Friday Rant: The Present Value Cost of Risk Demands Far More Attention at the Executive Level

- December 7, 2012 3:12 PM
Categories: Uncategorized |

Back in the early 80′s when I was at Wharton Grad and also a full time print shop manager, paper warehouse manager and buyer of copiers and peripherals, desktop computers with DOS operating systems were just beginning to replace card punching machines at Penn. It was a hands on era when professors of Computer Science still supervised campus wide hard wired networks to mainframes and the academic discipline of risk management resided in the Insurance Department populated by a hand full of professors near retirement. Much has changed since then, but not nearly enough.

A recent article on the Harvard Business Review Blog Network by Carlos Alvarenga, who leads the Operations Finance and Risk practice at Accenture got me to thinking about how much our knowledge base and technological potential to enable real time risk management has changed and how the vital importance of doing so is still sorely lacking within many corporate hierarchies. During my multifaceted tenure at Wharton, risk management was essentially synonymous with crisis management. I recall renting trucks and pallet jacks and personally driving and unloading tons of paper through picket lines that resulted from an otherwise predictable campus maintenance workers strike so that custom course reading materials could be printed in time for the impending new semester. But I digress.

Mr. Alvarenga correctly states that “Risk in supply chain is not a potential cost — it is an actual cost, very real and borne by every product and service company, whether they understand it or not… The possibility of more than one future outcome can very easily generate a cost in the present. How so? Because the fact that value is not guaranteed in the future lessens value in the present. This reduction in value is present and represents a cost today, not tomorrow. This is a concept fundamental to finance but that, for some reason, has not migrated into supply chain risk management.” While still today “the typical supply chain risk management discussion focuses on low probability, high impact events, such as the natural disasters or political uprisings… And yet almost no discussion of supply chain risk management deals with the reduction of these present costs in a systematic, quantitative way.”

The irony for me here is that while I attended MBA classes in the midst of local productivity chaos, obvious risks and their significant opportunity costs went unrecognized and unaddressed, and they still are at the corporate level over 30 years later. Mr. Alvarenga points out that “there is often a knowing-doing gap between enterprise risk management teams and the business itself. At a typical firm, the enterprise risk management team is eager enough to point out the many risks that a Chief Procurement Officer or Chief Supply Chain Officer faces but the risk team is often reluctant to join the CPO or CSCO’s team to tackle those risks directly. The operational executives, for their part, when confronted by a subject that typically neither they nor their teams completely grasp, all too often come up with little more than a contingency plan and then sit back and hope nothing goes wrong — meanwhile, excessive risk costs continue to reduce the company’s present value.”

To wit, before dawn this morning on a walk with a line manager at a publicly held Fortune 500 company, I heard a story about a CMO who planned to divert funds and circumvent HR to pay a part-time status contingent graphics professional “under the table” for a couple of additional days of work on site as an independent contractor during their busy season. When the CMO, oblivious to current widely enforced worker classification status contracts terms and conditions, was told by my friend that this could subject the company to astronomical fines, he replied “what HR doesn’t know won’t hurt them.”

The monetary cost and value of incorporating risk management is somewhat complex, though a “new generation of risk leaders has an opportunity to transform the discipline of supply chain risk management from a reactive planning exercise to a day-to-day operational function.” The ROI of doing so is self evident. Thanks, Mr. Alverenga, for such an observant and prescient column.

- William Busch

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Comments

  • Carlos Alvarenga:

    Glad you enjoyed the piece. There is a significant change taking place in this area and the field of SCRM will be very different in the future as a result.

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