The first category included major strategic blunders (such as new product or new market failures) or instances when a company was caught flat-footed by a major industry shift (such as digitization of content). We included failed mergers and acquisitions in this category, as well as dramatic shifts in major enterprise value drivers (for example, a major input cost), because these occurrences should have been foreseen. This category includes, for example, Time Warner and its widely criticized merger with AOL in 2000.
In the second category, we grouped together major operational problems, such as supply chain disruptions, customer service breakdowns, and operational accidents, that had caused substantial shareholder value destruction. A high-profile example is the April 2010 Deepwater Horizon offshore oil rig explosion and leak in the Gulf Coast, an event that wiped out more than $50 billion in BP’s shareholder value in the days and weeks following the accident.
The third category included fraud, accounting problems, ethics violations, and other failures to comply with laws, standards, or ethics. During the 10-year time frame we analyzed, a few prominent examples were Tyco’s accounting and discrimination lawsuits in 2002 and Tenet Healthcare’s 2006 legal battles over improper medical and business practices.
In the fourth category, we identified declines resulting from external shocks that were natural, political, or regulatory. We narrowed these situations down to circumstances in which the external event could not be controlled or easily anticipated by the company. For example, USEC — a supplier of enriched uranium for nuclear power plants — saw a sudden and sharp decline in enterprise value after the 2011 Japanese tsunami and ensuing nuclear disaster.
The results are unambiguous. Among the 103 companies studied, strategic blunders were the primary culprit a remarkable 81 percent of the time. (See Exhibit.) When we segmented the data by industry and geography, we found some variations; for example, strategic failures are particularly acute in the financial-services industry, and Europe has more operational problems than the U.S. or Asia. Nevertheless, strategic failure remained the major cause in these cases as well.
About half the time, the loss of value occurred gradually — over many months, or even years if the company took too long to grasp a changed strategic environment or lacked the agility to react. The other half of the time, the lost value occurred in a matter of months, weeks, or even days. Sometimes these sharp shocks were caused by strategic failure (for example, being caught by surprise when a competitor introduced a superior product), and sometimes they resulted from an operational issue, compliance problem, or external event that overwhelmed the company.
Often, it is a confluence of events that leads to value destruction. To better understand these more complex situations, we segmented loss drivers into primary, secondary, tertiary, and quaternary causes. But even when second-order causes were taken into account, strategic failure caused more than 60 percent of shareholder value destruction.
The Resilient Company
How should management respond to the threat posed by strategic risks? Senior leaders can’t rely on ERM teams to make the enterprise more strategically resilient, because ERM teams do not have the scope to question the strategic decisions that set the company’s course and undergird its operations. Make no mistake, the ERM function is vital: Once handed a strategic plan, these teams identify and quantify risks and then assign people to build continuity plans. Thus, ERM groups play an essential role in addressing frequently encountered risks in areas such as compliance, ethics, finance, and accounting, as well as safety. (The research shows that some companies could also stand to improve in these areas, but in general, most companies have a well-functioning program in place.) However, ERM groups can’t be the only source of protection, especially when it comes to the most potentially disruptive issues.