How Much Unnecessary Risk Is in Your Marketing Plan?

 

 

 

Globalization, multichannel marketing, supply-chain management, strategic alliances, managing partnerships, regulations, corporate governance — marketing is riskier today than ever. To put their companies at competitive advantage, marketers need to take more calculated risks. Yet to most marketing departments, "risk management" is limited to customer credit and vetting vendors — functions usually handled by finance or purchasing.

For marketing executives, risk management is a Darwinian experience based upon a trial-and-error evolution. Has this agency produced good work previously? Will this vendor deliver on time? Our experience has fine-tuned our instincts to a point where we intuitively assess risks based upon a combination of hundreds of deliberately and subconsciously collected data points.

But, today we are all in competitive overdrive. Even the most intuitive decision makers must make increasing risky calls in areas where they have less personal experience. Decision-making variables are climbing past the human ability to monitor them as time and again we hear the CMO yearn for simplicity and focus. Yet while it's difficult to argue against this common-sense gravitas, it's also unwise for marketing professionals to ignore the proliferation of data points that can facilitate resource allocation to generate competitive advantage.

Many executive committee members still view marketing as the last bastion of unaccountability. Everyone else from finance to operations, HR to IT, employs robust risk-assessment tools and processes and highly effective ways to demonstrate the risk-adjusted outcomes of their key projects. They talk in terms of "net present value" of "future returns" associated with an investment made today. They link their recommendations to the bottom line and present their cases in such a way as to reassure not just the CEO, but also their peers that they have carefully analyzed the financial, operational, organizational, and environmental risks and are proposing the optimal solution with the best likely outcome.

Marketers, on the other hand, seem to suffer from two conditions that block rigorous risk-assessment processes. The first is something Sam Savage of Stanford University calls "post-statistics stress disorder" — they are petrified by statistics and accounting. The second is a sense of obligation to be corporate cheerleaders, preferring to accentuate the positive as we rally emotional support for key projects, and often substituting passion and conviction where facts and financial assessments are scarce.

CMOs also seem to fear that a disciplined approach to risk management might suppress creativity by turning their market-driven culture into an inward-looking group of belly-button examiners, too risk-averse to hatch bold ideas. This argument is about as valid as the old contention that computers took the fun out of marketing, when the reality is that marketing gets better with the evolution of science.

Marketing = Change = Risk

 

Marketing is all about change. Change in pricing to stimulate demand; change in promotions to offset competitive thrusts. By genetics and training, marketers are more comfortable living in a world of constant change than many others in the organization. How would engineers react if the laws of physics suddenly changed? Remember how IT departments responded to changes during the feared Y2K threat? They froze entire systems and processes for months. Similarly, Sarbanes Oxley has thrown most accounting departments into an uproar. Yet marketers deal with changes on this order of magnitude almost daily as new competitors come and go and customers' needs evolve.

Unfortunately, one of the immutable laws of nature is that change begets risk, often because we can't immediately grasp the full scope of the change. So nowhere is risk management more appropriate than in the marketing department.

Sound risk-assessment processes can also help when the organization requires proof that marketing programs are working. First, by its very nature, risk assessment is an open dialogue where participants are invited to ask "what if" in a non-confrontational manner. So a thorough pre-launch risk-assessment will increase the likelihood that others will support your project since their opinions have been taken into account. Second, good risk-assessment is both quantitative and qualitative. It satisfies the demand to measure the likely program outcomes — even when many of the desired effects may themselves be less perfectly measured.

Risk-Assessment Tools in Marketing
Marketing departments already employ risk management tools. Market research is commonly used to measure risk by soliciting customer and prospect input on the likely outcome of changes in product, price, communications, or other variables. If research suggests the outcome will be unfavorable, the interpretation is that moving forward is a high risk.

Another well-known risk tool is the classic SWOT analysis where marketing teams attempt to define strengths, weaknesses, opportunities, and threats relative to a given program, initiative or the company. Many marketers are also familiar with a tool called the Ansoff Matrix, but better known as a two-by-two matrix of new vs. existing products and markets (below).

Other tools occasionally used to assess risk — often without explicitly being identified as such — include Fault Trees, Gantt Charts, and the ever-popular Excel model to forecast a likely outcome by changing variables. Some companies have even gone so far as to incorporate Game Theory into their planning processes.

In observations of hundreds of marketing departments over the past 20 years, we have seen increasing adoption of risk management tools on an ad hoc basis. However, rarely have we seen a marketing department that has adopted a disciplined risk assessment methodology that would:

So, how can CMOs begin to develop a risk management approach that achieves these benefits?

