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Risk from the Managers Perspective (Part 2)

Daniel Dumke — Fri, 12 Nov 2010 11:37:00 +0000

Today I will write about the implications of the risk understanding by managers covered in Part 1 of this series. After observing the mentioned factors on how managers perceive risks the authors categorize their conclusions in three areas.

Insensitivity of Risk Taking to Probability Estimates

[Decision makers] do not trust, do not understand, or simply do not much use precise probability estimates.

This quote summarizes one of the major findings. Probabilities – not risk at large – are not well understood and handled by managers. This is especially fatal when considering disruptions, events with low probabilities but high adverse effects. Because these events are then ignored since managers are overwhelmed by their sheer number. And of course this leads to organizations which are always surprised by events that they did not think of.

In some of my interviews during my research with business executives I spotted the same behavior: supply chain managers that never have thought of the possibility of a strike, a fire or another catastrophe. But the number of managers on the other end – so really managing these risks – seems to be even lower.

The Importance of Attention Factors for Risk Taking

Empirical research – as for example in Part 1 – indicate that risk preference varies with the context in which the decision has to be made. This includes everything from individual feelings of the manager, how and by whom the data is presented, the company context, etc.

In human decision making there is always the tendency to focus on a few key aspects of a problem at a time. Therefore it is of the utmost importance to define and calculate the key metrics correctly, but often not only the measures may pose a problem but also the target levels to assess performance (eg. break even) and survival levels. These two reference points partition possible states into three: success, failure, and extinction; and with that massively influence decision making in each of the three categories

Risk Taking, Gambling, and Managerial Conceit

Managers do care a lot about their reputations for risk taking, on the other hand are eager talk about how they assess the qualities of others in this regard and on the inadequacy of organizational incentives for making risky decisions intelligently. So risk taking seems to be a very important part of their definition of life as a manager. It is important to take risks, but not to “gamble”.

Hence, it is amazing to see that managers are still rewarded for good outcomes rather than good decisions (making).
The authors see this point very critical

Society values risk taking but not gambling, and what is meant by gambling is risk taking that turns out badly. Thus, risky choices that tum out badly are seen, after the fact, to have been mistakes. The warning signs that were ignored seem clearer than they were; the courses that were followed seem unambiguously misguided.

Conclusion

The authors conclude with the following recommendations for the proceeding:

Short run: Measures have to be designed which accommodate for these findings, but more importantly there has to be a concept on how to steer risk taking by managers.
Long run: These findings might have implications for the education of managers to improve the individual risk taking.

We may prefer to have managers imagine (sometimes falsely) that they can control their fates, rather than suffer the consequences of their imagining (sometimes falsely) that they cannot.

This article has been written in 1987, nearly one generation ago, but to be honest I believe most of the results are still true nowadays (to my knowledge there has not been another similar study, yet). Sadly, I do not think that neither companies have improved decision making nor education has picked up much. In my point of view the handling of decision making under uncertainty should be supported by IT and the organization.

Reference:

March, J., & Shapira, Z. (1987). Managerial Perspectives on Risk and Risk Taking Management Science, 33 (11), 1404-1418 DOI: 10.1287/mnsc.33.11.1404

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Risk from the Managers Perspective (Part 1)

Daniel Dumke — Wed, 10 Nov 2010 08:43:00 +0000

Today I finally read one of the most cited articles on subjective risk in general. In 1987 March and Shapira set out to shake up the existing theories on the perception and processing of risks by managers. Accordingly, they aggregated the information from various surveys on this topic.

The article is called “Managerial Perspectives on Risk and Risk Taking” and it can be downloaded here as PDF and I really recommend reading it.
In the first part I will analyze major empirical findings on how managers perceive risks, the second part will cover the implications from that and will be published this Friday.

Definition of Risk

Usually risk can be defined as a combination of an outcome and uncertainty / probability component. And most people would agree: An alternative with higher outcome is better and one with more uncertainty is worse. Decision theory therefore used the concept of the variance of the outcome distribution to describe risks and many models are based on this. But does this reflect how managers defines risks?

Probably not, the authors show that…

Most managers do not care about uncertainty of the positive outcomes: Eighty percent of the executives said they considered the negative ones only
For managers risk is not so much about probability, but much more about the magnitude of possible bad outcomes, so managers do not seem to be risk averse in general but more loss averse (with a clear focus on the amount not the probability)
Although many managers use numbers for quantifying risks and 42% argued that there was no way to translate a multidimensional phenomenon into one number. Interestingly 24% of the same managers felt it could be done and with additional probing said that actually it should be.

