Category Archives: Enterprise Risk Management

Elephant Risk Management & Technology Innovations

With dwindling habitats and large appetites, Elephants are increasingly dangerous in countries like India. Elephants are increasingly entering cities, killing people and eating crops of coconuts, ginger and other valuables.  On December 29th, for example, they entered the Indian city of Bhubaneswar, attacking a honking car and injuring six people reports The Times of India.  This video of an Elephant rampage in Sri Lanka shows how hard they are to control.  This elephant plays with a minivan like it’s a toy.

[YouTube=http://www.youtube.com/watch?v=qnOkbVJNaYc]

If you’re a farmer, or just live in a city with a forest that contains wild Elephants, they represent a special kind of
Enterprise Risks to your business, not unlike the Monkey Marauders noted in a previous blog entry.

But in the case of Elephants, several noteworthy options are being tested for efficacy in thwarting the Elephant menace:

1) The man honking his horn was hoping to scare away the elephant, and that strategy backfired

2) Forest officials in Mochapallam brought two trained elephants to drive a wild herd of 13 elephants back to the forest.  They successfully persuaded 12 to follow, but one got away and chased officials and local citizens.

3) The officials in Mochapallam ultimately were successful in getting the remaining renegade Elephant to retreat to the forest by lighting firecrackers.

4) A Bengali inventor, Amunuddin Ahmed, invented an “Elephant Repellent“, that combines sirens, bulbs and wires connected to a battery, or solar power.

Each of these examples, is a real option – the investment, or partial investment, with an uncertain payoff.  In one case, there was not only no payoff – but the strategy backfired.

I’m continuously fascinated by the range of risks that need to be considered by different industries in different countries.  Clearly Elephant rampages are rare, but so are Enron scandals and both have terrible outcomes. Are you considering all the risks to your operations, even if they’re not as exotic as Elephants?  Do you understand your options, and what they’re worth to you?

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Leader Due Diligence – Psychometrics as Part of Financial Transparency?

With the Bernie Madoff being the latest in a series of massive financial frauds caused by leaders who misrepresented themselves, the time may have come to broaden the financial world’s definition of “transparency”.  I’d like to offer a broader view to include publicly reported reports on leadership knowledge, skills, abilities, traits, values and interests.  Would you have invested in Madoff’s Ponzie scheme if you had previously reviewed a report from a trusted authority on leadership assessment that noted he is low on conscientiousness and prudence?  How would a board view this same report on a founder-CEO?

How well do you know your leaders?

How well do you know your leaders?

Poor leadership is common, but leaders rarely fail in such a public way.  In one study of nearly 400 Fortunte 1000 companies, 47% of executives and managers rated their company’s overall leadership as fair or poor; and only 8% rated it as excellent (Csoka, 1998).  Personality traits predict both performance and ineffective leadership.  For example, conscientiousness is one of the “Big 5” factors of normal personality that has been shown to consistently predict both job performance and dishonest behavior in the worklpace. Former professors of mine, Robert and Joyce Hogan have written extensively about this area, and have authored some of the better classical test theory instruments for normal personality, the “dark side” or disfunctional leadership, and leader motives, values and preferences.  None of these sorts of assesments are typically used systematically to plan CEO development in private by the board.  And it is entirely unheard of for these reports to be shared publicly with prospective customers, partners and shareholders.  Perhaps we should reconsider making these transparent, systematically, given the risk and lack of confidence in markets of late?   The free paper I drafted, “The Three Stooges of Operational Risk: Advances in Leadership Due Diligence and Rasch Measurement” proposes a way of improving our leadership assessments.  If desired, they could be used for this transparency purpose.   I welcome your feedback.

Special thanks to Alexei M for inspiring this idea.

References

Csoka, L. S. (1998).  Bridging the Leadership Gap.  New York: Conference Board.

Hogan, R., Curphy, G., & Hogan, J. (1994).  What We Know About Leadership: Effectiveness & Personality.  American Psychologist 49(6), 493-504.

Robie, C., Brown, D., & Bly, P. (2008, March).  Relationship Between Major Personality Traits and Managerial Performance: Moderating Effects of Derailing Traits.  International Journal of Management, 25(1), 131-139.

Madoff Destroys $50 Billion with “Giant Ponzie Scheme”

Bernie Madoff is the latest in the series of senior executives to destroy value, this time with an apparent $50 billion dollar fraud, according to the Financial Times.  Madoff, a former Chairman of the NASDAQ stock market, on thursday admitted to his employees including his two sons that his operations were “all just one big lie” and “basically, a giant Ponzi scheme”.  The alleged fraud is the largest ever investor fraud ever blamed on a single individual.

Previously, I had written about the “Three Stooges of Operational Risk“, where I detailed senior executive destruction from Key Lay of Enron, Bernie Evers of Worldcom and most recently, Dick Fuld‘s follies with Lehman Brothers.  In two of those three I noted the dishonesty and fraud that accounted for their downfall similar to Madoff.  But unlike Madoff, they were less candid about thair fraud.  After Madoff’s brazen alleged admission, is there any uncertainty that leadership due dilligence is a critical part of the selection process of hiring senior executives?  Could it be any more clear that the pre-hire assessment procedure is a non-trivial subset of Enterprise Risk Management?

