LEGO can tell investment people something about risk management

 

Investment management has not cornered the market on risk management strategy and techniques. Investors can learn from how firms approach corporate strategic risk management. One firm that seems to be ahead of many is LEGO. It has been successful navigating geopolitical risk, competition, and changing tastes, to become the largest toy firm in the world and the envy of all for their good values. 

The LEGO approach to risk management can be summarized in an informative article, "Strategic Risk Management at the LEGO Group" Strategic Finance, February 2012. What I find especially appealing are two LEGO ideas associated with their risk management process, Active Risk and Opportunity Planning (AROP) and the Park, Adapt, Prepare, and Act (PAPA) Model.

The AROP process subjects every project to a comprehensive review and analysis of not just downside risks but also upside opportunity. Good risk management does not dwell only on the bad things that could happen from undertaking a project but also looks at potential gains. Risk management without assessing upside is just an exercise in risk mitigation, and the easiest way to employ risk mitigation is to not take any risks; reject everything. AROP analyzes both tails to ensure appropriate risk assessment.

The PAPA model is a classic 2x2 matrix which looks at the firm's strategic response based on likelihood and the speed of change of different scenarios potentially being faced. This mapping of project or strategies into scenarios is a good way of prioritizing projects, opportunities, and risks. 

Scenarios that have low likelihood and a slow speed of change can be parked, although not forgotten, until the future, while scenario events that have high likelihood and fast speed of change will likely require immediate action. High likelihood events that are slow to evolve will involve adaption while fast events or scenarios with low likelihood require current preparation.

Investing has not cornered the market on good strategy and risk management principles. Investor can discuss different world views, but those views have to be placed in some context and looking at likelihood versus speed of change is a strong actionable framework. The AROP work can be mapped into these  strategic scenario assessments of the economic and market environment, so there is a holistic approach to test and compare investment ideas. Thoughtful analysis can lead to repeatable success if it is implemented in a structured framework.