Be a Ringmaster of Risk

Kai-Fu Lee joined Microsoft in 1998 and was in charge of creating and running operations in China. Responsible for development of the MSN Internet search program, Lee had knowledge of trade secrets. In 2000, Microsoft officials moved to protect the company by requiring Lee to sign a noncompete agreement. Nevertheless, Lee quit in July 2005 upon notifying Microsoft that he was moving to Google to lead the search engine's expansion into China. That prompted Microsoft to sue Google and Lee, contending that Lee's duties at Google would violate the agreement. Google hit back with its own lawsuit, contending that Microsoft's clause was "an illegal restraint of trade" since it violated laws in California, where Google is based, that protect workers' right to change jobs. In December 2005, the parties resolved the issues in a private agreement. In 2009, however, Lee reportedly left Google to work on his own venture in China.

In knowledge-based companies, the most valuable assets are not buildings or hardware; they are people. People make up a company's stock of human capital. As the above anecdote makes clear, the risk of losing key players is substantial enough that some companies try to lock in their services through legal constraints. Others may use restricted stock that vests over time. Still others, such as the SAS Institute, focus on creating great cultures and fun places to work that make it difficult for employees to leave. Each strategy is designed to mitigate human capital risk.

As defined by The Conference Board, human capital risk is "the uncertainty arising from changes in a wide range of workforce and people-management issues that affect a company's ability to meet its strategic and operating objectives." As S. Varadarajan, executive vice president for Tata Teleservices Ltd. in Delhi, noted in a 2011 research report by The Conference Board, "We have to manage human capital risk. In our business, human capital is our only asset, our only raw material and our only product."

Indeed, Ernst & Young identifies human capital risk as a key business risk. Its 2008 survey of Fortune 1000 executives reported that the top five HR risks are:

• Talent management and succession planning.
• Ethics and tone at the top.
• Regulatory compliance.
• Pay and performance alignment.
• Employee training and development.

More broadly, in a 2011 survey of more than 100 directors at large public companies, financial consulting firm BDO found that boards of directors now count risk management as their top concern. That concern is well-placed, as some recent events have demonstrated clearly.

The global financial crisis is one such example. In an ongoing series of articles, the publication Knowledge@Wharton has explored the underlying causes of the crisis. If one word characterizes that crisis, it would be "risk." Indeed, keen observers of the financial meltdown have concluded that it was less a failure of capital than a failure of people—people who took extraordinary risks, fueled by individual incentive plans that handsomely rewarded that behavior, as Wharton Professor Peter Cappelli and I wrote in an article published in the January 2009 issue of HR Magazine. Going forward, thefocus on risk will serve as a constant reminder of what happened during the global financial crisis.

The tragic events associated with the 2010 explosion of the Deepwater Horizon drilling rig in the Gulf of Mexico serve as another example. The tragedy left 11 workers dead and the worst oil spill in U.S. history. In January 2011, a national commission concluded that "The explosive loss of the Macondo well could have been prevented" and that "The immediate causes of the Macondo well blowout can be traced to a series of identifiable mistakes made by BP, Halliburton and Transocean that reveal such systematic failures in risk management that they place in doubt the safety culture of the entire industry."

In fact, a number of unattended HR issues regarding culture and leadership may well have contributed to the explosion and subsequent oil spill.

To their credit, BP leaders took serious steps following the spill to change the company's culture to emphasize safety. They established a safety division and, in the fourth quarter of 2010, based 100 percent of managers' incentive pay on safety, compliance, operational risk management, and whether managers exhibit and reinforce behaviors consistent with these goals.

Three Definitions of Risk

Now consider these scenarios in terms of three definitions in the lexicon of business risk:

As the examples above have shown, talent represents a major business risk to be managed. The Conference Board report identified 27 types of human capital risk.

With respect to each of these potential risks, consider asking the following questions:

• Is it relevant to your organization?
• Might it have a material impact on your organization?
• If relevant and material, is it an enduring risk?
• If relevant, material and enduring, is it addressable?

The objective of this approach is clear: Focus on addressing risks where they matter most. Having identified the kinds of human capital risks that do matter most, here are seven alternatives for dealing with them from a 2010 report by the Corporate Research Forum.

Tolerate the risk, taking no steps to address the issue.

Eliminate the risk; the possible outcome is unacceptable. For instance, you might not hire people with job-related personal or background characteristics that make them too risky, such as airline pilots with poor vision.

Minimize the likelihood of an outcome occurring and minimize its impact through training or backup systems.

Diversify the risk across areas such as management training programs that include rotations through various functional areas of a business.