A new study finds that underestimating strategic risk is the number one cause of shareholder value destruction. But it doesn’t have to be.

1. strategy+business
issue 69 WINTER 2012
The Lesson of Lost Value
A new study finds that underestimating strategic risk is the number one
cause of shareholder value destruction. But it doesn’t have to be.
by christopher dann, matthew le merle,
and christopher pencavel
reprint 00146

2. leading ideas
The Lesson
the sources of strategic risk have in- in the first place. This responsibility
creased. Accelerating technology gap can be costly.
of Lost
development is forcing the rapid
adoption of new products, services, Studying the Biggest Losers
Value
and business models; digital infor- To more fully support this conclu-
mation is making organizations sion — that the lack of attention to
more vulnerable to theft and loss; risk destroys shareholder value —
supply chain disruptions quickly we must look at our study in more
A new study finds ripple around the globe, affecting detail. We analyzed U.S. public
that underestimating both companies and customers; companies around the world with at
strategic risk is the consumer connectivity via social least US$1 billion in enterprise value
number one cause networks can broadcast missteps in- on January 1, 2002 (1,053 compa-
of shareholder value stantaneously to millions of people nies met these criteria). We calcu-
1 worldwide; and natural, political, or lated each company’s change in en-
destruction. But it
regulatory shocks can reverberate terprise value over the next 10 years,
doesn’t have to be. widely. Companies must learn how and then indexed each company’s
to effectively anticipate and hedge annualized return to that of its in-
by Christopher Dann, Matthew against these and other risks in or- dustry benchmark to control for in-
Le Merle, and Christopher Pencavel der to survive. dustry-specific effects. This allowed
M
To be sure, during the past de- us to zero in on the biggest losers
any benchmarks of corpo- cade, companies have steadily dialed — the companies that experienced
rate practice start by look- up their focus on risk, in part as a the most dramatic losses of enter-
ing at successful compa- reaction to the requirements of the prise value. Only 103 companies
nies. But a recent Booz & Company U.S. Sarbanes-Oxley Act of 2002. had annualized returns relative to
survey took the opposite tack. We But they have usually done so with a their respective industry bench-
decided to study the biggest losers: bottom-up approach that has prov- marks that were worse than negative
companies that, in one way or an- en flawed. Individual functions such 10 percent. This group correspond-
other, had seen their fortunes go as accounting, finance, and compli- ed to the bottom 10 percent of per-
south over a 10-year period. We had ance have improved risk controls.
gone through this exercise once be- Meanwhile, executives have made
fore. In 2004, when the Enron, their enterprise risk management
Tyco, and WorldCom scandals were (ERM) teams accountable for iden-
fresh, we surveyed thousands of tifying and evaluating the intercon-
public companies and determined nected risks facing their companies.
that, contrary to prevailing wisdom, But although ERM teams can
it was not compliance issues that identify and hedge risks related to
were most responsible for destroying relatively narrow business decisions,
shareholder value. That distinction they do not have the mandate to
went to the mismanagement of stra- evaluate the strategic risks rooted in
tegic risks — those risks embedded the decisions made by senior man-
in the top-level decisions made by agement. An ERM team must as-
the executive team, such as what sume that the strategic course set by
Illustration by Mark Matcho
products and services to offer, senior management is sound.
whether to outsource manufactur- For example, an ERM team
ing, or what acquisitions to make. can call attention to risks associated
Our 2012 survey revealed the with doing business with manufac-
same culprit, and suggested that it turers in Southeast Asia, but it can’t
still leads to significant value de- evaluate whether the company
struction. Making matters worse, should be outsourcing to the region

