This article summarizes the benefits of strategic risk identification and governance methods for financial institutions, identified by applying business war games as a standard testing method. Strategic Risk is difficult to quantify. Unlike other risk categories such as market, credit, or operational risk, where metrics can serve as guideposts to motivate senior management discussions, quantifiable thresholds can be leveraged to support conclusions. Given that strategic risk is an intangible quantity understanding how to test your assumptions can support strategic decisions and help set estimated thresholds.
Risk Identification biases and managerial myopia can be a barrier to turn-based scenario-style games. However, many large organizations use techniques like wargaming to build support for strategic decision-making. Wargames should be used when your company wants to predict new threats to your market share or to test realistic reactions from competitors. For example, this technique could test threats to income from cryptocurrencies and digital innovations or peer-to-peer payments solutions, reducing market share dominance from companies like Visa or Mastercard.
Defining the Company’s Strategic Risk
Strategic Risk is not a new subject and has been debated in board rooms, among risk committees, and executives across industries for many years. Strategic risk is often defined as the financial risk to your firm’s ability to earn revenue, which can be affected by internal and external factors (economic, political, regulatory, and episodic events). Strategic risk management seeks to quantify the risk to your company’s revenue and market share as a direct consequence of managerial decisions (or lack of) and adjustments in business strategies. These can include delays in responding to industry changes, lack of response to competitor moves, or missed opportunities such as entering new markets or expanding existing services. No matter how your company defines strategic risk – the potential to miss, omit and mistakenly calculate economic factors is extremely high. Given the potential for error in measuring the intangible, how can you depend on your risk identification team to find holes in a weak strategy or detect a bad decision?
Here is a non-exhaustive list of examples of potential strategic risk:
- Strategic decisions that are unclear or poorly made
- Changes in senior management and leadership
- The introduction of new services or products
- Market or industry changes, such as a shift in the needs or expectations of customers
- Problems with suppliers and other stakeholders
- Financial challenges
- Failure to adapt to a changing environment or keep up with competitors
- And income effects where your reputation is damaged
Business Wargaming History and Misconceptions
Wargaming is rooted in military planning, and despite allusions to warfare, business wargaming is not about airstrikes or tabletop simulations with miniature soldiers. Wargaming should be designed to test what a competitor, or decision-maker, might accomplish in each scenario.
Business wargaming does not need to be analytically complicated and expensive. Consultants and technologists might pitch mathematically interesting algorithms, maybe even suggest optimal decision analysis through game theory – but to be effective, a war game must be realistic and never entertain an outlier-style event. Realistic and likely scenarios enable managers to focus on how their company might react to a change in the business landscape.
What makes a business wargame realistic? Let’s start with what is not a business war game:
- War games are not based on executive bias, e.g., a senior executive has valuable experience – but in a wargame, it is their strategy we need to test. Individual views hurt a wargame, and a scenario should include managers across your companies disciplines to be effective.
- War games are not based on fantasy or zombie apocalypses. The company’s strategy should be defined, and the objective should be to test one theory or question against competitors’ most likely moves.
- There is no need to understand 10 or 20 moves ahead; you need to understand the next move to your strategic decision and two to five outcomes. Attempts to predict longer-dated future landscapes become more like fantasy and less like strategic outcomes.
- Wargames ask uncomfortable questions of business leaders. Anyone running a test will need to ask serious operational and performance questions that some in your company may find difficult to discuss.
Gaming Approaches to Identify Risk and Test Real-Life Questions
Wargaming is a process that enhances risk-informed decision-making through captivating experiential learning. It is an event that sets aside time for strategic thinking and educates managers on the dynamic aspects of strategic planning. Reasonable, interchangeable scenarios bring diverse stakeholders together to challenge biases and assumptions, identify critical gaps and vulnerabilities, and provide insights into emerging threats and opportunities. Players are allowed to experience failure in pursuit of these insights, all without facing real-world reputational, organizational, and financial risk.
You can use a war game to test scenarios; here are some examples:
- Future Planning (what if?) – gives investors a peek into the expected returns and risks involved when planning for future investments. The goal of any business venture is to increase revenue over time, and it is best when used as predictive analysis.
- Predicting Competitor Moves – Companies can avoid or decrease potential losses from uncontrollable factors during worst-case scenarios by analyzing events and situations that may lead to unfavorable outcomes.
- Avoiding Risk and Failure – Scenario analysis enables businesses or independent investors to assess investment prospects to avoid poor investment decisions. It takes the best and worst probabilities into account so that investors can make an informed decision. Scenario analysis gives measurable data that investors can use to achieve a better outcome. As an example, think of where there is a lack of available clean data; you can’t understand what you cannot measure, and you cannot measure what you don’t track. Business wargames can illuminate where your data team misses the mark; or where your business intelligence team cannot answer fundamental competitor moves?
Wargaming as a Strategic Requirement
In any strategic risk scenario or analysis – pinpointing holes in your data capture systems is crucial to the success of any game.
Often the failure to capture lessons learned from external events while re-examining the execution of the company’s strategy and blindly adhering to the mission statement leads to missing events and inflection points that should be quantified in the company’s strategic plan. Consider the rise of companies like Robinhood or Coinbase. Could financial institutions have anticipated these external threats to their business services and developing products by simulating services by FinTech, RegTech, and challenger companies where new players took over market share?
Likely, all the company analysis can come down to a few individuals who make decisions that impact the firm. Those few critical executive decisions are made by humans who can have biases, regardless of metrics and sometimes because of hubris. Ask yourself, if income or an economic indicator for your new strategy misses the mark, will you change direction, or will you as the decision-maker stay the course and see what happens? More importantly, who gets the information? Are those reports discussed in committee, and what governance on those discussions disseminates to decision-makers?
Through constant wargaming and scenario modelling, threats can potentially be spotted and predicted by utilizing business intelligence data and visualizations.
About Vox (Now Part of Treliant): Vox has a wealth of risk experience within their ranks, providing SMEs, change management, and analysis expertise to deliver a basis for their clients to perform wargaming exercises. To find out more, please contact email@example.com.