Risk and Reward Often Arrive Simultaneously for Nonprofit Boards

The phrase “black swan” comes from 2nd-century Roman poet Juvenal who described “a rare bird in the lands and very much like a black swan.” The poet and most others assumed that black swans didn’t exist. They were wrong. Today, we use the term as a metaphor for the fragility of any system of thought that can come undone once we disprove a set of assumptions.

Expanding on Nassim Nicholas Taleb’s theory, we now explain things as black swans if they are hard-to-predict, rare events that don’t fit our expectations. Taleb regarded almost all major scientific discoveries, historical events, and artistic accomplishments as “black swans”—undirected and unpredicted. He was wrong, too.

Risk Management Nonprofit

Nonprofit boards have to do better. Organizations count on them to recognize that black swans exist and to identify them before the competition does. To do that, directors must overcome the psychological biases that blind them to uncertainty and a rare event’s potential risk. Traditional enterprise risk management (ERM) processes do not address key assumptions on which boards base the organization’s strategy and operating model. Nor do these conventional approaches help directors determine the impact and likelihood of potential risks in order to prioritize scarce resources. Too often boardroom discussions involve an examination of past performance, which can limit insights about unexpected and rare risks. Instead, these discussions should address the changing landscape, customer demands, and innovation.

As a Nonprofit – Who’s Going to Try to Kill Us Today?

In 1983, Motorola introduced the world’s first cell phone, the DynaTAC 800x. In 1987, Nokia introduced its first mobile phone, the “Mobira Cityman 900.”  No one was paying attention to Apple, but after the company’s first smartphone in 2005, no one could ignore them. What were once large and bulky luxury items became small, compact devices we can’t live without. In fact, by 2018, 95% of Americans owned a cell phone of some kind, and 77% of those were smartphones. Directors at Nokia and Motorola probably thought of Apple as a computer company, as we all did. Apple’s application for a patent should have mobilized those making mobile phones to suspect a black swan might be lurking, but it didn’t because directors didn’t have “situational awareness.”

In general, situational awareness involves three segments: perception of the elements in the environment, comprehension of the situation, and projection of future status.  Although the term itself is fairly recent, the concept has roots in military theory and appears in Sun Tzu’s The Art of War and in World War I records, where decision-makers recognized it as a crucial skill for crews in military aircraft. In a nonprofit boardroom, situational awareness means directors should be aware of their own biases that stem from their past experiences and personal, yet limited perspectives. Only then can they ask, “In today’s climate, what business are we really in?” That will lead them to ask, “What are we doing proactively to listen to those we serve and to respond to the direction our mission is taking us?”

The landscape in nonprofit organizations changes a bit differently from how it does in for profits—with more layers of complexity and complications. First, like their for-profit counterparts, directors of nonprofit boards need to protect themselves against disastrous outcomes that could threaten their survival. But they must go a step further—to consider how these risks may affect their mission, especially when that means guarding against potential liabilities from operating risky programs such as children’s summer camps.

Second, as nonprofits consider alternative ways to address their missions, they may find that those options that promise the greatest rewards also involve greater risk. In these situations, the strategic balancing of risks and benefits allows organizations to have the greatest impact on their missions. Since nonfinancial impacts of financial decisions often matter more to nonprofits than they do to for-profit companies, financial decision-making can prove more complicated for the nonprofits.  Therefore, nonprofit directors must weigh combinations of risk and reward more deliberately.

As a Nonprofit – What Will Those We Serve Need Tomorrow?

Too many boards focus on last year or last quarter. They need to quit looking in the rearview mirror and start inviting other directors to view the company through a kaleidoscope to see multiple possible futures and to develop a mindset devoted to continuous learning.   Certainly, effective directors need to be students of history, but boards that keep their eyes on the future realize they need a soothsayer—a human crystal ball who can look into the future to identify where and when the opportunities and risks will appear. Many directors fail this future-oriented litmus test, however.

