Risk management and indicators…
In business, everybody knows the word KPI which stands for Key Performance Indicator. When talking about risk, you can talk about KRI a.k.a. Key Risk Indicator.
KPIs and KRIs are, in some ways, very similar: KPIs measure performance, KRIs measure risk.
But…
KPIs are about performance, that is about the past.
KRIs are about risks; things that may go wrong in the future.
They measure the level of exposure and impact.
Leading and lagging indicators
In the core difference regarding timeframe between KPIs (past) and KRIs (future) lies the difference between leading and lagging indicators.
Lagging indicators
These are indicators related to a result, an outcome. “Lag” means that the indicator will change after something happens. In other words, such indicators measure the results of an action. They do not measure or help identify what happened.
Leading indicators
Leading indicators measure an input that leads to a result. If selected properly, they are the best indicators because they are about predicting a result, and they are related to something you can influence.
Example in Procurement
“Savings” are a very common KPI in Procurement. Not a big news. Such a KPI is a lagging indicator. Leading indicators that could be used next to it are:
- Percentage of spend under management: the more you manage, the more actions, the more savings
- Percentage of spend negotiated
- Percentage of spend included in competitive biddings
- …
A lagging indicator is the leading indicator of the next process. Because business processes consist of several steps / actions taken in series, the output of a process is the input of the next one. So, a lagging indicator becomes a leading indicator for the next process step. Example with savings: “negotiated savings” can be considered as a leading indicator with respect to “captured savings.” Obviously regarding “captured savings”, some other leading indicators exist. An example could be “percentage of renegotiated prices updated in ERP”.
So, the key characteristics of KRIs…
Predictive
Because Risk Management is about “changing the future” by, whenever possible, reducing the likelihood and/or impact of a potential issue, KRIs are more of the leading type.
- Measurable — metrics should be quantifiable (e.g. number, count, percentage, dollar volume, etc.)
- Predictable — provide early warning signals
- Comparable — to track over a period of time (trends)
- Informational — provide a measure of the status of the risk and control
Source of performance and opportunities
Risk Management is about preventing problems. When a problem occurs, you talk about crisis or issue management. Therefore, the discipline of risk management is strongly related to “crisis”. That is why I will use the “famous” say that in Chinese, the word for crisis is composed of elements meaning danger and opportunity.
For the record, the Western belief that, in Chinese, the word crisis is danger + opportunity seems wrong, but I like the “image”, so I used it… Another parallel I could use if the half full / half empty glass. Whatever you look at you can see it through different prisms.
Back to risk management… If you set up the right KRIs, you can reduce the likelihood / impact of events. But there is more… You can go beyond the simple goal of “reducing negative situations” by turning that into opportunities and business advantage. This is especially true if you look at risks that you and all your competitors / your industry are exposed to.
If your organization is the only one, or the fastest one, to take actions regarding a potential threat and if that threat turns into an actual situation, then you will obviously have an advantage over your competitors.
Such a competitive advantage could last, as demonstrated in a 2014 study by Zurich Insurance Group. The important takeaway from that study is that, yes, disruptions have a cost when they occur but the effects of the disruptions last. It takes months to recover and, in many cases, there is no full recovery!