3. leading ideas
leading ideas
Exhibit: Why They Fail grouped together major operational the time. (See Exhibit.) When we
Strategic blunders result in the greatest loss of problems, such as supply chain dis- segmented the data by industry and
shareholder value.
ruptions, customer service break- geography, we found some varia-
Distribution of Bottom Performers
by Reason for Failure downs, and operational accidents, tions; for example, strategic failures
that had caused substantial share- are particularly acute in the finan-
External holder value destruction. A high- cial-services industry, and Europe
Compliance
profile example is the April 2010 has more operational problems than
Operational
Strategic
Deepwater Horizon offshore oil rig the U.S. or Asia. Nevertheless, stra-
explosion and leak in the Gulf tegic failure remained the major
Coast, an event that wiped out more cause in these cases as well.
than $50 billion in BP’s shareholder About half the time, the loss of
value in the days and weeks follow- value occurred gradually — over
–35% –30% –25% –20% –15% –10% ing the accident. many months, or even years if the
Change in Enterprise Value The third category included company took too long to grasp a 2
Source: Booz & Company
fraud, accounting problems, ethics changed strategic environment or
formers in our overall sample. violations, and other failures to lacked the agility to react. The other
We checked to see if the com- comply with laws, standards, or eth- half of the time, the lost value oc-
panies on our list of the biggest los- ics. During the 10-year time frame curred in a matter of months, weeks,
ers were simply the weakest compa- we analyzed, a few prominent ex- or even days. Sometimes these sharp
nies in one or two industries in amples were Tyco’s accounting and shocks were caused by strategic fail-
terminal decline. But this was not
the case. There was broad industry Senior leaders can’t rely on enterprise risk
representation among the bottom
management teams; they do not have the
performers.
Next, to get at the root cause of
scope to question the strategic decisions
this lost value, we conducted an that set the company’s course.
event analysis by going back to news
reports, press articles, and brokerage discrimination lawsuits in 2002 and ure (for example, being caught by
reports for each of the 103 compa- Tenet Healthcare’s 2006 legal bat- surprise when a competitor intro-
nies before and after their loss of tles over improper medical and busi- duced a superior product), and
value. We then assigned each com- ness practices. sometimes they resulted from an op-
pany’s economic decline to one of In the fourth category, we iden- erational issue, compliance problem,
four categories. tified declines resulting from exter- or external event that overwhelmed
The first category included ma- nal shocks that were natural, politi- the company.
jor strategic blunders (such as new cal, or regulatory. We narrowed Often, it is a confluence of events
product or new market failures) or these situations down to circum- that leads to value destruction. To
instances when a company was stances in which the external event better understand these more com-
caught flat-footed by a major indus- could not be controlled or easily an- plex situations, we segmented loss
try shift (such as digitization of con- ticipated by the company. For ex- drivers into primary, secondary, ter-
tent). We included failed mergers ample, USEC — a supplier of en- tiary, and quaternary causes. But
and acquisitions in this category, as riched uranium for nuclear power even when second-order causes were
well as dramatic shifts in major en- plants — saw a sudden and sharp taken into account, strategic failure
terprise value drivers (for example, a decline in enterprise value after the caused more than 60 percent of
major input cost), because these oc- 2011 Japanese tsunami and ensuing shareholder value destruction.
strategy+business issue 69
currences should have been fore- nuclear disaster.
seen. This category includes, for ex- The results are unambiguous. The Resilient Company
ample, Time Warner and its widely Among the 103 companies studied, How should management respond
criticized merger with AOL in 2000. strategic blunders were the primary to the threat posed by strategic risks?
In the second category, we culprit a remarkable 81 percent of Senior leaders can’t rely on ERM

4. leading ideas
leading ideas
teams to make the enterprise more 2. Integrate risk awareness di-
strategically resilient, because ERM rectly into strategic decision making.
teams do not have the scope to By conducting more conversations
question the strategic decisions that about risk at the top levels of the
set the company’s course and under- company, looping in key individuals
gird its operations. Make no mis- as needed, management acquires a
take, the ERM function is vital: full understanding of the uncertain-
Once handed a strategic plan, these ties — both upside and downside
teams identify and quantify risks — inherent in strategic decision
and then assign people to build con- making.
tinuity plans. Thus, ERM groups 3. Focus on strategic resiliency.
play an essential role in addressing Managers need to consider how stra-
frequently encountered risks in areas tegic decisions can affect resiliency,
10
3 such as compliance, ethics, finance, incorporate resiliency into all deci-
and accounting, as well as safety. sion making, and always be on the
(The research shows that some lookout for more strategically resil-
companies could also stand to im- ient alternatives in order to build
prove in these areas, but in general, greater corporate agility.
most companies have a well-func- Just as managers can make use
tioning program in place.) However, of advanced tools to analyze cost,
ERM groups can’t be the only source revenue, profits, and value, they also
of protection, especially when it need sophisticated tools — such as
comes to the most potentially dis- scenario planning, wargaming, and
ruptive issues. trend analysis — to judge the poten-
Instead, what senior executives tial risks of the decisions they are
need is a more balanced approach to making before turning the strategy
strategic decision making, augment- over to the ERM team. Ultimately,
ing traditional cost and value con- companies need both a robust ERM
siderations. They need to adopt an function and leaders willing to eval-
element of ensuring resiliency that is uate risk at the highest level of stra-
critical, yet currently missing in tegic thinking. This combination
most companies: a top-down view of will bridge the gap, enabling execu-
risk. To improve their risk manage- tives to preserve and grow share-
ment capabilities, executives should holder value. +
add the following three steps to their Reprint No. 00146
decision-making process — all of
which are outside the scope of most
ERM teams. Christopher Dann
1. Broaden awareness about un- christopher.dann@booz.com
is a partner with Booz & Company’s energy
certainty and risk. We expect change practice, and is based in San Francisco.
to continue accelerating and uncer-
Matthew Le Merle
tainties to increase. Extreme events matthew.lemerle@booz.com
with extreme consequences cannot is a partner with Booz & Company’s
be accurately predicted, but they can communications, media, and technology
strategy+business issue 69
practice, and is based in San Francisco.
be anticipated. Management teams
need to think broadly about what Christopher Pencavel
could occur and constantly layer christopher.pencavel@booz.com
is an associate with Booz & Company’s
new risks into their calculations as communications, media, and technology
these risks emerge. practice, and is based in San Francisco.

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