It is currently in vogue for companies to eschew quarterly guidance to stay focused on long-term goals. Focusing on quarterly guidance, they say, takes time and attention away from longer-term goals. In theory, this is a good plan, but often the long view of which they speak lacks appropriate focus on risk.
Take Mattel Inc., for example. In one of those delicious coincidences, the El Segundo, Calif.-based toy maker stated its intent to move to a more long-range focus just before news broke that it had been importing toys from China that contained lead paint. In this "long view," the specter of selling items covered in poison to toddlers was conspicuously absent. On Oct. 10, CFO.com ran a story titled "Bad Play: Mattel Sued for Keeping Mum on Toy Defects." Apparently, in its desire to focus on long-range goals, Mattel became blind to the long-range risks.
The discussions regarding financial guidance and the focus on short-term or quarterly results revolve around financial projections. Somehow, publicly traded companies are expected to make earnings calculations and present these in the form of an expected range. But as Mattel demonstrated, even companies advocating a longer-term vision still miss one key element; they rarely if ever make any mention of the risks that threaten those goals.
When creating projections, the one unavoidable barrier to accuracy is uncertainty. No one knows what will happen in the next quarter, month or even in the next few moments. As one extends a projection further and further into the future, the amount of uncertainty increases. One might have a good idea what oil will cost tomorrow, but guessing the price in June 2011 is a bit more difficult. Projecting the likelihood of achieving a financial goal in three months is moderately uncertain; projecting the chances of attaining a goal in three years is highly uncertain.
But uncertainty can be tamed to some degree by stochastic analysis. This, however, can lead to deadly miscalculations. Companies often become so focused on execution that they fail to assess the risks.
For example, if one has a goal of driving across the United States, one can plot out a route, estimate the time it will take to complete various legs of the journey and arrive at a reasonable estimate of the time it will take to drive from New York to California.
This estimate would be rendered completely meaningless if one failed to assess all of the things that could either stop or accelerate progress. Bad tires and no spare in the trunk could add days to the journey as could any number of mechanical breakdowns. Running out of gas in the sparsely populated and sometimes dangerously cold Rocky Mountain states could cause the type of delay that ends in a eulogy.
It is not as if risks have diminished in the modern world. With supply chains stretched across the globe, a truckers' strike in Indonesia could stop the supply of products in the United States for months. Political unrest or changing regulations can have devastating implications for a business, as can a myriad of other risks.
It is not at all clear whether Mattel's senior leadership, in its quest for long-range vision, suffered from severe risk myopia. However, it is clear that it was blindsided by the revelation that toys manufactured in China could contain lead paint.
A long-range view that excludes potential risk is not simply flawed, it is dangerous. It should be a surprise to everyone, including institutional investors, how rarely risk is explicitly contemplated by senior management. Failing to manage risk is a very short-term view.
is the risk management columnist for Risk & Insurance®.
January 1, 2008
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