Blame it on the Black Swan! - Can Strategic Risk Explain Why Project Business Objectives are Sometimes Not Met?
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Blame it on the Black Swan!
Can Strategic Risk Explain Why Project Business Objectives
are Sometimes Not Met?
25th Anniversary Seminar
Continuing Education in Project Management
19 November 2008
Presented by Richard E. WestneyIt’s Time to Rethink
Financial Meltdown
Global Warming
Energy Crisis
• Who will the players be?
• How will they make capital investment decisions?
• What risks will they need to manage?
• Which strategies will be required?
• HOW WILL THEY BUILD THE CONFIDENCE NEEDED TO GET IT DONE?We Begin With Decisions • Many/most strategic decisions turn out to be wrong! – Capital projects – Mergers & acquisitions – New product launches • It is all about how decisions are made – Which projects should we do? – What expectations should we set? – What strategies are most likely to achieve those objectives? • We make these decisions based on: – Expert opinion – Quantitative information & analysis – Our organization’s decision process – Gut instinct
1. The Importance (?) of Expert Opinion
The Experts Predict ….
• Thomas Edison
– In 15 years more electricity will be sold for electric vehicles
than for light (1910)
– The nickel-iron battery will put the gasoline buggies our of
existence (1910)
– The talking motion picture will not supplant the silent
motion picture (1913) Charlie Chaplin agreed: The
cinema is little more than a fad (1916)
– The phonograph (which he invented) is not of any
commercial value (1880)
– The radio craze will die out in time (1922)
– The possibilities of the airplane … have been exhausted
(1895).
Wilbur Wright agreed: Man will not fly for 50 years (1901)The Experts Predict ….
• Albert Einstein
– There is not the slightest indication that (nuclear) energy will ever be obtainable
(1932)The Experts Predict …. • Pope John Paul II: Its too early for a Polish pope (1978)
The Experts Predict …. • Margaret Thatcher: No woman in my time will be Prime Minister (1969)
Sometimes Expert Advice is Best Ignored…
• To Marilyn Monroe: You’d better learn secretarial work or else get
married. (1944)Sometimes Expert Advice is Best Ignored… • To Ronald Reagan: You don’t have the presidential look. (1964)
Sometimes Expert Advice is Best Ignored… • To Fred Astaire: Can’t act. Can’t sing. Balding. Can dance a little. (1928)
Sometimes Expert Advice is Best Ignored…
• To Clint Eastwood: You have a chipped tooth, your Adam’s apple sticks out, and you
talk too slow. (1959)Sometimes Expert Advice is Best Ignored… • To Wolfgang Mozart: Far too noisy, my dear Mozart. Far too many notes. (1786)
Sometimes Expert Advice is Best Ignored… • To Elvis Presley: You ain’t goin’ nowhere son … go back to driving a truck! (1954)
Sometimes Expert Advice is Best Ignored… • To the Beatles: Groups of guitars are on the way out (1962)
Sometimes Expert Advice is Best Ignored…
• To Thor Heyerdahl: Who in hell wants to read about a bunch of crazy Scandinavians
floating around the ocean in a raft? (1947)2. The Insights (?) from Quantitative Analysis
The More Things Change ……….
• Beware of Greeks bearing gifts
Virgil – 1184 BC
• Beware of Geeks bearing models
Warren Buffett as quoted in WSJ – Nov 3, 2008Crunching the Numbers (Analysis)
• Who’s got the answer?
Q: Assuming a fair coin is flipped 99 times and gets Fat Tony
heads each time. What are the odds of heads on the
next flip?
A: ??????
Dr. John
From: The Black Swan, Nicholas Taleb3. The Power (?) of the Corporate Decision Process
Rethinking Decision-Making
Consider: Owning the right risks - rather than seeking to transfer all risks
Recognize: Organizations have fragmented views of risk – alignment is required
Lacks the knowledge and risk vocabulary
From: Owning the Right Risks; to dialogue with management
Buehler, Freeman, Hulme; Board
Harvard Business Review,
September 2008
Seeks strategic dialogue about risk but
must rely on intuition
CEO
Understands the risks but Has narrow view of risk,
has little influence on often focusing on
decision-making CRO CFO compliance
Uses sophisticated risk
management tools but only
for short – term risk Treasurer BU BU BU
Lack the sophistication to understand,
much less measure, their own risksIs This Any Way to Make Investment Decisions?
Lacks the knowledge and risk vocabulary
to dialogue with management
Board
Seeks strategic dialogue about risk but
must rely on intuition
CEO
Understands the risks but Has narrow view of risk,
has little influence on often focusing on
decision-making CRO CFO compliance
Uses sophisticated risk
management tools but only
for short – term risk Treasurer BU BU BU
Lack the sophistication to understand,
much less measure, their own risks
Inherently optimistic … anchored to “first
number” … fear reprisals for bad news …
willing to accept ‘stretch goals” … risk
Project focus is TACTICAL - on what can be
controlled – rather than Strategic (which
Rational economic behavior Team
has the most impact).
drives desire to make project
look good … assumptions &
qualifications made as needed Contractors SuppliersIs This Any Way to Make Investment Decisions?
