Robert S. Kaplan, Ph.D. '68, Describes Key Elements of Managing Risk
Following his introduction at an Enterprise Engineering Colloquium session, Harvard Business School (HBS) professor Robert S. Kaplan joked that he has been elected to the Accounting Hall of Fame despite having taken only one accounting course in his life, as a student in ORIE's Ph.D. program.
Kaplan, whose 1968 doctoral thesis dealt with optimal policies for inventory and investment decisions over time, became interested in accounting research soon after joining the faculty of Carnegie Mellon University, where he worked with accounting professor Yuji Ijiri. After serving as Dean of what is now the Tepper School of Business, Kaplan moved to Harvard, where he is Baker Foundation Professor.
Kaplan's colloquium talk discussed the measurement and management of risk from an organizational and cultural perspective. Noting that Wall Street may be "the simplest place to estimate risk - they have so much historical data," he used an HBS case study, which he coauthored with HBS professor Anette Mikes, to highlight a processes to measure and manage the risk of "real assets and complex liability structures of non-financial corporations." Using the case of the Mars Phoenix project of NASA's JPL, he illustrated his teaching by the method for which HBS is famous.
Like other Mars landings, the Phoenix landing entailed a daunting engineering challenge - bringing a craft traveling at 20 times the speed of a rifle bullet down to 5 miles per hour within seven minutes. Because communications from Mars take 10 minutes to reach Earth, risk must be dealt with in advance. Kaplan drew parallels to other high risk projects, such as finding oil and holding portfolios of high risk mortgages, for which the potential return is huge. "The goal in risk management is not to eliminate risk altogether; to do so would stifle innovation," Kaplan claimed. "The goal is to determine risk and mitigate it."
At NASA's JPL, mitigation is accomplished through a system that confronts challenges that are primarily organizational and cultural, not technical: "how to get people who have never experience failure to think about what can be done without getting defensive," Kaplan said. He quoted the Chief Systems Engineer for JPL missions as noting that "JPL engineers graduate from top schools at the top of their class. They are used to being right in their design and engineering decisions. I have to get them comfortable thinking about all the things that can go wrong."
|A heat map showing the levels of liklihood and consequence of the numbered risks, and their resultant criticality. Trends and approaches are arrayed separately.
The key elements in JPL's Risk Management System are a Risk Review Board (independent of the project team) that creates a culture of "intellectual confrontation," a "heat map" that displays and tracks the status and trends of key risks, cost and time reserves to permit solving problems within the budget and project time frame, "tiger teams" to address problems that the team cannot fix themselves, and a "go - no go" decision point within 30 days of the planned launch.
After describing each of these components in detail, Kaplan discussed the examples of Lehman Brothers and Bear Stearns, who fell victim to risky mortgage securitization instruments purportedly based on portfolio theory and diversification. "Suppose they had to go to a review board to discuss novel mortgage products," he asked. Other examples, such as the costly delays experienced in the Boeing Dreamliner project and the culture at BP that led to Deepwater Horizon explosion, served to generalize Kaplan's point that companies need better approaches to deal with risk.
Kaplan's many honors, including his election to the Accounting Hall of Fame and his inclusion in the Financial Times 2005 list of the Top 25 Business Thinkers, stem from his development, with David P. Norton, of two widely used approaches to management: activity-based costing, and the Balanced Scorecard. Activity-based costing provides a means to allocated "overhead" costs to the activities and products which consume them, as a basis for good decisions. The Balanced Scorecard is a system to align business activities to the vision and strategy of the organization.
In addition to research on measuring and managing organization risk, Kaplan is working with HBS professor Michael Porter on a project on measuring the cost of delivering health care and linking patient costs to outcomes. Kaplan is chairman, Professional Practice, at Palladium Group, Inc., the "official home of the Kaplan-Norton Balanced Scorecard."
The Enterprise Engineering Colloquium is sponsored by the Cornell Engineering Alumni Association.