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Process Vs. Capabilities: Part 2

What can a race between a racecar and a cross-over tell you about how well designed your risk management program is? It depends ... what sort of race track are you on?

In part 1 of our discussion on risk management capabilities versus processes, we highlighted the point that a company can be incredibly good at risk management but have it be very capabilities driven, rather than in the form of formal processes.

To better compare these two approaches, let's look at an illustrative case study. Imagine a race between two vehicles. The first vehicle, the Punxsutawney Process, is a rear-wheel-driven Indy racecar with slick tires that is highly tuned based on the types of races that it has participated in the past: i.e., Indy-style racing on an oval track. This car is analogous to a process-driven organization that has strong monitoring, firm limits and the discipline to refine its processes based on its past experiences.

The second vehicle, the Chattanooga Capability, is a front-wheel-driven cross-over vehicle that has the capability to race in many different conditions and terrains. This car is analogous to a capabilities-driven organization that anticipates and is prepared to perform in diverse conditions.

I am guessing that I could simulate this matchup through extensive research by playing hours and hours of car-racing video games on my favorite gaming consol (with of course the aid of my closest friend ... um, research assistants ... and a few cases of beer ... um, I mean rations), but I would probably not be very popular with my wife and kids. As a risk manager, I am smart enough to avoid that scenario.

So let's just imagine the race that would ensue in this matchup between the Punxsutawney Process and the Chattanooga Capability. I speculate that the Process would easily win on any well-paved tracks, especially those that resemble past tracks that the car's encountered. In contrast, the Capability would win on many other tracks or in less-than-ideal conditions: e.g., off-road courses, rainy conditions, pot-hole ridden courses, etc.

However, as we know, winning is not everything. Finishing races (i.e., surviving) is just as (if not more) important. Would both the Process and the Capability be able to successfully survive/finish in any race, in any conditions? My money is on the Capability. How about you?

This does not mean that we should all immediately toss out our risk management processes and focus all of our attention on building capabilities-driven risk management environments by only hiring very intelligent people and teaching everyone to be paranoid about risk. There is a balance required between process and capabilities.

That said, I would suggest that many organizations have applied more focus and resources on the process side of this equation; and for a very rational reason. In a way, process is the easier and more tangible of the two components to address. It can be clearly documented, dissected into activities and decision points, demonstrated, measured and even audited.

Capabilities, on the other hand, are less apparent and tangible. They are often perceived as more difficult to see, document and measure, thereby making it more difficult to determine if one has achieved any degree of improvements. Nevertheless, just because capabilities are more difficult to assess and measure does not mean that they are not a critical component of the risk management equation.

One way to look at this balance is to think about process and capabilities as the two axles of a car. Some cars are rear-wheel drive (process-driven), some are front-wheel drive (capabilities-driven), and some are all-wheel drive; however, all cars must have two functioning axles to drive. The kind of car you choose depends on your organization's needs, preferences and resources (i.e., all-wheel-drive cars are often more expensive).

For instance, companies that operate in very stable and highly predictable environments may be better served by having a process-driven philosophy; whereas, companies that operate in more volatile, less predictable and ever-changing environments may be better served by having a capabilities-driven philosophy.

Just because you own a front-wheel-drive car, though, that does not mean you can simply disregard the rear axle, and vice versa. Similarly, whether your risk management program is process-driven or capabilities-driven, you also have to apply an appropriate amount of focus on also developing the other axle.

In my eyes, the companies that will be the most successful in the unpredictable terrain that we are all driving across today are those that are able to mature their risk management programs into all-wheel drive, where they have both strong but adaptable processes and phenomenal capabilities.

In the end, the key is a balance between both process and capabilities that is congruent with the nature of your organization and environment. After all, how many cars do you know that can drive very far on one axle?

(Editor's note: Follow this link to read part 1 of David's column about distinction between risk management process and capabilities.)

DAVID M. WONG is director of enterprise risk management at CME Group, the world's largest and most diverse derivatives exchange.

April 21, 2010

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