daniel chigunwe
Elgin Chetsanga
One of the most debated questions in risk management is whether risk appetite or strategy should come first.
Many businesses default to strategy but is this the best approach and risk appetite is considered afterward. But could this approach be holding organisations back from making smarter, more informed decisions?
Strategy and risk definitions
Well part of the answer lies in the strategy and risk appetite definitions. Simply taken, strategy is the plan that defines how an organisation or individual intends to achieve their goals. Strategy can be thought of as the “what” and “why” of an organisation’s goals, direction, and vision.
Risk appetite on the other hand is the “how far” the business is willing to go in pursuit of those strategic objective. The strategy-first approach, the “what and why”, then seems naturally logical, but what are its advantages and limitations?
The strategy-first approach: Advantages and pitfalls
The strategy-first approach has been the most common and most preferred by many businesses. The reasons for adoption of this approach are compelling.
Putting in place a strategy first develops a clear picture of the desired future state and the path to get there.
Additionally, it helps the business to focus on opportunities by prioritising strategies based on potential benefits, while not being constrained by upfront risk considerations.
However, the strategy first approach has drawn criticism for its perceived lack of upfront risk assessment. Critics believe that this can lead to “risk overreach” and underestimating resource requirements for risk mitigation and contingency planning.
For instance, a company that sets an ambitious growth target without considering the potential regulatory risks. This oversight could lead to costly delays and a damaged reputation when it faced compliance issues.
Which brings us to the other end of the spectrum. Can setting risk appetite first be the solution?
The risk appetite-first approach: Benefits and limitations
Starting with risk appetite has its fair share of proponents and not surprisingly these include second line functions personnel. This approach is lauded primarily because it has upfront risk assessment.
Also supporting its adoption is the argument that starting with risk appetite helps organisations make informed decisions by guiding strategic choices within the boundaries of acceptable risk limits.
The risk first approach is not without its limitations as well. The biggest push back is that it may hinder innovation by placing a heavy focus on risk.
Take for example an organisation that became so risk-averse that it missed out on adopting a new, promising technology, ultimately losing market share to more agile competitors.
Businesses also often fail to revisit the risk appetite as circumstances change, which could impact the feasibility of existing strategies.
Notwithstanding its limitations, there are some industries such as the financial services, insurance, venture capital, aviation, healthcare etc where this approach is favoured.
These industries tend to prioritise their risk appetite more prominently, often adapting their strategic decisions based on the level of risk they are willing to take on at any given time.
This is because these industries operate in environments with high downside costs and ensuring that risk appetite is prioritised becomes necessary. However, this risk first approach has its weakness as well leaving us with a need for a third option.
The risk-strategy loop
Critics argue that neither approach is perfect. From the two options it becomes clear that there is feedback loop between risk and strategy and one benefits from the other.
Strategy can be adjusted based on risk appetite. If a business finds that the risks associated with a chosen strategy exceed its appetite for risk, it may adjust its approach.
For example, a high-growth strategy might be scaled back if the business faces financial strain or operational challenges.
Simultaneously risk appetite can be adjusted based on strategic direction. A change in strategy — say, a shift towards a more aggressive market positioning or innovation-driven growth — might lead the company to reassess its risk appetite.
The leadership may decide to be more aggressive with investments, financing options, or business expansions, which may require a broader acceptance of risk.
A balancing act
A school of thought has emerged that recommends considering both risk and strategy at the same time.
This approach allows for a business to conduct the difficult but beneficial of discussions with 1st and 2nd line functions to essentially find middle ground which ticks all the boxes on both sides.
For instance, this means the business needs to setup up regular checkpoints, where strategy and risk appetite are evaluated and re-evaluated together, ensuring that neither element is deprioritised.
Businesses could implement quarterly reviews where cross-functional teams — from risk management to strategic planning—collaborate to assess the organisation’s progress and challenges.”
Easier said than done.
Considering risk appetite and strategy simultaneously presents a range of challenges for organisations, primarily because these two elements often require balancing conflicting priorities.
It requires organisations to be flexible and adaptive while also maintaining a clear and coherent approach to managing risk.
This collaborative approach should include regular communication, shared frameworks for risk assessment and a commitment to revisiting both strategy and risk appetite as market conditions evolve.
Successful integration of these two components demands strong leadership, clear communication and a well-defined process for assessing and responding to risks as strategies evolve.
Elgin Chetsanga is a risk management expert. He can be contacted on 0774 438 480, or [email protected]
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