“How much risk is right?” — Where’s a framework for assessing risk?

The feature article in the January 2011 issue of Associations Now, ASAE’s monthly magazine, is entitled: “How much risk is right?”. It contained a few useful points, but overall it was disappointing. It would have been more useful if the author had recommended a general framework to making decisions involving risk.

What I liked about it includes learning about author and consultant David Ropeik and his book “How Risky Is It, Really?” and referencing Paul Wehking’s observation that ‘continuing the status quo might actually bring more risk to an organization than making a change, which may or may not involve doing something new.’   That was the only value for anyone with any direct management experience.

No, I’m not looking for academic coursework on the subject from Associations Now, but it would be helpful to lift their aim a bit higher and make their articles more than thinly veiled ‘infomercials by vendor members’. Suggesting even one framework for working through strategic decisions involving risk would have been nice. For example…

A More Pragmatic Framework for Assessing Risk
The author defines risk in broad terms as “the possibility of loss or injury.” While this is true, it’s also not very useful for managers. Alternatively, if we define desired outcomes as an outcome based on “known” and “unknown” contributing factors we allow ourselves the ability to assess the likelihood those contributing factors have on the desired outcome. Let me illustrate with a true story involving the board of an independent school on which I sit.

Identifying and Reducing Risks in Critical Decisions

1. Background
Independent schools, by definition, charge tuition to raise operating revenue. The vast majority of independent schools typically set tuition rates to cover most, but not all of their operating costs. The difference between tuition revenue and operating costs is referred to as “the gap”. The gap is traditionally closed by a variety of fund raising activities, where depending upon the particular activity some or all of the funds contributed may be a tax-deductible gift for the donor.

2. The Dilemma for Independent Schools
Independent schools face a classic price optimization problem; the need to charge as much as possible, but not price themselves out of the market. This price pressure has been growing over the past decade and getting even worse in the past three years. This is especially the case with independent schools that serve special needs where attending the school is less of a choice than a necessity. This is the case with the school in this example. We must be careful not to price our educational offerings beyond the market for which they are intended.

3. Risky Idea
For a couple of years a very contrarian tuition policy has been floating around the board but it was never really studied seriously because it was deemed “too risky.” The idea is to lower tuition instead of raise it — and lower it by a lot; on the order of 25 to 30%. It turns out, the idea may not be that risky, but the expected cost of failure is quite high. Think in terms of an asteroid hitting your city. The probability of the event happening is low, but if it did happen, chances are pretty high that the costs would be enormous.

4. Differentiating Between Risk and Bad Outcomes
By using a risk model of “knowns and unknowns” I was able to construct a model that rested on only two unknown factors. The value of this was twofold: i) we eliminated those unknown factors that are irrelevant to the outcome and causing significant distractions; and ii) we were able to put those unknown factors into their proper size and proportion. Further, we were able to reformulate those unknown factors into questions that we could answer before a decision was required. If not answer them fully, we could certainly reduce the level of uncertainty about them, raising our level of confidence in the final decision, whether it was to lower or raise tuition — as a board we just wanted a high degree of confidence that we’ll make the right choice for the school.

The unknown factors are: i) would such a tuition policy compromise the school’s 501(c)(3) exemption status; and ii) would the school’s families expand voluntary giving to close the much wider “gap” resulting from a lower tuition model:

 
risk_model.jpg

The above illustration represents the final “risk assessment” of our decision. This approach allowed us to eliminate several distracting factors. First, how would significantly lowering tuition affect tuition assistance, which has been adding more pressure to school finances since 2007? We think it would likely reduce the pressure, but in the end we realized that it would have no impact on the desired outcome. There were several other questions that were bothering us simply because they were complicated, but until we produced a general framework for the decision it was hard to see that those particular unknown factors were not relevant to the outcome we’re trying to maximize.

Also, once we isolated the key factors we were able to connect existing data that we had not associated with this question before this exercise — before we knew it, we were facing a strategic decision that was not fraught with risk we couldn’t manage or handle.

Is it higher or lower tuition?
At the risk of being a tease, “we don’t know yet!” As of this writing we’re still studying the two unknown factors. We’re about to obtain a legal opinion on the IRS question, but we’re fairly optimistic that there are no barriers to lowering tuition, as long as solicitations to close the gap are strictly and legitimately for voluntary giving. Will the families increase their giving, or will we have a free-rider problem? We don’t know, but realized we could reduce the risk of this factor by polling our families. Our school is small enough that each board member can personally survey a manageable number families and we’ll have our risk assessment completed in time to set tuition for the next year.

In Conclusion
This post is not intended to be a full-on rebuttal of the Associations Now, but to register disappointment that such an important topic to the association management community was handled in such a trivial way. Further, Associations Now would produce stronger articles, especially feature articles, if they were authored by individuals with direct experience in the subject matter. Case in point — the Ropeik reference (included above) about board members wanting to be right personally and do the right thing for the organization — any experienced association executive and honest board member would put this in more concrete terms: above all, board members want to avoid criticism for their decisions and positions. Let’s face it, it’s only human nature. Board members are not compensated for their time and efforts as board members, so where’s the payoff for “doing the right thing?”. This distinction is significant. An irrational fear over the prospect of being criticized for supporting something different is very different from what could be interpreted as doing the right thing for the organization.

The typical board member will do right by their organization if we can remove, or significantly lower the prospects that they will be criticized for decisions they support.

For association executives, learning how to navigate this decision-making dynamic is more at the heart of the matter than the issues raised in the largely superficial treatment of risk in this month’s Association Now.

Posted in Management.

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