The relationship between innovation and risk

I have had many arguments with people about the cliched use of the concepts of risk and risk management. The standard line is ‘building a culture of risk taking for innovation’. The implication is if we encourage people to take risks more innovation will happen. The paradox is that when I interview people who tried big and bold ideas, I ask them if they felt like they took a ‘risk’. Most say no. They will say something like they found a better way to solve an old problem that led to greater results.

I knew that our current way of viewing risk was too simplistic and not useful for innovationalists. I have changed my mind.

I recently reviewed ‘Managing Opportunities and Risks’, a report written by a collaboration of several public and management accounting groups in the US and Canada. It views the risk management process as a way to exploit opportunities to drive innovation.

To quote the report, all managers can benefit by developing “the capacity to minimise unrewarded risk — risks that have no upside even when handled perfectly, and maximise rewarded risk — risks that present opportunities for success”. The very idea of splitting risk into two categories is powerful.

Unrewarded risk

• Strategic risks relate to an organisation’s choice of strategies to achieve its objectives.
• Operational risks relate to threats from ineffective or inefficient business processes for acquiring, financing, transforming or marketing goods and services.
• Reporting risks relate to the reliability, accuracy, and timeliness of information for either internal or external decision making.
• Compliance risks address the presence or lack of systems to provide information about failure of management or employees to comply with laws, regulations, contracts, and expected behaviours.
• Our goal is to minimise these risks. Reviewing these risks as an internal exercise will strengthen a business.

Rewarded risk

• Expanding our insight into these areas may uncover new potential opportunities for innovation.
• The process of innovation is a key part of capturing opportunity from risk. After an opportunity has been identified, moving the idea to market requires a system. Innovation is not just having a good idea at the right time, it is a system to improve the likelihood that these ideas will succeed inside the business and lead to market success.

Assessing opportunities

• Assessing the increased market share that can be captured.
• Calculating the likely profit from the innovation.
• Quantifying the number of new customers.
• Calculating the potential sales growth that could stem from capturing the opportunity.
• Measuring the residual income to calculate value added as a result of capitalising on the opportunity.

This type of calculation makes it easier to include potential opportunities in ROI calculations. It helps assess if the opportunity is worth pursuing.

• Assessing risks of new opportunities
• Measuring the risk we can identify by using the above ‘risks’ of new opportunities can be done in five steps:
• Quantify the magnitude of the impact of the risk.
• Assess the probability that the risk will emerge and affect the company.
• Quantify this impact on the company. (Magnitude) x (Probability)
• Analyse the cost/benefit of taking action to mitigate risk.
• Prioritise various risks to understand which are most critical.

The report then continued: “The ability to use tools to simultaneously recognise and assess risk and opportunity can enable a company to manage offensively as an opportunity rather than defensively as a hazard”. The concept of “managing risk offensively as an opportunity” is powerful.

Those innovationalists who create new ideas as opportunities for new products and services can benefit from harnessing the expertise of the internal accountants and risk managers to develop stronger business cases for these ideas. This takes a dedicated effort to develop new skills and internal competencies. The rewards are obvious: a greater capacity to innovate. This should be a goal for all executives.