A High-Level Process Flow
Begin with a concise definition of each initiative's objectives, scope, and critical success factors. Link each objective back to some common economic unit of measurement reflecting overall marketing goals, such as net incremental sales or profit; net present value of future profits, or internal rate of return. Be careful to ensure common length of time and cost of capital assumptions are used by all.

Many get lost at this first stage by trying to define common economic units in terms of intermediary outcomes such as awareness, trial, retention, or customer lifetime value. Each intermediary can be boiled down into a common economic unit with some reasonable assumptions regarding the relationships between the intermediary factor and the economic unit (i.e., 3% percent increase in awareness generates 5% percent increase in trial, which in turn generates $500,000 in net incremental sales). It doesn't matter how perfectly those relationships are defined, so long as the key people in the process agree with the approach and everyone employs the same assumptions. Being consistent is more important than being right. The exercise itself will uncover valuable information about what is known, unknown, and unknowable. If there are some initiatives whose intermediary benefits defy translation into economic units, set them aside for separate consideration and work them into the next planning cycle.

Once each initiative has been defined and ranked on its raw economic unit potential, you can begin to identify the types of risks present for each. Start by listing factors that could inhibit the initiative from fulfilling its potential. The factors include internal (e.g., access to capital, manufacturing productivity, etc.), environmental (i.e., economy, weather, technology, etc.), and competitive (i.e., pricing power, brand strength, etc.) considerations.

Next, assess the potential range of conditions you might encounter for each identified risk factor. For example, if the risk factor is "unemployment rate", identify the range of possibilities that unemployment rate may increase significantly, modestly, remain the same, decline modestly, or significantly. If weather was a factor and both temperature and precipitation had a potential impact on your initiative, build a simple matrix of possibilities like so:

 

For each possible condition, identify the likely impact on the initiative's forecast of common economic units. In the example above, if the weather was colder than normal, some people will not shop and the initiative might then generate 15% less in net incremental sales; but if it is both colder and wetter, then anticipate as much as a 60% reduction.

In most cases, the impact of the condition on the economic unit is determined through a best guess based on historical data. Be as precise as reasonable without investing excessive time digging for obscure data at this stage.

Once the impact for each condition has been determined, assign a probability to the condition. If, for example, the national weather service forecasts a 40% probability of a wetter-than-normal spring, a 10% chance of it being dryer than normal, and a 50/50 uncertainty about temperature, you can revise your conditions matrix to incorporate the probabilities of each as follows:

 

Now, you can see the probability of it being colder is 33%, and the probability of it being colder and wetter is approximately 13%. So, if the initiative is a national clearance sale, and you know cold weather is like to reduce incremental sales by 15%. That information suggests that you reduce the forecast outcome by five percent (33% X 15%) to hedge against a potential cold weather blast. Further, we need to reduce it by another roughly 6% for the likelihood that it will be both cold and wet. So if we were counting on this national clearance sale and expecting $100 million in incremental sales from it, we should reduce that expectation to $89 million, assuming weather is the only risk factor.

But before you go about cutting the initiative's expected value, consider which risk factors could be controlled or managed to minimize negative conditions. Can you take certain precautions? Could you postpone your national clearance sale from early spring to late spring, reducing the likelihood of bad weather? Even if the postponement costs $2 million for higher expected labor rates, then could you still come out ahead? If risk was caused by new competition, could you increase media weight to make it more difficult for competitors to generate trial among your customers? This process is one of seeking to understand which risk factors can be mitigated or managed and at what cost. (See sidebar below, "Strategies for Dealing with Risk.") At the end, we know that the actual risk-adjusted net sales benefit from conducting the national clearance sale is likely to be only $89 million if you hold it in early spring, but may be $95 million or more in late spring, even with higher labor costs.

If you perform such an analysis for each of the great ideas/initiatives on the funding-consideration table, you will improve your perspective on which will provide the best returns. You'll also have a much higher level of confidence in the forecast results and a more defensible pitch to fund your best bet initiatives.

This is the concept of risk-adjusted portfolio management and the diagram of the process above is presented below.

The lower loop highlights key factors for senior focus. This project risk-management process ensures each initiative will avoid stumbling caused by previously identified risks.

