and predictably, large numbers of people surrender their thinking so that pre-baked opinions can be hand-fed to them. This happens in business just as much as it does in politics and only hindsight restores sensibility. For example, who could have possibly thought that risk of cheating emissions tests, on a global basis for an extended period of time, was a worthwhile business strategy to pursue? Well, only the citizens of Planet VW following the oft-described ‘dictatorial style of leadership’ of their then CEO, Martin Winterkorn.
Risk management provides a basis for transparent, evidence-based decision making, which gathers the input of all relevant stakeholders and attempts to layout the nuanced landscape of decision possibilities. Although a group or an individual leader may make the final decision, many people are required to contribute to it. The risk team should ensure that the finest brains available are recruited to the cause. Relying on a leader’s intuition or instinct is rarely the best way to manage a complex risk with long term implications.
Use time creatively
Any talk of the future has got to involve some sense of scale. It’s not uncommon for me to hear a business leader say something like “We’ve got a 25% chance that this bad thing may happen to us”. Any Maths teacher can tell you that probability is meaningless without a timeframe. 25% chance today, this week, this year, in the next 20 years…? For our ‘Brexit’ campaigners, the risks that they are setting out for the public are incredibly non-specific. In what timeframe should we be thinking when deciding our voting intention?
This works on two axis: firstly, a skilful risk manager will determine if speed of decision making takes priority over depth or quality of the decision to be made; it’s no good doing superb analysis if you reach your conclusion a month after you can do anything about it! Secondly, the risk manager will understand that sometimes, risks have different kinds of impact profiles in short and longer terms.
The UK joined the European Community in 1973, realising it was being left behind by the countries that had signed the Treaty of Rome in 1957 and formed the EC in 1967. 43 years later, the UK? economy seems to have rebounded slightly more quickly from the global financial crisis in 2008-9, than the majority of her neighbours, creating a sense of confidence that she might be better off ‘going alone’. If the objective of the UK is to pursue short term economic success, then the almost unanimous opinion of economic forecasters is that a decision to leave would be detrimental to this purpose, with some variation about the duration of the impact.
Should voters be considering the impact of leaving the EU on the amount of disposable income they have in 2017? That seems like a poor way to decide; it may take several years to understand what is actually at stake by unwinding EU membership and several more years before new solutions to old problems are discovered. Is a 10-year time frame better? Risk management plays with timescales like a photographer zooms in and out on an image: to see if they can gain revealing perspectives.
The UK Treasury decided that they would build models of economic performance against a 15-year timeframe and sensibly, looked at 3 different scenarios of how Britain could trade with other nations. The forecasts suggested that Britain would have in the best case, 3.8% less GDP than if they were to remain in the EU, or worst case 7.5% loss (and a middle case of 6.2% loss – and this was the case used by the UK Chancellor to brief the public).
Stop fiddling with my cognitive bias
The Chancellor’s figures established such a desperately bad outlook that instead of settling the argument that ‘Brexit’ would be a counter-productive decision, it had the effect of stimulating irrational scorn. People thought the numbers were too bad to be believable, so the public mood shifted to thinking about whether the messenger could be trusted, or indeed, whether any economic forecast should be listened to and taken into account. Opposing politicians howled that the Chancellor was trying to scare people and implicitly offered comfort from fear, behind a cosy and romantic image of British sovereignty and capability for being effective traders.
It is true that under the British Empire, the country had an impressive global trade network that created vast amounts of wealth. This image conjures up a number of predictable inconsistencies with which our brains seriously mishandle information: availability cascades, confirmation bias, framing effects, hyperbolic discounting, illusion of control, optimism bias, Parkinson’s Law of Triviality, naïve realism, rosy retrospection bias – these all play cruel tricks on our impartiality and are readily manipulable by skilled actors.
Good risk management should provide a framework that decisions remain as much as possible, within the realm of examining information, even if it initially offers us frightening insights. Good risk management knows that perception is a risk in and of itself and takes such human factors into account.
Executives frequently dismiss solid data because it does not correspond with their prevailing view of reality. How much better would our decisions be if we continued to refine our models and data sets, to examine how we handled outliers and deviations and disputed conclusions, rather than flipping out to allowing beguiling personalities to fiddle with our cognitive biases, to serve their underlying ambitions?
Take the long view
The further into the future you try to imagine your risks, the more varied the results will be. This is a challenge for the lazy because it is much easier to think about near term issues. Risk management is the business of living with uncertainty and modelling is a good way of approaching complex but measurable problems, with lots of relevant and available data. This makes sense for areas such as economics, climate, radioactivity of nuclear waste, urban planning or actuarial calculations etc. But it does little to inform us about human behaviour or geopolitical intentions. Do any of the objectives we have as citizens of a country, make sense in even longer timeframes?
If we look at the United States of America, it has taken over 200 years since its declaration of independence (1775), the writing and ratifying of its constitution (1787-88), the fighting and settling of a civil war (1861-65), to becoming the most concentrated technical, military and economic force on the planet in the 20th century. By contrast, the European Union was only formed in 1993 on the back of various treaties dating back to 1951: a mere 59 years of trying to be an effective collective enterprise. Would it not be reasonable to wait another 100 years before trying to assess if this was a worthwhile endeavour, or at least thinking forward to what our governance needs would be 100 years from now?
Risk management consciously seeks to define parameters that help organisations decide what ‘reasonable’ means. For those concerned about economic performance in the next decade, 100 more years of European unionising is totally irrelevant.
But if we consider that the objective for the UK in being a part of the European Union, is to continue to enjoy economic prosperity against a background of peace and security in Europe, then the risks in the debate begin to look altogether different. In 1951, Europe was devastated and dysfunctional. Two ‘World Wars’ in the last 35 years had created poverty, distrust and debt and the possibility of a new, “Cold War” with the Soviet Union threatened further destabilisation. The purpose of the Treaty of Paris was to create economic prosperity and to ensure that war in Europe was not just “merely unthinkable, but materially impossible”. The benefits of European unity were meant to be discovered over a sustained period of time. If Risk Management does not operate in appropriate timeframes it will fail to detect significant events or value drivers.
When faced with complexity, work-specific questions
Good risk management sets up the questions which pinpoint the nature of uncertainty being faced.
Some issues are so complex that there is insufficient time to understand all the relevant factors. But good risk management can identify a number of key questions that can be addressed and provide a degree of certainty, by which other more difficult questions can then be dealt with. Incremental but reliable answers based on quality information are of more value than quick guesswork on big topics by those who are not aware of the boundaries of their insights.
In this case, some of the narrow questions might be: Who are the trade negotiators that would save the UK from brutal economic headwinds? How many of them are there, how experienced are they, how long will it take to get sufficient trained people in place, what will their priorities be for action, what will happen in the period when they are not available or ‘up to speed’? To what extent will their absence affect business confidence or the willingness of investors to flow capital into the British economy? How much will terms of trade deteriorate in the period where a full complement of skilled trade negotiators are unavailable?
Questions such as this help risk managers to establish scenarios to be researched and discussed, leading to nuanced understanding and ultimately, a sense of consensus about uncertain issues before there is an urgency to determine the issues.
There is no doubt that the referendum about whether the UK should remain in the European Union is a vexed question. I would probably argue against the theory that suggests the widest number of opinions is the best way to settle such an issue, which some might think anti-democratic. My feeling is that a decision of this scope and magnitude should have been settled by the strongest minds, with the deepest insights, rather than risking a populist brawl that descends to the lowest common factors of understanding. Which is, after all, one of the essential components of vibrant risk management: know your stakeholders well and communicate with them often.