For example, merger and acquisition (M&A) activity within the healthcare industry shows no sign of diminishing, with nearly all indicators pointing to continued consolidation, according to a 2019 Health Leaders Mergers, Acquisitions, and Partnerships Survey. The fundamental need for greater scale, geographic coverage, and increased integration remains unchanged for providers, and this will sustain M&A activity for years to come.

Nonprofit directors that don’t take a strategic approach—one that carefully balances risk and reward—to an M & A deal risk creating unintended consequences. That’s what happened in Maine.

Beginning in January 2019, MaineHealth became a single nonprofit entity with nearly 19,000 employees and more than $3 billion in annual revenue. MaineHealth joined a long list of hospitals that have merged to form large healthcare systems. According to the American Hospital Association, of the more than 5,500 hospitals in the United States, nearly 60% are part of a health care system. In many cases, a single board of trustees governs the large systems. From a purely reward point of view, successful large healthcare systems can reach economies of scale, share resources, reduce cost, and leverage their increased revenue to attract physicians and purchase the latest medical technology.

From a risk-management standpoint, however, the news isn’t all good, with rural hospitals facing the greatest challenges. Since 2010, The Cecil G. Sheps Center for Health Service Research has recorded 87 rural hospital closures in more than twenty states. According to one study, more than 600 additional hospitals in 42 states are vulnerable to closing, with 12 million patients losing direct access to care and about 99,000 jobs at stake. In short, nonprofit deals are more complicated because they must consider keep a keen focus on how risk and reward march in lockstep precision with the organization’s mission

When leaders acquire a company, of course they believe the deal will work. If they felt otherwise, they wouldn’t have gone forward. Human beings have a psychological tendency to justify our decisions, making it difficult to see the signs that we made a mistake. Thus, a leader who drove an M & A deal is usually more hesitant to pull the plug than someone who didn’t make the acquisition in the first place.

In general, boards of nonprofit health care organizations have done a good job of asking what patients will want and need in the future. They realized years ago that a hospital’s best customers don’t want to be patients in the hospital. So, they started offering more out-patient options, including same-day surgery centers. They asked themselves the question their patients wanted them to ask, “What can a health care organization do to keep people from becoming patients?”

Mission-driven boards address the health, education, and spiritual needs of people, look to improve the quality of life, champion the arts, or seek social change. Additionally, they consider how to satisfy the ever more demanding accountability requirements of funders, donors, and government overseers. Consequently, directors often find themselves trying to develop quantitative measures of their mission-related impacts.

Unfortunately, too many directors focus too much on reviewing data and setting it aside until it’s time to review the data again—usually within a terribly short interval. The value isn’t in tracking the metrics, however. The real value in metrics is the customer-focused discussion they drive, the decisions directors make, and the actions they take as a result of the discussions. The process starts with the right questions, which lead to an understanding of which data are important and which measurements they should really pay attention to. By doing this, they spot customer patterns before the trends cease being trends. Learning from the data can also help them engage in scenario planning to be to speculate about the unknown.

Adaptive Governance

Adaptive governance describes an emergent form of environmental governance that scholars and practitioners increasingly call upon to coordinate resource management regimes in the face of the complexity and uncertainty associated with rapid environmental change. Nonprofit directors apply the principles of adaptive governance when they actively involve directors in setting and maintaining a boardroom culture that involves open discussion and constructive challenge. These directors devote ample time on board agendas to looking at the future because failure to respond appropriately to disruptive situations can make the difference between growth and obsolescence. These directors demonstrate an openness to alternative, nontraditional viewpoints and a willingness to question assumptions. They recognize that some level of tension is acceptable and insist that management share bad news early. Their bias for continuous improvement encourages them to engage in honest self-reflection.

Directors committed to adaptive governance understand that they need to encourage innovation and learning, set ethical standards, and promote accountability, especially with the CEO. Most importantly, these directors take a proactive approach to the oversight of culture to drive sustained success and long-term value creation.