Lacks the knowledge and risk vocabulary
to dialogue with management
Board
Seeks strategic dialogue about risk but
must rely on intuition
CEO
Understands the risks but Has narrow view of risk,
has little influence on often focusing on
decision-making CRO CFO compliance
Uses sophisticated risk
management tools but only
for short – term risk Treasurer BU BU BU
Lack the sophistication to understand,
much less measure, their own risks
Where did STRATEGIC RISKS get discussed???
Inherently optimistic … anchored to “first
When did the REALITY CHECK take place???
number” … fear reprisals for bad news …
willing to accept ‘stretch goals” … risk
Project focus is TACTICAL - on what can be
controlled – rather than Strategic (which
Rational economic behavior Team
has the most impact).
drives desire to make project
look good … assumptions &
qualifications made as needed Contractors SuppliersBlame it on “The Planning Fallacy”
In its grip, managers make decisions based on delusional optimism
rather than on a rational weighting of gains, losses, and
probabilities. They:
• Overestimate benefits and underestimate costs.
• Spin scenarios of success while overlooking the potential for
mistakes and miscalculations
As a result, (they) pursue initiatives that are unlikely to come in on
budget or on time – or ever to deliver the expected returns..
NEEDED: an outside view to provide a reality check
(from: Delusions of Success, Harvard Business Review, July 2003)What Can We Do to Improve?
Rethinking our Management Process
Due Diligence
How will we be confident
we have discovered what Governance
we need to know?
How will we be confident
our organization can Decision-Making
perform?
How will we be confident
we are making the right
decisions?Rethinking Due Diligence From this: To this: • “Developer optimism” drove early • Independent perspective business decisions & commercial ensures all risks and impacts terms are considered • Rating agencies and independent • Early, “wide-angle” view engineers informed investment ensures realistic expectations decisions in commercial terms • Commercial terms/covenants used • Strategic risk analysis provides to limit risk exposure financial view of Risk Exposure
Rethinking Due Diligence
Consider: Strategic risks often outweigh tactical risks
Recognize: Many risks are volatile - and not reduced with time Strategic Risk examples:
• Global market conditions
• Location-related risks
• Scope/technology risks
“Wide-Angle Vision” recognizes ALL RISKS
“Black Swan” strategic risks are considered outliers
“Tunnel Vision”
Commercial Feasibility Pre-FEED* FEED* Execution
Development
Start
Start of
of FEL
Sanction / Production
Financial CloseRethinking Our Paradigms
Consider: “The Stockdale Paradox”
Recognize: Accepting reality is essential for success
Retain faith
Be clear, & Optimal
AND at Be brutally
that you will
committed to the same frank about
prevail in the
decisions
your vision of time your current
endsuccess
… & plans realities
From: Good to Great, Jim Collins, describing the survival mindset of Medal of Honor winner Adm. James Stockdale
while a prisoner in North Viet Nam.Rethinking Governance
From this: To this:
• Organizations were based on • Risk-driven competency
legacy and/or desire to model drives organization
minimize headcount development & resource
requirements
• “Stage-gate” processes were
• Decision gates and focus areas
applied to all projects with
are tailored to risk mitigation
discipline & consistency
strategies
• Risks were reduced by • Risks are allocated to the most
maximizing allocation to others appropriate partiesRethinking Governance
Consider: A Risk-Driven Competency Model – in which staffing and functional
requirements are dictated by the risks to the project portfolio
Recognize: Strategic risks require management attention
Typical risks:
Management
Management intervention • Geopolitical trends
in project-level activities
• Global economic conditions
Level of Governance
and tactics leads to
internally-driven risks • Partner & counterparty issues
• Organizational misalignment
Typical risks:
Unmitigated strategic
• Project definition changes
Project Team
risks eventually become
• Contractor performance tactical issues for the
project team
• Pricing & lead times
• Execution difficulties
Tactical Strategic
Level of RiskRethinking Decision-Making
From this: To this:
• Open and realistic
• Management by expectation dialogue on risk drivers &
inhibited realistic/open exposure aligns all parties
discussion of all risk
• Probabilistic view of risk
• Single-point, deterministic exposure drives strategic
estimates provided the basis plans
for analysis & decisions
• Portfolio strategy and
• Projects were evaluated on a value at risk are part of
standalone basis project funding decisionsRethinking How We Manage Consider: The new landscape has destroyed long-standing business models Recognize: With Creative Destruction comes opportunity for those that can adapt "Corporations are built on the assumption of continuity; their focus is on operations. Capital markets are built on the assumption of discontinuity; their focus is on creation and destruction. Unless companies open up their decision-making processes (and) conventional notions of control, and change at the pace and scale of the market, their performances will (slide into) mediocrity." (from Creative Destruction, Foster & Kaplan)
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