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How to manage effectively in the face of risk

With globalization comes increased risk and uncertainty in nations, environments, communities, and businesses. As growing complexity makes it more difficult to determine the source of risk in these complex systems, it also reveals the interdependent nature of risk within a greater ecosystem. New studies show the best way to manage an organization in the face of risk is to build resiliency—the ability to withstand, recover from, and maintain function through a crisis.  But in order to manage risk effectively, resiliency must be built into the entire interrelated system of an organization.

In the MIT Sloan research paper, “Uncertainty and Risk in Global Supply Chains,” MIT Sloan Professor Donald Lessard states that “risk management requires systematic management of risks that are generated within each link in the chain and, more importantly, in the interfaces among links in order to limit disruptions and their propagation throughout the system.” Effective management of risk, therefore, requires a systems thinking approach—understanding how systems influence one another within a whole.

Global supply chain presents variable risks

Lessard defines global supply chain sources of risk as “variables whose future values are not known with certainty, either because of a lack of information regarding the underlying process, or because they are the result of social, economic, or political events.” For example, a fire at a manufacturing plant, or a political protest outside a Chinese telecommunications hub; both of these events would disrupt—with unknown consequences—the cost, timeliness, safety, and reputation of a company and its products or services.

It’s important to note that not all risk is bad. Lessard also states that when you stake a systems thinking approach to break down the sources, causes, and effects of risk, you discover that there could be an advantage to approaching risk, rather than taking a risk-averse stance. The key to being able to make that call, however, is to determine your system’s resiliency.

Systems thinking builds resilience

Resilience in this context is a basic capacity to recover quickly from stress, to endure greater measures of stress, and to adapt new methods to deal with ongoing stress to a given system. According to an article in Forbes from 2013, business organizations that work on short- and long-term goals, prioritize middle management, invest resources into building a culture, and embrace cognitive diversity all have better chances at succeeding in building resilience. Also important to note is efficiency. Businesses that place too high a priority on efficiency at the expense of resiliency often fare worse, because too much pressure to be efficient can create unnecessary risk.

Near shoring strategies: Risk mitigation vs. volatility

One popular strategy many companies are using to help mitigate risk and build resilience is called “near shoring”—the transfer of business or IT processes to companies in a nearby country, where both parties expect to benefit. But according to Lessard, near shoring can often do more harm than good. “While it will reduce disruption risk and product risk in the form of stale inventories held in the supply chain, it will also increase product demand volatility in terms of employment and factory loading, as it limits the spreading/pooling of this volatility across regions.” It is wise to take a conservative approach to a near shoring strategy and weigh out all potential risk consequences.

The clear takeaway for organizations seeking to manage growing risk would be to first identify the framework through which they currently view their operations and, if necessary, initiate a paradigm shift that creates a systems thinking approach to identifying the causes and effects of risk within each level of an organization. Only then can these organizations develop a long-term plan to build resilience—a critical factor in their future success.

Donald Lessard is the EPOCH Foundation Professor of International Management at the MIT Sloan School of Management and teaches in the MIT Sloan Executive Education course Strategy in a Global World.