In fairness, these Industrial Organizational Psychology methods have their limitations.  No forecast could ever be perfect, or and even the best assessment procedures only account for 30-60% of the variance in job performance.  But it’s relatively rare that factors such as conscientiousness are used to screen executives – and conscientiousness highly predicts dishonest, and imprudent behavior in the workplace like that of Madoff.  With new methods from Rasch Measurement, Computer-Adaptive Testing, and an innovation from the Scientific Leader, “Inverted Computer Adaptive Testing” using Virtual Realtity, it’s increasingly difficult for people to fake or misrepresent themselves on these assessments. 

How much risk are you accepting when you use standard interviews to hire your employees?

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Should Harvard Follow Peter Schiff?

Harvard expects it could loose as much as 30% of its’ almost $37 billion dollar endowment fund that finances over a third of its’ expenses annually, according to the New York Times. Harvard President Drew Faust’s note to his Deans indicates that their diversified portfolio has lost about $8 billion, or 22% of their value.  While Harvard appears to be diversified, with investments in everything from private equity to timber and real estate, it appears to have been hit by the current crisis like most other organizations and private citizens.  The Times reports that Harvard only had about 12% of their portfolio in foreign equities, and another 10% in emerging markets.  It didn’t mention whether or not Harvard held non-US currencies or hard assets such as gold.

Here’s a 10-year view of Gold’s value in dollars.  While it’s taken hits recently, overall it has dramatically outperformed the dollar.

Peter Schiff is the President of Euro Pacific Capital, and has called the US recession many years ago.  His clients are well diversified out of US currencies and equities, in favor of developed economies because his motto is “There’s a bull market somewhere”.  Uniquely, he sells gold held at the Perth Mint in Australia, and gold has done relatively well as an investment against the dollar.  Anyone else think Harvard could do better by following Peter’s guidance, and perhaps moving a massive amount of their assets outside the US?  As I noted previously, I’m moving my assets to Peter’s firm.  Should Harvard follow my lead?

Silver Lining to Financial Crisis?

Excellent leaders persevere in the face of adversity such as the current financial crisis.  We need to help our people through difficult times, with personal resiliency and authentic optimism about the future.  We have to be candid about the dire situation of the financial markets and the significant pain and suffering that awaits employees in countries affected by the downturn. In the US, the likely long-term recession or horrific possibility of a sequel to the great depression is a possibility we must acknowledge.

But today, November 27 2008, is the day people in the US celebrate those things we appreciate.  On Thanksgiving, can we also have a vision of the big picture beyond the painful side of the crisis?  Can we credibly claim an upside?  The Scientific Leader thinks so.  I’ll outline some of the potential good that may come to business as a result of this difficult time, and welcome your own ideas:

  • Demise of Snake Oil
Could it be that a massive financial belt tightening across industries and boarders will cause leaders to consider the evidence before they buy?  I suspect that managers and employees will be more prudent than ever before, when cash is extremely limited.  As Bob Sutton notes that 90% of Consultant’s advice is crap; those of us in the 10% minority who use evidence may see an uptick in our business.

  • Respect for Uncertainty

Too few leaders historically cared about risk and uncertainty as major aspects to business management.  But the recent high-profile collapses may have changed this forever.  Lazy managers and leaders of the past would rely more on intuition and judgment instead of the more complicated and tedious methods that use probability.  But as Richard Feynman once noted, “Mother Nature Can’t Be Fooled”.  The scientific method requires uncertainty to approximate the truth.  Leaders who seek to manage risks and returns would do well to study the leadership methods to measure and value risk and uncertainty.  These include Monte Carlo and Real Options methods as part of a portfolio in managing Enterprise Risk. 

  • Substance trumps slick

Will companies managing through this downturn tolerate glitz without substance?  Will the trash and trinkets given away at large-company meetings lessen?  I don’t know for sure, but I suspect there will be less tolerance for this in the near term at least.  The free t-shirt for the “flavor of the month” initiative may be as endangered as the constant initiative churn that burns capital without creating value.  Demonstrable value may come into vogue again.  The Scientific Leader’s “Cue See” model attempts to be a practical way of discerning and improving the value creation process.

  • Global Cultural Savvy

With the US Dollar likely to follow the way of Zimbabwe, firms heavily dependent on the dollar will have to hedge their risk.  Even small to medium sized firms may be wise to consider holding retirement and other assets in foreign equities, currencies, bonds, and hard assets like gold.  To do this, Americans will have to learn more about other countries rules.  In many cases, people will find that places such as Singapore and Hong Kong have even more freedom than the so called “land of the free”.  Americans may have more sensitivity to different ways of working and doing things, rather than a mindless, “US is Best” mantra of the past.  Businesses like Peter Schiff’s Euro Pacific Capital are staged to take their business and help them diversify.

