Is risk management a component of competitive advantage?

Competitive advantage is dead!  Long live competitive advantage! 

Several previous posts argue that strategic risk management creates value for a corporation by operating within the company’s value chain. The point was to demonstrate that strategic risk management is an important component of any company’s competitive advantage, as described by Michael Porter of Harvard University. And competitive advantage can be expressed quite well in terms of a SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis.

But now The End of Competitive Advantage is upon us. A book by that title, from Professor Rita Gunther McGrath of Columbia Business School, argues that “the era of sustainable competitive advantage is over.” Professor McGrath wrote an article, “Transient Advantage,” for the June 2013 Harvard Business Review (HBR) to summarize her book and ideas.

Still waiting for a breakthrough

McGrath makes many good points, and she offers some timely insights that are real contributions to strategic thinking. She advocates the use of real options analysis.  She warns against analysis paralysis. Her concept of creating a “pipeline of new advantages” that can be quickly put into action when needed is particularly valuable, if not terribly new. The Smithsonian points out it was a very effective operating principle used by Thomas Edison in the 19th century.

But McGrath’s arguments do not add up to a break with traditional strategic analysis, no more than Porter’s did. Instead, she is building upon it. Like Porter, McGrath finds it difficult to develop the escape velocity to leave the SWOT behind. Just as planet Porter orbits the SWOT, comet McGrath finds itself sucked into its gravitational pull.

One of the underdeveloped ideas in Porter’s original work on strategy, competitive advantage and value chains was the role of risk and uncertainty in value creation. Risk provides an underlying context for Porter’s ideas, but he does not explore it as a strategic factor. Porter considered his work an advance over what he saw as the “traditional approach” taken by the SWOT analysis and its treatment of the four basic factors: strengths, weaknesses, opportunities and threats. But risk is at the heart of the SWOT: threats are risks.

Likewise, McGrath considers her ideas an advance over Porter’s “traditional approach” and thinks it is time to move on. She calls for companies “to abandon many of the traditional notions about competitive strategy.” The situation “calls for an entirely new strategy playbook,” she said in an interview with Strategy & Leadership. Like Porter, McGrath treats risk and uncertainty as an underlying context for strategy. Like Porter, she uses ideas and arguments that could easily be restated in terms consistent with a SWOT analysis. What is interesting is that McGrath’s rationale for going beyond Porter is that business is more complex, risky and uncertain than it was in his day.

What is another word for “risk”?

McGrath treats risk euphemistically, which I guess does take her work beyond Porter’s, but she does not relate it to the value chain or capture its contribution to competitive advantage. Instead, risk and uncertainty are the forces driving the transition from sustainable to transient competitive advantage. They are forces driving management.

The language of change McGrath employs to make her arguments is laced with allusions to risk and volatility. She advocates the use of real options and talks about the need for managers to think “about option value.” But she does not bring risk systematically into her analysis or her prescriptions.

McGrath also echoes Porter. She modifies, but does not reinvent, Porter’s concept of competitive advantage. “There are still places where the old rules and ideas apply,” McGrath states in an interview with Strategic Direction. She refers to barriers to entry, one of Porter’s five forces of competition. She also speaks of “reinventing the category” and opening up “a completely new space.” Both characterizations are essential Porter’s definitions of strategy as a force that transforms an industry.

Let us not reinvent the wheel

What McGrath is saying is that competitive advantage still exists but that it does not last as long as it used to. Her conclusions are apt. The business environment has become more complex, more competitive and more uncertain. Innovation occurs at a rapid pace, and business as a whole moves at a higher speed. “Competitors and customers have become too unpredictable,” she says in the HBR.

Strategic business activities are more and more affected by time compression: things that once took years now cycle through in shorter periods. Strategy has to accommodate this. Time compression creates greater risk and uncertainty, and strategy and competitive advantage have to adapt. It is necessary, she says, to “view strategy differently – as more fluid.”

It is hard to argue with McGrath’s analysis, but it does not amount to a sea change in strategic thinking. In a quickly moving world, the basic principles of the SWOT, Porter’s Five Forces and Porter’s generic strategies still hold. If McGrath is right, they should become even more important. Greater complexity does not invalidate the need to describe and understand a situation before implementing strategic action.

If anything, the more dynamic and fluid world McGrath describes creates a greater need for sound strategy and a deeper understanding of risk management. The very dynamism and fluidity she sees is evidence of the growing importance of risk and uncertainty in decision-making and in value creation. The situation demands a greater integration of risk analysis into strategic planning. It requires greater emphasis on understanding risk management, its role in strategy and its ability to create value through the value chain and so contribute to “traditional” competitive advantage.

SWOT and Porter are good systems for this purpose. More businesses would be better off using them; properly employed, they help make strategy more fluid and prevent business from growing static.

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Categories: Economics, International

Author:Steven Slezak

Steven Slezak is on the faculty at Cal Poly in San Luis Obispo, California, teaching finance, strategy, and risk management. His research is supported by the university’s Farm Credit Program in Finance and Appraisal. Previously, he taught financial management and financial mathematics at the Johns Hopkins University MBA program. He holds a degree in Foreign Service from Georgetown University and an MBA in Finance from JHU. He has worked in fields as diverse as international economics, national security, commodities trading, and risk management. He consults on business management and strategy.

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2 Comments on “Is risk management a component of competitive advantage?”

  1. December 18, 2013 at 10:02 am #

    Interesting post Steven! Thanks!

Trackbacks/Pingbacks

  1. Risk management is at the core of strategy development | Global Risk Insights - January 24, 2014

    […] have previously argued that risk management is integral to the value chain and to competitive advantage. Risk management’s central role derives from the fact that risk is at the core of the process […]

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