Risk-Assessment Tools
Risk assessment doesn't really require any "tools" per se. It does require diligent effort to be comprehensive in uncovering risks, and a very honest assessment based on available data, experience and intuition to assess the potential negative impact of each risk factor (which can be particularly difficult for some of us marketing types given the genetic predispositions mentioned earlier). Attempting to delegate this responsibility to an analyst working full-time in the marketing department would undermine the purpose and benefit, much like asking an auto mechanic to find the structural flaws in an architect's plans. To be effective risk-assessors, marketers need to turn the microscope on themselves.

The simplest techniques are often the best. Contributing Factor (a.k.a. Influence) Diagrams are excellent for getting everyone on the same page with risk factors. They begin with brainstorming to identify as many potential risks as possible. The list is then de-duped to make sure that two entries aren't just different ways of expressing the same risk. Finally, each factor is drawn into a diagram in which it is placed into perspective with other related and unrelated risk factors (see diagram below). This format helps identify where factors are chained and how they interrelate. And a good diagram can visualize all risk factors and spot redundancies early on.

Another risk management tool, usually requiring only a whiteboard, is a simple decision tree. For each initiative, risk factors are identified; conditions are determined; probabilities are assigned to conditions; and the risk-adjusted expected value of the initiative is calculated by multiplying probabilities. An example of decision-tree problem solving can be seen in The New Product Conundrum.

Fault trees are decision trees built backwards from some unfavorable outcome to determine where it was most likely to have gone wrong. NASA used fault trees to diagnose where to look for the likely cause of critical malfunctions such as those underlying the Challenger and Columbia disasters. Marketers could easily employ fault trees to help understand why some initiatives launched with high hopes and great fanfare ultimately failed. The process of reverse-engineering an unfavorable outcome leads to the development of more refined risk-assessment skills among the team, which will serve the company well when new initiatives are considered.

Lastly, one of the most effective and least employed risk assessment tools is Monte Carlo simulation. Developed by the scientists working on the Manhattan Project, this technique asks for your best-guess estimates of the ranges each key assumption variable might fall into, and then runs thousands and thousands of trials combining all possible outcomes to see which are more likely to occur. It takes only a few minutes, and in the end, it helps you understand which variables need to be more closely managed to achieve a desired result. An example of the benefits of Monte Carlo simulation can be seen in Just Give Me a Number: How to Avoid the Flaw-of-Averages.

Implementing Risk Management in Your Marketing Department
There are a few organizational considerations that a good CMO needs to consider before charging headlong into risk assessment and management.

First and foremost, people view the idea of risk management very differently depending upon their relationship to it. Executives who benefit from the clarity and perspective a thorough risk assessment process brings are normally very supportive and enthusiastic about it. But for those who are used to "selling" their ideas and initiatives largely on the strength of their creativity, persuasiveness, or logical powers, risk assessment (and portfolio management in general) can be very threatening. Beyond the normal discomfort associated with any new discipline imposed, risk management has the potential to label some initiatives as "winners" and others as "losers." And no one likes to see his or her conceptual baby branded a "loser."

To minimize the potential for ego destruction, introduce the process slowly and articulate broad goals such as "helping the company improve return on every dollar invested". Allow everyone to contribute to defining how the process should work, and, equally importantly, where/how it can and cannot be applied. Then consistently reinforce the use of the process (perhaps going so far as to refuse to consider proposals not accompanied by an appropriate risk assessment) and continue to prompt for its enhancement, expansion, and integration. Look for ways to reward people for applying the process in creative, enlightening ways — especially those who may uncover the very risks that kill their own proposals. Plan on taking about a year to get to a fully integrated process. Manage the timeline to coincide with next year's budgeting cycle to achieve the ultimate benefit.

Watch out for people "gaming" the system. Inevitably, some people will view the shortest path to project approval as the manipulation of the risk process to either hide or minimize risk factors.

Weigh the pros and cons of creating a marketing-dedicated analytic group versus establishing a common analytic resource pool with finance. The trade-offs are not only cost and accessibility, but the degree to which the analysts will truly come to understand the nuances of the marketing function and incorporate them into their thought processes. On a dedicated basis, this might take a year. On a shared basis, expect it to take a few years.

Finally, as with most new things, you probably can't overcommunicate. Talk to your staff about why you are doing this and how they will benefit from it. Find opportunities to publicly reinforce your support for the process and highlight its successes and failures in the context of learning. Solicit their observations, opinions, and feelings about the process and progress towards the stated goal(s). And be open to the subtle introduction of new opportunities emerging from the effort. Nowhere is it more true than in risk management that where one door closes, another opens.