The last point is supported by a common quote:

A senior vice-president observed: “You don’t quantify the risk, but you have to be able to feel it.”

Attitudes toward Risk

It has been acknowledged for some time now that decision makers do not necessarily act purely rational, so several concepts of risk aversion have been developed from a theoretical point of view. But how do managers think about risks.

There are individual differences on the degree of risk aversion, but these differences are less influential than other differences in “incentives and normative definitions of proper managerial behavior”
Some managers show a very negative attitude towards individual risk taking (vs. group decision or “gambling”), this behavior is particularly characteristic of managers who see risk as single construct of the magnitude of the expected loss (ignoring the probability)
Managers tend to believe they are greater risk takers than they are in reality
Motivations to take risks

Risk taking is essential to success in decision making
Risk taking is an expectation on their job
Emotional pleasures of risk taking

Most managers would take more risks when faced with a failure to meet targets than when targets were secure. Furthermore, managers would take riskier actions when their own positions or jobs are threatened then when they are safe

Dealing with Risk

In theory dealing with risks is easy since there are alternatives to choose from and depending on the individual definition of risk and the risk preferences (see above) the correct decision is made. But the behavior of the decision makers shows distinctive features as well.
Very often manager focus on ways to reduce the negative outcomes while retaining the gain of a given alternative. The easiest way to do this is to reject the estimates which form the basis of the proposed alternative. And even after doubting the odds executives still feel that they will be better of since they expect being able to avoid the risks using their experiences.

Go on reading Part 2.

Reference:

March, J., & Shapira, Z. (1987). Managerial Perspectives on Risk and Risk Taking Management Science, 33 (11), 1404-1418 DOI: 10.1287/mnsc.33.11.1404

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Learning from the Military how to handle Disruptions

Daniel Dumke — Mon, 02 Aug 2010 08:45:00 +0000

Disruptions are a fact of life not only since the Supply Chain literature gained awareness of it. So some institutions in fact specialized on handling disruptions as their core competency.
The article “Responding to Disruptions in the Supply Network – from Dormant to Action” tries to transfer the knowledge and best practices present at the military and humanitarian organizations to Supply Chain Management.

Methodology

The authors (Kovács and Tatham) are using case research and a resource based view to find common patterns in military and humanitarian practices to efficiently and effectively act on disruptions.

Military vs. Humanitarian Organizations

The authors find three decision categories common to the two institutions: Physical Capital, Human Capital, Organizational Capital.

Capital	Military	Humanitarian Organizations
Physical Capital	Relative abundance of materials and equipment due to focus on preparation “just in case” Internal resources: importance of individual ownership Location in country of origin or at allies’ site	Lack of own materials External resources: focus on supplier relations (vendor managed inventory, capacity reservation systems), postponement of ownership Pooling of resources Location close to disaster-prone areas
Human Capital	Emphasis on own training of personnel Focus on the knowledge of the doctrine	Mapping potentially available personnel from other organisations In-sourcing personnel from external resources Focus on local knowledge
Organizational Capital	Command and control structure Focus on hierarchy Codified internal processes (doctrine) Limited interoperability	Case-based structure (disruption / programme based) Establishment of common standards Co-ordination with other actors

Results

The article identifies two states for the observed institutions: During times without disruptions they are dormant and only when a disruption occurs they come to action. Though preparation for the “action” phase is very important.
The Military and Humanitarian Organizations exhibit distinct approaches to it.

The Military uses a strong asset focus (acquisition of equipment, training personnel, abundance of internal resources) at the same time they keep a high inventory level and have a rigid command-and-control structure within their organization.

Humanitarian Organizations often specialize in a specific type of disaster, region or type of material. The “Human Capital” is seldomly trained extensively and most often only held in a loose connection to the organization. From the organizational point of view they focus on a strong local presence and, due to the limited resources, focus on postponement (decide on purchasing orders as late as possible), therefore Physical Capital is often local and low.

Conclusion

Supply Chain managers and researchers can learn from both cases alike. The major difference is the resource position from which one acts. Therefore the first step for a company must be to assess the resources available to act on disruptions as soon as they occur.