What do we mean by “culture”?  Legends tend to have differing adaptations; the truth has no versions. Both influence—either intentionally or unintentionally—the cultures we build. Corporate culture, the way we do things around here, the pattern of shared assumptions that the group has adopted and adapted, develops in much the same way as legends and traditions do.

Organizations learn as they solve their problems and adjust to the world around them. When something works well over time, and leaders consider it valid, members of the organization begin to teach the behavior or idea to new people. Through this process, new directors find out what those around them perceive, think, and feel about issues that touch the organization.

Excellent decisions serve as the coinage of the nonprofit realm. When directors consistently make good decisions, little else matters; when they make bad decisions, nothing else matters. A pivotal decision—or, more likely, a series of pivotal decisions—literally separates the organizations that flourish from those that flounder. Every success, mistake, opportunity seized, or threat mitigated started with a decision.

Success doesn’t happen without decisions, but neither do mistakes, except when the decision involves indecision—a kind of decision not to decide. When directors play in the most competitive leagues, they will have mishaps and missteps, but indecision doesn’t have to be among them. However, the culture of too many organizations conspires against success. Decisions—good, bad, or decent—get stuck in the entrails of the organization, much as flotsam and jetsam accumulates on an untended beach. Boards create their own bottlenecks and harm themselves in ways that the competition never could. They become their own strongest competitors—the enemy within—the entity that creates risk rather than mitigating it.

Effective directors set the tone at the top and lead the never-ending journey to discover new and better ways to solve problems and adapt to the world around them. For example, when discussing risk, directors often home in on data breaches because this sort of risk can quickly move from bad news to full-blown catastrophes. Addressing a data breach should be done quickly, honestly, and responsibly. Frequently, however, companies minimize the seriousness, explain what happened but fail to apologize, or treat it as merely a public relations problem. Boards spend time discussing cyber risk, but a cyber breach won’t usually put them out of business. A failure to learn from mistakes and make the requisite changes can, however.

Nonprofit directors tend to underestimate the importance of a change-oriented culture when they should see it as one of their top governance imperatives. Culture inextricably links strategy and risk, and it can be an organization’s biggest asset or its greatest liability. Yet, recent studies indicate that more than 80% of directors don’t have a firm grasp of the culture that exists in the organizations they serve. Most directors would be hard-pressed to define corporate culture, and those that can don’t always know what their role should be in influencing it.

Successful directors realize that, in the long run, how a company does business is as important as short-term gains. Now, more than ever, directors are taking their responsibilities seriously, speaking up, and striving for results; but in many cases, the evolving relationship between the company’s executives and the board has not found the right symmetry. Both the company and the board benefit when directors take a more active role in influencing culture.

Conclusion 

Up until now, for various reasons, nonprofit boards have not taken a sufficiently robust approach to risk management. While this tactic has seemed sensible because it minimized risk, it also reduced the rewards of growing and changing.

In his book I Really Didn’t Say Everything I Said, baseball’s great philosopher, Yoggi Berra, cautioned us that we can’t know the future because it “ain’t what it used to be.” Mr. Berra was correct. Directors can’t know the future, yet the organizations they serve depend on them to do just that—and the future arrives more quickly than it used to. Today, directors have learned that opportunity and risk often arrive at the party concurrently—and instantaneously, without warning.

Directors need to strengthen the aspects of board culture that help the organization identify and respond to disruptive risks—to make the board’s culture a corporate asset. When they do that, they will support the management team, even while engaging in uncomfortable conversations. They see tension as a catalyst that motivates deeper engagement. Then, they will be able to welcome both opportunity and risk.

The future will remain uncertain and unstable for nonprofit decision-makers—and we probably won’s see these unpredictable situations diminishing, either. All indicators point to continued change and limited options for preserving the status quo. An expanded capacity for strategic risk management and a willingness to consistently and continuously balance risk with reward will serve nonprofits well, however.

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