Leveraging Performance Management to Support Risk Management
Performance management systems not only provide a means of measuring success for current business activities and a view of planned activities for the future, but also act as a warning signal for risk.
March 21, 2011
The objective of a performance-management system — and its underlying management processes — is to enable managers and executives to understand what is going well, what is not and what the future might look like, given data from the past.
Similarly, the objectives of a risk management process are to provide warning signals of impending or potential events that may impact the organization and quantify those impacts, while enabling the organization to assess the efficacy of its mitigation strategies.
But there is frequently a gap between these two processes. This is because the performance management and risk-management processes are not intertwined. Therefore, risks are often assessed and managed without a complete understanding of the broader performance implications. Similarly, performance decisions are often made without regard for the risks they may inadvertently aggravate or mitigate. Both of these can be looked at through the metaphor of a rock being thrown into a pond: the first ripple is quite large and disturbs the water around the point of impact substantially, but each successive wave causes ever smaller ripples.
In bringing these two processes together, it is clear that strong performance-management systems should incorporate measures of risk and be able to predict future results if risks materialize and/or risk mitigation actions are taken.
Consider the following example:
Therefore, the most effective way for performance-management systems to support risk management is to incorporate those measures that predict events or trends, as well as enable the tracking of mitigation actions. The latter situation is shown in Figure 3, in which we have added the period results of our risk-mitigation actions, such as tracking the spend on customer-service actions as well as the change in performance ratings resulting from those actions.
The role of Finance in these areas is to provide the analytical tools and capabilities to enable performance metrics to be estimated, calculated, interpreted and reported to senior management. But through it all, it is important to keep in mind that the ultimate goal is not keeping score, but improving the score!
Robert Torok, CA is an executive consultant with IBM Global Business Services, leading the development of solutions and methods and delivering Enterprise Risk Management (ERM) services for IBM clients. He is a chartered accountant and a member of the Institute of Chartered Accountants of Ontario (Canada).
A version of this article appeared previously in the Controllers' Corner series on IBM.com.