This post first appeared on Risk Management Magazine. Read the original article.
Corporate history is littered with examples of major companies that adopted the wrong strategy and paid the ultimate price. For instance, even though the firm had been a digital pioneer, photography behemoth Kodak failed to foresee how quickly the world would embrace digital images and was never able to catch up with the competition even after eventually changing tack. After 124 years in operation, it filed for Chapter 11 bankruptcy protection in 2012.
Similarly, Research in Motion (RIM), the producer of BlackBerry handheld devices, ignored the threat of Apple’s iPhone when it debuted in 2007 because RIM’s technicians thought it was a substandard device and the company felt confident about its strong market position and two million users. The rival product proved a hit with the public, however, and BlackBerry fell out of favor. RIM could not replicate its earlier success and, in 2013, it was acquired by a group of investors and broken up.
As these and hundreds of other examples illustrate, strategic missteps can often have dire consequences. To some extent, this is the nature of business competition and can never be eliminated, but understanding the contributing factors in critically failed strategies and recognizing the warning signs can help companies spot flawed moves and attempt to course correct before failures become fatal.
When companies fail, blame is usually laid squarely on executives for making two common mistakes: First, they focused on the company’s historical performance and ignored what was happening in the wider market; and second, they were reluctant to dump a strategy that was not working until it was too late.
There are several other reasons that poor strategic direction is allowed to continue. In many cases, companies fail to learn from the experiences of others. “Organizations tend to have this bizarre belief that the same problems won’t hit them—especially if the company is in a different industry sector—or that they are capable of dealing with them differently and successfully,” said Mark Brown, vice president and senior risk practitioner at enterprise risk management software provider Sword Active Risk.
Executives also often fail to fully appreciate what risk management can actually do. “Most organizations say that they have an enterprise-wide risk management system in operation, but relatively few have full executive buy-in or an acceptance from boards that they are ultimately responsible for it,” Brown said. “As a result, there is a disconnect about what executives should be doing and a false view that the risk management function prevents all risks.”
Personality can also have a sizeable impact on the direction of a company. According to Val Jonas, CEO at software firm Risk Decisions, “executive ego” can play a major part in preventing risk management (and others) from challenging boardroom decision-making and the rationale underpinning corporate strategy.
“Some boards tend to believe in their own intuition rather than actual evidence,” she said. “Boardrooms are where key decisions are made and executives are in that room because they have made quick decisions in the past and they probably have had a good hit rate, or at least they did early on in their executive careers. As a result, executives feel that they have good instincts and they become less willing to listen to challenge, listen to bad news, or accept contrasting views from assurance functions that they think are meant to check the numbers and any legal issues, not set the agenda.”
Ego trips can often turn into nightmare corporate journeys. “Biases are often projected onto strategies and they become inextricably linked with directors’ egos,” said James Berkeley, managing director at strategic advisory firm Ellice Consulting. “Executives take the notion of strategy too personally and take offense when it is questioned. Boards can then dig in and become defensive about something that ordinarily they would not be so supportive over.”
Berkeley said that there are two ways to prevent boards from backing poor strategies, or from continuing to pursue them in the face of overwhelming evidence that they have gone wrong. The first—and most preferable—involves hiring people with the appropriate talent, experience and judgement into board roles from the start who can deliver the intended strategy, and who are prepared to adapt it—or scrap it—if circumstances change. The other is to make executives more accountable for the strategies they greenlight and steer by making pay and rewards much more contingent on actual performance—not just in terms of financial results, but also in securing the business’s long-term future by, for example, committing to improving and investing in recruitment, retention and training programs.
“Making sure that you have a strong leadership team from the start is crucial, but it is also important to know up front whether they have the nerve and good business sense to pull the plug on a failing strategy,” Berkeley said. “There need to be benchmarks in place to measure success and a recognition that, if these aren’t met, then the strategy needs to be changed or dumped. Linking executive pay and reward schemes to these benchmarks is also vital to ensure accountability and to measure the performance of both the strategy and the executive team.”
Talent recruitment firms report that some companies fail to formally review and verify a board member’s identity, education, employment history or criminal records, and that they may be introducing significant—but eminently avoidable—risk into their organizations as a result. According to research by HireRight, 26% of HR professionals surveyed admit that it is possible board-level staff have never had their qualifications and experience verified, while 28% of HR respondents say that they have uncovered unspecified issues during the screening of senior-level staff. In fact, 28% of executive-level candidates go through fewer tests and interviews to secure a job than an entry-level hire does.
Experts believe that better executive screening is necessary and recent corporate governance scandals may put executive appointments under greater scrutiny in future. This May, for example, a joint committee of members of the U.K. Parliament published its final report into what went wrong at collapsed construction giant Carillion.
Up until 2017, Carillion was one of the largest contractors for U.K. government infrastructure projects, employing 43,000 people worldwide. But despite such impressive figures, the report found that Carillion’s business model was an “unsustainable dash for cash” and that it deliberately used aggressive accounting policies to present a rosier picture to the markets. Its cash flow, for example, relied on stringing suppliers along for months. A succession of directors maintained the image of a healthy and successful company by increasing dividend payments year-over-year, irrespective of company performance. In fact, more was paid out in dividends than the company generated in cash. For years, the board helped maintain a “deluded” sense of optimism even though the company was “crying out for help.”
