Kevin Buehler

Andrew Freeman

Ron Hulme

In the 1970s a revolution occurred in the field of corporate strategy. A boom in mergers and acquisitions launched new professions in M&amp;A banking, M&amp;A law, and strategy consulting. Given an active and efficient market for corporate control, companies shifted their focus from owning the most attractive businesses to owning the businesses in which they had a competitive advantage. If an owner was not advantaged, even its fastest-growing or most profitable businesses could be sold at a premium. Conversely, when the company was competitively advantaged, keeping even its least exciting businesses made sense.

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Reprint: R0809H
In the 1970s a revolution occurred in the field of corporate strategy. A boom in mergers and acquisitions launched new professions in M&#038;A banking, M&#038;A law, and strategy consulting, and companies started to focus on owning businesses in which they had a competitive advantage. At the same time, another revolution occurred in how financial services companies understood, bought, and sold risk&#8212;described in the authors&#8217; companion article in this issue, &#8220;The New Arsenal of Risk Management.&#8221; Now these two revolutions are coming together to trigger a third in the corporate approach to risk management.
Engineering and dynamically managing a company&#8217;s risk portfolio has become the organizing principle for strategic choice. When companies focus on the risks for which they are naturally advantaged, they can typically support higher debt levels and save on operating costs. McKinsey&#8217;s Buehler, Freeman, and Hulme describe five steps to help corporate managers adjust to the third revolution: 1) Identify and understand your major risks; 2) decide which risks are natural; 3) determine your capacity and appetite for risk; 4) embed risk in all decisions and processes, including investment, commercial, financial, and operational; and 5) align governance and organization around risk.
TXU is one company that has already successfully adapted. Following the 2002 deregulation of wholesale and retail electricity markets in the U.S. state of Texas, TXU embarked on an ambitious risk-return restructuring program that relied on sophisticated risk-management tools to quantify its risk capacity. The program led to share price increases that created more than $32 billion in value before the company was taken private in the largest leveraged buyout in history.

Owning the Right Risks

Reprint: R0809H In the 1970s a revolution occurred in the field of corporate strategy. A boom in mergers and acquisitions launched new professions in M&A banking, M&A law, and strategy consulting, and companies started to focus on owning businesses in which they had a competitive advantage. At the same time, another revolution occurred in how financial services companies understood, bought, and sold risk—described in the authors’ companion article in this issue, “The New Arsenal of Risk Management.” Now these two revolutions are coming together to trigger a third in the corporate approach to risk management. Engineering and dynamically managing a company’s risk portfolio has become the organizing principle for strategic choice. When companies focus on the risks for which they are naturally advantaged, they can typically support higher debt levels and save on operating costs. McKinsey’s Buehler, Freeman, and Hulme describe five steps to help corporate managers adjust to the third revolution: 1) Identify and understand your major risks; 2) decide which risks are natural; 3) determine your capacity and appetite for risk; 4) embed risk in all decisions and processes, including investment, commercial, financial, and operational; and 5) align governance and organization around risk. TXU is one company that has already successfully adapted. Following the 2002 deregulation of wholesale and retail electricity markets in the U.S. state of Texas, TXU embarked on an ambitious risk-return restructuring program that relied on sophisticated risk-management tools to quantify its risk capacity. The program led to share price increases that created more than $32 billion in value before the company was taken private in the largest leveraged buyout in history.

Owning the Right Risks

Summary.

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