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strategicrisk - 1 STRATEGIC RISK MANAGEMENT Why would...

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1 STRATEGIC RISK MANAGEMENT Why would risk-averse individuals and entities ever expose themselves intentionally to risk and increase that exposure over time? One reason is that they believe that they can exploit these risks to advantage and generate value. How else can you explain why companies embark into emerging markets that have substantial political and economic risk or into technologies where the ground rules change on a day-to-day basis? By the same token, the most successful companies in every sector and in each generation – General Motors in the 1920s, IBM in the 1950s and 1960s, Microsoft and Intel in the 1980s and 1990s and Google in this decade- share a common characteristic. They achieved their success not by avoiding risk but by seeking it out. There are some who would attribute the success of these companies and others like them to luck, but that can explain businesses that are one-time wonders – a single successful product or service. Successful companies are able to go back to the well again and again, replicating their success on new products and in new markets. To do so, they must have a template for dealing with risk that gives them an advantage over the competition. In this chapter, we consider how best to organize the process of risk taking to maximize the odds of success. In the process, we will have to weave through many different functional areas of business, from corporate strategy to finance to operations management, that have traditionally not been on talking terms. Why exploit risk? It is true that risk exposes us to potential losses but risk also provides us with opportunities. A simple vision of successful risk taking is that we should expand our exposure to upside risk while reducing the potential for downside risk. In this section,, we will first revisit the discussion of the payoff to risk taking that we initiated in chapter 9 and then look at the evidence on the success of such a strategy. Value and Risk Taking It is simplest to consider the payoff to risk in a conventional discounted cash flow model. The value of a firm is the present value of the expected cash flows, discounted back at a risk-adjusted rate and derives from four fundamentals – the cash flows from
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2 existing investments, the growth rate in these cash flows over a high-growth period accompanied usually by excess returns on new investments, the length of this high growth period and the cost of funding (capital) both existing and new investments. In this context, the effects of risk taking can manifest in all of these variables: - The cash flows from existing investments reflect not only the quality of these investments and the efficiency with they are managed, but also reflect the consequences of past decisions made by the firm on how much risk to take and in what forms. A firm that is more focused on which risks it takes, which ones it avoids and which ones it should pass through to its investors may be able to not only
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