At the time of its collapse, Carillion left a pension liability of around £2.6 billion (about $3.31 billion) and owed around £2 billion to its 30,000 suppliers, sub-contractors and creditors. The company went into liquidation in January 2018 with liabilities of nearly £7 billion ($8.9 billion) and just £29 million ($37 million) in cash. The subsequent furor prompted the U.K.’s corporate governance regulator, the Financial Reporting Council, to request greater powers to investigate and prosecute all directors. Currently, it is limited to pursuing only those with an auditing, accounting or actuarial background (meaning finance directors, for the most part).
While the buck may stop with boards for pursuing a flawed strategy or for failing to implement a good one, others are also culpable. According to U.K.-based risk consultant Keith Blacker, there is increasing evidence that those who are supposed to provide independent assurance on risk and corporate governance are not doing their jobs properly. “Auditors, advisors, non-executives, risk managers, internal auditors, in-house legal, compliance and others are all meant to present a challenge to the board and act as a ‘critical friend,’” he said. “No area of discussion should be left unchallenged, including corporate strategy. But somehow, their contribution often falls short or they are not listened to. Boards may have ignored them, but there is also a case to say that these people did not shout loud enough.”
In the case of Carillion, the company’s non-executives were supposed to challenge boardroom strategy but were “unable to provide any remotely convincing evidence of their effective impact,” the MP report found. Professional services firms were also slammed for being unable to effectively identify to the board or persuade executives about the seriousness of the risks associated with their business practices. “The appearance of prominent advisors proves nothing other than the willingness of the board to throw money at a problem and the willingness of advisory firms to accept generous fees,” the report said.
Ensuring that assurance providers remain independent is crucial. “Consistently rotating auditors is an excellent way to ensure independence from management influence and having an appropriate proportion of independent directors—both on the board and internal audit committees—will promote greater accountability and bring fresh, diverse perspectives,” said Kurt Rothmann, head of management liability at insurance broker JLT Specialty. “It is also important to have a whistleblowing policy in place that creates a comfortable environment for employees to anonymously report any suspicious behavior.”
Risk managers also need to share some responsibility for corporate collapses. “People in the profession can be more intent on putting processes in place for people to follow than looking at whether the underlying business is actually at risk,” Brown said.
He believes that risk managers need to work better with other assurance providers to give boards a single view of risk. “There is absolutely no point in presenting the board with five different risk scenarios from risk management, internal audit, compliance, legal and so on,” Brown said. “Whom are they supposed to favor? Risk management functions need to present their findings in association with other assurance providers within the organization to show that the weight of evidence is on their side and that management should listen and act on their recommendations.”
Brown also suggested that heads of operational areas should be thinking about risk management more and should be encouraged to speak up if they have doubts about corporate strategy, as “they will have a better day-to-day view of whether the objectives are likely to be met, and a better overall business focus.”
Ewan McIntyre, commercial disputes partner at U.K. law firm Burness Paull, said that risk managers should also speak up if they think that boards are being steam-rolled by a dominant group of executives, or if non-executives are just rubber-stamping executive decisions. “Heads of risk and other assurance functions should look at the minutes of the meetings to see who said what, who dissented, and what recommendations and strategies were ignored, and report any concerns to the company secretary,” he said. “After that, you can report your findings to a regulator or enforcement agency, but this may protect the market rather than the company.”
Experts say that there are some simple warning signs that risk managers can look for to help assess governance failures and potential collapse. For example, Blacker recommends looking at publicly exposed red flags like whether the company fails to abide by any regulatory warnings or has an increasingly poor public compliance record. He also recommends looking at whether the company is setting tougher customer/supplier terms, delaying payments, or only making partial payment for goods and services. It can also be helpful to check whether the company heavily relies on third parties and consultants to improve governance, rather than trying to reform itself from within. Additionally, check whether there is an increase in the number of complaints and grievances made by employees at ground level.
Sometimes, the best evidence (and compulsion to act) can come from showing the board the true figures—how much cash the company is actually holding. “Boards like to have projections on turnover and profit, but show them how much the company actually has in the bank and they can get a short, sharp shock,” Blacker said. “If that doesn’t get them to turn around an underperforming strategy, nothing will.”
Following the money can also help identify current or future problems staying afloat with a given strategy. “Start with the company’s finances,” said Philippa Foster Back, director of the Institute of Business Ethics, a U.K.-based organization dedicated to improving business culture and executive behavior. “Look at turnover and find out where the company makes its money. For example, if the organization’s main source of revenue comes from government contracts, risk managers can assess how exposed the business would be if these tailed off, slowed down or were cancelled. Also, they could question how sensible it is for the company to be so reliant on such contracts at a time when government spending is being curbed and contractors are being squeezed to provide more for less.”
It is also valuable to assess how the average employee feels about the company. “Employees pick up bad vibes very easily, and if they don’t like the company they work for, they leave as soon as they can,” she said. “Risk managers should therefore look at staff turnover rates and exit interviews to get an idea of what the workforce thinks about the organization and what prompted them to leave. Common gripes like departmental budget cuts, reduced headcount, slow authorizations and management’s ingratitude can be symptoms of much wider organizational problems.”
Risk managers should also visit other departments and sites. “People get a fixed view of how companies operate because they only see the parts of the business they work in,” Foster Back said. “Everything might be ok in that particular office, but other parts of the business may tell a very different story. Get out and have a look, particularly if you have heard rumors about potential trouble spots. If several different departments speak up with the same concerns, boards are much more inclined to listen.”
Deciding corporate strategy will always remain a responsibility of the board. However, other stakeholders—including risk management—must be prepared to step in and say something when the strategy is not paying off.