Reference:

Gyöngyi Kovács, & Peter Tatham (2009). Responding to Disruptions in the Supply Network from dormant to action Journal of Business Logistics, 30 (2), 215-229

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AMR announces Supply Chain Ranking 2010

Daniel Dumke — Fri, 04 Jun 2010 16:49:00 +0000

Gartner just announced the 2010 Supply Chain ranking conducted by AMR Research.
The ranking consists of the 25 companies with the best-ranked Supply Chains.

Ranking

This years Top 5 (extract):

Apple
Procter & Gamble
Cisco Systems
Wal-Mart Stores
Dell

Methodology

The following factors are included in the ranking and make up the overall score.

Peer Opinion / 154 voters (25%)
AMR Research Opinion / 27 voters (25%)
3-yr weighted ROA (25%)
Inventory Turns (15%)
3-yr weighted Revenue Growth (10%)

So there are three factor categories: subjective expert opinion, one supply chain number (inventory turns) and two primarily financial figures.

Methodology / Conclusion

There exists research supporting a correlation between supply chain performance and financial performance of a company, but up to now I have not found papers suggesting that the opposite is true as well. So I doubt that Revenue Growth and Weighted ROA are good indicators to appreciate supply chain performance.

Inventory turns on the other hand is probably very depend on the industry and product in focus and should be used with care.

The last factor is the expert opinion which contributes to the overall ranking. The expert ranking is split into the Peer Opinion and the AMR Research ranking. It is noteworthy, that the weights of both opinions are the same, even though there are five times more Peer Opinion experts than AMR experts indicating, that the AMR experts should be five times as knowledgeable than the other supply chain professionals.

From a business point of view the ranking show companies which have performed above average for a sustained period of time and their example could be used as a blueprint for Supply Chain Design.

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Supply Chain Manager of the Future

Daniel Dumke — Sat, 20 Feb 2010 14:50:00 +0000

“Management Development and the Supply Chain Manager of the Future” by J. Mangan and M. Christopher (2005) aims to bridge the gap between current offerings of knowledge providers (eg. universities), current capabilities of users (eg. students and managers) and buyers (aka. companies).First it seems to be a good idea to get an impression of the demographics of the current supply chain managers. The Supply Chain Management Research Group at Ohio State found in a study, that nearly 95 percent of the supply chain managers are male, median age of managers 39 and about 20% have an additional professional qualification (eg. APICS). It’s also quite interesting to note that the average time the managers worked in the field of supply chain management is about 18 years combined with a high job rotation.

It is also highlighted how these SC-professionals gain the foundation of their knowledge.

In decreasing order of frequency: formal college, in-house training, seminar / workshop, ‘on the job’, and in-house training with an external trainer. Three major institutions are identified to support the professional education. First, so called professional bodies (like CSCMP), second, tertiary education at universities and lastly, publicly funded centres of excellence (like The MIT – Zaragoza International Logistics Program).

The authors argue that the current business transformation processes lead to a special need for experience and education for supply chain managers (this is taken from Christopher, 2004). For example:

The transformation from supplier-centric to customer-centric SCM, leads to the design of customer-driven supply chains, therefore a manager needs market understanding and customer insight.

In their own research they asked the provider-side (universities) what key changes they see to enhance the education. These are the main topics:

Specific logistics competencies are required for emerging markets.
Courses need to be more practical.
Multimodal nature of logistics and SCM needs to be highlighted more.
Need to differentiate between different learners.
Focus on processes and flows.
In-class exercises.
Best practice exists within certain companies.

The goal is to train the future supply chain manager to acquire the knowledge in the following areas:

General

Finance
IT
Management / Strategy

Logistics & Supply Chain Management

Operations
Focus on processes / flows
Legal, security and international trade
Multimodal logistics
Logistics in emerging markets

Competencies / Skills

Analytical
Interpersonal
Leadership
Change management
Project management

Conclusion

On the plus side the article summarizes the literature about the key qualifications, knowledge and skills which are necessary for supply chain managers to cope with the requirements of a changing business.

But on the other side the research part seems to be unilaterally focussing on the provider side, and there especially on the universities. Not only is one of the three randomly selected (?) public funded institutions located at the Hull University (home of the lead author), but also one of the research questions “What are the optimum approaches for career development?” was posed only to the provider side. I guess the result (Masters degree is listed first) does not come as a surprise.

Reference:

Mangan, J., & Christopher, M. (2005). Management development and the supply chain manager of the future The International Journal of Logistics Management, 16 (2), 178-191 DOI: 10.1108/09574090510634494

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