Internal Controls Design website by Matthew Leitch (tutor, researcher, author, & consultant)
New website, new perspective: www.WorkingInUncertainty.co.uk - Related articles - All articles - The author - Services

Column 2004 number 3
Overconfidence and strategic mistakes

by Matthew Leitch



(This article first appeared under the title "The Matthew Leitch Column: uncertainty suppression and strategic blunders" in Emerald Insight's publication "Balance Sheet", volume 12 number 3, 2004.)

Regulations on risk management and internal control, such as Turnbull and Basle II, are trying to close off some of the ways that companies destroy themselves but the traditional favourite route, strategy, is still widely available.

Risk management - or rather, mis-management - plays its part in strategic blunders. A look at strategic marketing shows how this can happen.

Last year I went to an event organised for marketing people. I was the only accountant in the room. The speaker was a friend who has been researching risk management in strategic marketing and he spoke brilliantly for an hour on how marketers should consider risk more systematically when making strategies.

When he had finished, the questions and comments raised by the audience were eye opening. For example, the first person pointed out that ideas had to be sold to senior management and talking about risks would be a problem. Someone else pointed out that, although it is good to consider a range of outcomes, in the end you need one number for the budget.

They were talking about forces that tend to discourage us from being open about uncertainty and managing it properly.

Not just careless

If you've ever tried to get people to consider risks more professionally in business cases, or perhaps when making bids, you probably realised early on that people don't want to comply. It's not just carelessness or lack of time.

As everyone knows, success in business has a lot to do with getting authority and money for your ideas. We instinctively become advocates for business ideas, not analysts.

We feel that our case is weakened when we show doubts. Factually accurate words like "may" get crossed out and rewritten as the more bullish "will". No need to mention all the assumptions we made. Our spreadsheet shows exactly how much money our proposals "will" make.

Often we are challenged to provide unreasonably strong evidence that our idea will work, and we respond by providing that proof. This is particularly difficult for strategic plans, where there is often little directly relevant experience to rely on.

As a team gets behind an idea it usually becomes more difficult to talk about why the idea might fail. We do not want to be seen as negative thinkers, undermining team morale.

Things can get to the point where, if an opponent suggests an alteration to the idea that would better manage its risk, our first thought is to resist. To accept the alteration would be to admit to doubts.

Companies often have sensible requirements of business cases, such as sections on assumptions and risks, and requirements for optimistic and pessimistic estimates as well as the main forecast. But by the time we reach this stage we are often too committed to let these formalities get in the way. We gloss over awkward risks/assumptions and give a narrow range of estimates with a skew towards the optimistic.

When targets are set our focus narrows still further. We avoided mentioning things that might go unexpectedly badly for fear of losing support. Now we also avoid mentioning unexpectedly good outcomes for fear of being set a tough target.

Judgements of uncertainties are easily distorted by bias and wishful thinking. We ignore remote risks one by one, sometimes ending up ignoring risks that, in combination, are not remote.

All this adds to our normal human tendency to see the future narrowly. The result is that we don't think enough about alternative outcomes, don't discuss or manage our uncertainties, and tend to propose brittle plans with poor prospects.

Possible solutions

So what, if anything, can be done?

Some risk assessment and planning tools are more resistant to fudging than others. For example, risk ratings using scores based on a number of objective factors cannot be fudged without a factual lie, whereas nobbling subjective assessments of riskiness or the spread of outcomes just requires bias.

If you want to see proper risk responses don't just ask for a list of risks and responses. Make it a policy that a standard set of risk responses will be included in every proposed plan unless compelling reasons are given for doing something different - and that may mean doing more as well as doing less.

Although people tend to resist tools that bring their uncertainty out into the open, tools can help to create a climate where people begin to believe they are expected to be open about uncertainty.

One strategy is to use technology. Instead of relying on ordinary spreadsheets, provide a tool that adds Monte Carlo simulation, such as Crystal Ball, @RISK, or one of numerous low cost Excel add-ins. Although there is still room for systematic underestimates of risk, the ritual of using a tool that handles uncertain variables creates an expectation that uncertainty will be talked of openly and tends to improve risk awareness.

This is one way that finance professionals can help to see off strategic blunders.

It may be possible to reduce the pressure people feel to suppress uncertainty by other means, such as setting a good example from the top of the organisation, praising thorough disclosure and management of risk while punishing its concealment, changing performance evaluation criteria, and organising so that people are less personally committed to individual ideas.

Whatever is done to influence attitudes it will be more successful if done early. Once people become committed advocates of an idea it is usually too late to get uncertainties into the open.

Instead of seeing uncertainty concealment as a social skill, we should see it for what it is: lying.

We are accustomed to praising leaders for having a vision, being positive, and showing confidence of success. Shouldn't we be more impressed by people who open our minds to more potential futures, have ideas for thriving in all of them, and can even point out the conditions that might lead to failure? Looking confident is something anyone can do, but opening our minds takes real experience and insight.


New website, new perspective: www.WorkingInUncertainty.co.uk - Related articles - All articles - The author - Services

If you found any of these points relevant to you or your organisation please feel free to contact me to talk about them, pass links or extracts on to colleagues, or just let me know what you think. I can sometimes respond immediately, but usually respond within a few days. Contact details

Matthew Leitch - Author

About the author: Matthew Leitch is a tutor, researcher, author, and independent consultant who helps people to a better understanding and use of integral management of risk within core management activities, such as planning and design. He is also the author of the new website, www.WorkingInUncertainty.co.uk, and has written two breakthrough books. Intelligent internal control and risk management is a powerful and original approach including 60 controls that most organizations should use more. A pocket guide to risk mathematics: Key concepts every auditor should know is the first to provide a strong conceptual understanding of mathematics to auditors who are not mathematicians, without the need to wade through mathematical symbols. Matthew is a Chartered Accountant with a degree in psychology whose past career includes software development, marketing, auditing, accounting, and consulting. He spent 7 years as a controls specialist with PricewaterhouseCoopers, where he pioneered new methods for designing internal control systems for large scale business and financial processes, through projects for internationally known clients. Today he is well known as an expert in uncertainty and how to deal with it, and an increasingly sought after tutor (i.e. one-to-one teacher). more

Please share:            Share on Tumblr