What upsides do you see from such a crisis for business?

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Marriott Brand Equity Overcomes Hiccups

I’ve been fond of Marriott Hotels for many years.  Marriott properties are consistently clean, affordable, and the restaurants are good.  I especially liked the J.D. Marriott in Hong Kong – their Dim Sum breakfast was amazingly good.  Because I’ve had such a good experience, I strongly prefer Marriott to other brands.

Recently, my family took a vacation to the Marriott Timber Lodge.  They offered us a special deal, as “Marriott Rewards” members with tens of thousands of “points” from prior visits, and we got a great bargain.  But after we reserved our room, my wife noticed some bad reviews on tripadvisor.com about this particular property.  They claimed that lackadaisical European students took jobs there to ski, but didn’t give good service and that the rooms weren’t clean.  Worried, but skeptical, we called customer service.  The representative politely reassured us that we had numerous sources of recourse if we were less than satisfied, so we went ahead and checked out the hotel ourselves.

While it wasn’t a flawless stay, the hotel was absolutely beautiful, clean and organized for lots of complimentary fun.  The location is excellent – nearby many nice Lake Tahoe activities and restaurants – right on the Nevada-California boarder.   Our reservation included a sofa bed for our two boys, and when we noticed our room didn’t have one, we were pleased to get a much better and bigger room with a better view.  Kevin, the housekeeping supervisor, gave one of our already discounted nights for free to compensate for our trouble.  The rest of the stay was just great.  We had a wonderful time.

Marriott’s excellent brand is a good example of what Industrial Engineers and Lean Six Sigma practitioners would consider variance reducing mechanism.  These are the sorts of advanced topics The Scientific Leader enjoys teaching to advanced practitioners, called “Black Belts” and “Master Black Belts.  Brand equity is created because companies like Marriott consistently deliver the value they promise.  Consistently good performance causes people to associate all services of Marriott as valuable and consistently good.  Consistent performance is possible because firms like Marriott systematically manage their processes, both inputs such as high quality employees, training and high quality furnishings; and they combine these together so consistently well that it makes customers happy.

Customers return the favor by being willing to give more business, telling their friends and paying premiums beyond those without such a good reputation.  In my case, the brand also overcame some small negative feedback on a Web 2.0 social network.  Because I already had such a good impression of Marriott, I discounted heavily the negative feedback on tripadvisor.com; and now that I’ve experienced Marriott’s Timber Lodge myself, I can completely ignore the negative feedback as we had a great time.

Could Marriott have improved their process and not had the hiccups I experienced, or those of the customers who wrote on tripadvisor.com?  Sure, they can and should.  Lean Six Sigma methods can help.  But Brand involves the complete set of memories I’ve had of all the value I’ve gotten from them.  One “delighter” was that every time I called the front desk, they answered, “How may I serve the Barney family today”?  That’s not happened to me before.  Little touches like this are pleasant surprises, and because my total experience was great, I’m still very loyal and will continue to differentially frequent Marriott whenever I can.  What brands make you loyal?  Have you noticed that superior brands lower the cost of sales and reduce sales variability?  Are you making investments in your company or personal brand? Do you consider your Brand management as part of your Enterprise Risk Management process – to mitigate customer and marketplace risks?

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American and European Human Capital Options

A derivative is a financial instrument that gets it’s value from something else.  One special type is an “option” that gives the owner a right, but not the obligation, to buy or sell an asset.  Human resource, or personnel, employment is a special case of Real Options applied to people. In our case, though, we own ourselves and our labor, but for the right price we’re willing to lease it out to employers and clients for a period of time. 

In the case of employment, hiring an employee amounts to buying (call option) the right to utilize labor for 8 hours a day.  In some cases, the terms of an employment contract are extremely limited, such as contracts for professional athletes and union members.  These amount to a European option, such as the case where the owner of a baseball team has the right to release an athlete, on but not before a certain date.  The more flexible type of employment arrangement is the American option variety.  With an American option, the owner can exercise their right (e.g. liquidate the asset, or fire the employee) without respect to a specific date.  In option terms, letting a person go, or not hiring a consultant for another project is called a “put option”.

But with human assets, there are numerous other options employers can choose to take – including redeploying people to work on new projects, in new departments and in different jobs.  The more flexible a person in having skills and motivation to work in areas that are profitable to the firm, the more valuable the person. 

When mixed with psychometrics such as The Scientific Leader’s Computer-Adaptive Measurement(TM) approach, human capital can be valued the same way as other uncertain financial assets – using Managerial Real Options.  Have you valued your human capital the same way as professional financiers?  Do you know where your human capital is best deployed in the portfolio of job tasks and projects in your firm?  How flexible and adaptable is your workforce – to be able to redeploy them to new work as customers, markets, and economic crises unfold?  Have you considered the option of investing in growing the skills of your employees to increase their value and reduce your risk, through training and development?

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