Peter Drucker on risk

by Michael Werneburg
on 2015.02.04

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Peter Drucker left us with a vast wealth of insights about business. He was a prolific and talented writer, and though he wasn't for the most part writing on risk, his work can be directly applied to thinking about risk.

I started reading the man's articles on the Internet, but found that I needed a more thorough summation to get my head around what he was saying. So I bought a copy of the Essential Drucker and am now on my second read. The following is my interpretation of some of Drucker's many excellent insights, applied to how I practice enterprise risk management.

Drucker outlines three management responsibilities regarding strategy. The first applies to discovering and documenting that strategy, the second two relate to execution. Briefly stated, they are:

Establishing the specific purpose and mission of the firm

According to Drucker, ...success always rests to a large extent on raising the question, What is our business? clearly and deliberately, and on answering it thoughtfully and thoroughly. He asserts that the only possible starting point in answering this question is the customer. The business is defined by the customer's needs – what benefit the customer realizes when they obtain the good or service. The question, What is our business? has to be answered in terms of how the business benefits its customers.

Understanding the customer

In my experience, it's not always easy to even frame meaningful questions about the clients. However, a starting place is to look how the firm is evaluating its customers and their needs. Is the firm asking who their customer is:

These are natural questions, if you think about it in the context of determining how well you really know anyone. Here, of course, the thrust is to best understand how you may present the customer with solutions for problems. Solutions that add enough value they'd be willing to pay for it.

And when it comes to purchase decisions, it's also vital that a firm's strategy consider practicalities around those purchase decisions:

A simple example offered by Drucker on the last point is the grocer who must be convinced to stock the products that are ultimately intended for the housewife. Another example that I'm all too familiar with: the buyer of software may be a subject matter expert in a given field (say, life insurance product design, or wealth management compliance, or sales) but they alone don't make the decision – there are the IT executives that will be integrating the solution, and if the solution's large enough: Legal, Procurement, and Vendor Management.

What will the business be?

All visions of a business eventually age. It's important to understand that change is always on the horizon, and that that change will (and should) change the business.

Some questions:

Marketing and Innovation

Drucker also writes, Because its purpose is to create a customer, the business enterprise has two—and only two—basic functions: marketing and innovation. By "marketing", he uses the original sense of the word: to discover and develop a market. This does not mean the modern consumerist use by which new products and services are relentlessly pushed upon people.

Some obvious points may be drawn from this:

Here, innovation is defined in terms of delivering improved economic benefits, either by improving the products delivered or by improving their means of delivery. In either case, more value is added to the customer. As Drucker points out, It is not confined to engineering or research but extends across all parts of the business, all functions, all activities.

Some questions emerge that help the risk manager determine whether there is sufficient innovation occurring.

Innovation and financial performance

Business management must always, in every decision and action, put economic performance first.

I love this concept. So many useful questions about risk arise, here:

Making work productive and the worker effective

Guiding the execution of strategy is the responsibility of the management team. Drucker defines some "essential principles" of management as follows.

1. "Management is about human beings. Its task is to make people capable of joint performance, to make their strengths effective and their weaknesses irrelevant."

The author demonstrates how critically important the management function is in the age of the knowledge worker; specifically, that for a knowledge worker to be effective, his outputs must be usable by the organization for which he works. The organization must be shaped to make use of those outputs.

Understanding this lets you start to study the specifics in your organization. You can look at a host of factors, such as:

It can be easy enough to pick up clues to any of these matters: if you listen to management, they will frequently volunteer the existence of problems of this nature.

2. "Every enterprise requires commitment to common goals and shared values."

Oh yeah? Some questions to consider:

3. "Management must also enable the enterprise and each of its members to grow and develop as needs and opportunities change."

This all sounds very lofty, and touchy-feeling in that HR way, but its relevance is of crystal clarity. In short: there's really no such thing as an expendable, non-knowledge worker in most business environments today. As Studs Terkel said, "Work is about a daily search for meaning as well as daily bread; for recognition as well as cash; for astonishment rather than torpor; in short for a sort of life, rather than a Monday-to-Friday sort of dying."

Here the risk should be obvious: if your firm is doing nothing for each of its member in this knowledge-based economy, something is wrong. How do you know those members aren't experience a "Monday-to-Friday sort of dying"? What happens when ignored employees start holding back? When someone's "discretionary energy" stops being spent on their work, it starts being spent more and more on non-productive or even deleterious activities (such as finding a new job).

Some questions:

4. “Every enterprise is composed of people with different skills and knowledge doing many different kinds of work. It must be built on communication and on individual responsibility.”

Some more questions:

5. “All members need to think through what they aim to accomplish—and make sure that their associates know and understand that aim. All have to think through what they owe to others—and make sure that others understand. All have to think through what they in turn need from others—and make sure that the others know what is expected of them.”

I touched on this above, and Drucker had this text connected with the previous point. I think it's important enough that I've broken it out into its own point. Some questions:

6. “Neither the quantity of output nor the "bottom line" is by itself an adequate measure of the performance of management and enterprise. Market standing, innovation, productivity, development of people, quality, financial results—all are crucial to an organization's performance and to its survival.”

Obviously, this represents most of the responsibility of the management team. Running through the list in the second sentence we see the responsibilities of Marketing, R&D, the COO's office, HR, Quality Assurance, and the Finance office. But the questions here are fairly straightforward:

7. “Finally, the single most important thing to remember about any enterprise is that results exist only on the outside. The result of a business is a satisfied customer.”

Questions:

Managing social impacts

Drucker writes, Business exists to supply goods and services to customers, rather than to supply jobs to workers and managers, or even dividends to stockholders.

But he also acknowledges that every business exists only as part of the society in which that business exists. In fact, he points out that the modern society is now less a collection of individual citizens but rather a collection of organization citizens. This has implications for the political power of the individual, and for the power of the corporation. Specifically, that the firm must watch how it impacts the society in which it finds itself, and must not abuse that society. Out of self-interest, an organization must ensure that its host society is healthy. Some questions arise:

These points can be most easily applied to the recent financial disaster. Clearly, there were firms that were knowingly doing things that would harm the global economy generally, and customers, specifically. Unintended impacts to a host society are a danger; uncontrolled, almost certainly deleterious, and reflecting badly on the company that caused allows them, these byproducts must be eliminated.

In summary

Many of the one-line questions I list here can lead to a tremendous amount of work. This one-page write-up cannot do justice to the subject. It doesn't even do justice to Mr. Drucker's book; in fact all of the above deals only with the first chapters in a book with more than two dozen chapters. That said, I believe it reflects the thinking evident in the original.

I'm going to follow this with a section based on the writing of Michael Porter, because I think a lot of what he says is also directly applicable to a risk manager's job.