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By Murray Wolfe & Cathy McIsaac
Illustration: Katy Dockrill
 AN INTRODUCTION TO METHODOLOGIES TO HELP YOUR ORGANIZATION MANAGE FUNDAMENTAL RISK OF ALLOCATING SCARCE RESOURCES
With increasing attention being paid to risk management and internal control, enterprise risk management (ERM) has gained prominence in corporate North America and is emerging as a discipline that defines risk not just in terms of threats but as opportunities and how they relate to the achievement of an organization's goals and objectives. ERM helps break down organizational silos and differs from traditional risk management by focusing on minimizing losses and realizing potential benefits. There are several approaches to ERM. However, the methodology generally follows an iterative application of four distinct elements with the goal of embedding a clearly defined, comprehensive and rational method of managing risk throughout organizations:
• Identification of significant organizational risks on a comprehensive basis, usually captured as a risk profile or risk inventory organized by specific risk category (financial, strategic and operational).
• Assessment of identified risks usually through interviews and facilitated workgroup sessions involving senior management who rank the risks high, medium or low. Rankings are usually defined as the product of probability and severity.
• Managing assessed risks by developing and implementing enhancements to the internal control systems that will effectively mitigate and address risks and take advantage of opportunities.
• Monitoring the success of implementing risk management and internal control system changes and taking advantage of evolving opportunities.
Undertaking the first two elements is relatively easy. Determining how to best manage the resulting risks is more difficult, especially with respect to the effective allocation of scarce financial resources, a prominent risk for most organizations.
Searching for an effective method to address risk related to the allocation of scarce resources, we discovered a potential solution in the investment value management (IVM) methodology. This article presents an abridged version of IVM, described in detail in John Thorp's The Information Paradox.
IVM was developed with the information technology industry in mind, because most organizations are notoriously poor at executing IT projects on time, on budget and to design specifications. Inevitably the project scope expands, budget overruns occur, business requirements are not satisfied, and both business and IT departments end up disappointed in the results. Because similar problems are encountered in the management of any project, IVM can be applied to any initiative bound by scarce financial and other resources.
The term "investment program" is used here to describe any activity requiring financial or other resources. The interrelated concepts of projects, programs and portfolios are important distinctions for IVM, however, and are described in greater depth in Thorp's book.
For investment programs, when making decisions regarding where to best devote resources, the selection is affected by three blind spots: selection is seen as a one-time event; selection is done in isolation; and selection is done without looking at all aspects of value.
IVM is intended to minimize the effects of these blind spots by applying a portfolio perspective to the selection and management of investment programs. This reduces the risk inherent to making the investment and reflects the reality of the ever changing business environment.
According to Thorp, "Portfolio management has been applied to financial investment programs for decades, helping decision-makers choose among increasingly numerous and complex options in a volatile environment." IVM is about undertaking active investment, which includes monitoring the portfolio over time and re-evaluating the investment decisions in relation to changes that occur within the dynamic business environment. "The portfolio concept allows [organizations] to select among complex options and adjust investment program selections over time to meet defined risk/reward criteria," he says. "The portfolio's composition reflects a balanced set of high-value opportunities that, together, promise the best overall return, in dollars and other benefits."
With IVM, the decision to invest in a program, the re-evaluation of commitment to the program, and the adjustment of the portfolio of investment programs is done on an iterative basis over time. The investment program portfolio is selected and adjusted using these five steps: categorize investment programs; prepare value cases for investment programs; manage the risk of the portfolio; manage and take advantage of interdependencies between investment programs; and adjust the portfolio composition over time for changing business circumstances.
The first step to selecting an effective portfolio of investments is to compile an inventory of potential investment programs, categorizing them into rational groupings. The groupings will be specific to the organization and might include such investment programs as mandated by regulation (i.e., related to safety and security); required to maintain and/or grow existing services and products; and intended to realize a business opportunity.
Any other category applicable to the particular organization is possible, but the choice should be guided by overarching organizational goals and objectives. The purpose of categorizing potential investments is to explicitly recognize and acknowledge that all investment programs do not have the same priority.
Mandatory and required investment programs by definition are not optional. Although they may be implemented over a specific time period, they are given priority and must be undertaken to meet the requirements generally dictated by a third party. With mandatory investment programs it's an issue of "when" not "if."
Of the three categories, therefore, only the one relating to business opportunities requires a full analysis of the investment program to support selection as part of the portfolio. Analysis is done by the preparation of a value case for each program.
Traditional methods of selecting investment programs generally rely on static business cases developed to justify investments as part of the annual budgeting process. IVM does not rely on business cases but employs detailed value cases for each investment program.
Value cases include assessments of all value related to the potential investment program, using an iterative technique, the "four ares," applied at any level and within any function of an organization:
1. Alignment: are we doing the right things?
2. Integration: are we doing them right?
3. Capability efficiency: are we getting things done well?
4. Benefits: are we getting benefits?
The answers need to be calibrated in order to compare them across investment programs. To do so, use of three measurement dimensions — alignment, financial worth and risk — is recommended.
Alignment refers to the degree an investment program supports the goals and strategic purpose of the organization and is intended to capture contributors to organizational success beyond financial worth. Financial worth reflects the value of the investment program in pure financial terms, using standard financial measures such as ROI or more recent innovations to measure financial worth. Any measure must be all-inclusive, taking into consideration the probable life span of the investment and the cost of all operating and sustaining efforts required to ensure the investment continues to deliver benefits over the full investment life span.
Risk is measured in terms of not realizing the expected potential value of the investment program.
After value cases have been defined using the "four ares," these cases form the basis for further managing the portfolio of investment programs to achieve the greatest benefit.
On a portfolio basis, overall risk is managed with the aim of increasing the total value of the investment program to the organization. This is done by balancing the portfolio with a mix of high-, medium- and low-risk investment programs and matching the portfolio to the organization's level of risk tolerance.
Interdependencies between investment programs can present a wealth of opportunities for an organization, opportunities not well identified or understood when investment program selections are made in isolation. Individual programs should be selected from a broader organizational perspective and all implications should be considered, including upstream and downstream effects the program will have on business and operations, information systems and human resources. The overall objective is to maximize the benefits to the organization with the minimum allocation of scarce resources.
Over a short period of time, business conditions can change dramatically, calling into question the current validity of business cases used to justify investment selections made in the past. IVM takes such changes into consideration when evaluating portfolios of investment programs on a repetitive basis, providing a structured process in which projects can adapt to changing circumstances in order to maximize the achievement of expected value and benefits. Steps are taken to ensure individual programs are reevaluated on an ongoing basis, and decisions to continue programs or change initial plans are then made on an ongoing basis.
How to allocate scarce resources, financial, technological or labour, is a fundamental and perennially difficult problem for all organizations, regardless of size and whether they are for profit or non-profit. For this reason it is often identified as a significant risk when most organizations initially implement the first two phases of ERM.
IVM provides a valuable tool for management when aligned with ERM, helping to ensure threats and opportunities (or benefits) are defined in relation to organizational goals and objectives, and are then managed over time in a rational manner to minimize risk and maximize value.
The actual implementation of both ERM and IVM is more complex and detailed. This introduction to both methodologies is a first step to organizations looking to manage the fundamental risk of how best to allocate scarce resources because they are considering an ERM strategy.
Murray Wolfe, CA, is manager, control & enterprise risk management at a Canadian transportation company. Cathy McIsaac, CMA, is a leadership coach specializing in IVM. They can be contacted at mdwolfe@telus.net or mcisaacc@7CZ.net
Technical Editor: Peter Jackson, CA, Toronto-based consultant in risk management, governance and strategic change | 
