Operational Risk: Mitigation is not Self-evident
Operational risk is everywhere in the business environment, every decision has its share of uncertainty. Nothing is a sure thing, yet we when we make important decision we certainly want to “keep the odds in our favor”. I have often heard the terms like ‘risk appetite’, ‘risk tolerance’, or ‘risk aversion’ used in reference to making forward-looking choices about operational risk as if we can rationally and effectively manage risk based on our subjective feelings. These terms, however, provide little guidance and position risk-management in the domain of oracles and soothsayers. Business is not a game of chance based on our subjective ‘feelings’ regarding operational risk.
The stakes are too high relative to operational risk to leave it to subjective guesses or ‘gut’ feelings. Mitigation actions or counter-measures are often quite expensive, and the consequence of doing nothing or doing the wrong thing can be enormous. When Executive Leadership is asked to make a choice such as ‘investing $60 million for an effective disaster recovery solution’ or to ‘continue to operate under the status quo and risk going out of business'; do we really expect our executives to make this choice by asking themselves the Dirty Harry Callahan question, ‘Do I feel Lucky?’.
Of course not, we expect our executives to make rational and well-informed decisions. We don’t expect our leaders to gamble with $60 million neither do we expect them to put the organization into a position of 'going out of business'. Terms like risk appetite, risk tolerance, and risk aversion are not measures of risk. These terms are merely abstract measures of emotional and subjective feelings and it has been well established that people tend to make many mistakes about risks when they use their subjective feelings.
In addition, there is a flawed notion that when a risk is intuitively large, such as a 'going-out-of-business risk', that the solution will be self evident. This notion, however, is also just another subjective feeling. Knowing that there is a large risk does not mean the optimum mitigation-action is also well known. Whether it is a ‘$60 million investment’ or a ‘going-out-of-business’ condition, the stakes are too high to take a guess at it. To develop a proportional response we must to inform ourselves accurately about the facts of the situation. To keep the odds in our favor we must economically-quantify the operational risks so that we can properly evaluate the many tradeoffs.