RISK APPETITE AND THE LAUDA FORMULA
The late Austrian Ferrari race car driver Andreas Nikolaus (Niki) Lauda’s ability to size up the risk in a race is a perfect example of how corporate risk assessment guidelines and processes should work. When Lauda’s efforts to persuade his fellow drivers to boycott the 1976 German Grand Prix failed, the race went on and he was nearly killed in a tragic accident on the track.
The execution of corporate risk assessment and identifying opportunities to include as negative risks, are the responsibility of an internal function, such as governance or the holistic governance, risk and compliance approach. But the decision to accept, reduce, avoid or transfer the risks is up to management, aligned with the company’s ‘risk appetite’. The level of risk appetite depends on the company’s philosophy – its interpretation of sustainability and long-term value – and its operational position inside the competition. Leading companies may have a lower risk appetite than their challengers, as they perceive they have more to lose than to win.
Similar to motorsports, overtaking is accepting a risk, as it means doing something differently, for example braking later. Overtaking not only takes place on the track, it also requires synchronisation with the pit crew, using different strategies or changing the setup. Translated for business: companies should disrupt the market with new products, processes and solutions. A calculated risk, based on key employees’ opinions, as well as market research and development, is defined in conclusions later to be classified as restricted information. This is a challenge for the governance department, as the function is not limited to fostering the adequate execution of global and local processes, but also ensuring that, together with the guideline owners, these processes are aligned with identified business risks and appetite. The participating experts of the risk assessment define probabilities and impacts. The appetite is more difficult to understand, as below the top management level, employees have limited access (the ‘need to know principle’) to restricted information and, as a result, cannot retrace management decisions and evaluations. As a consequence of this disconnection, guidelines may either be too restrictive and bureaucratic, or not strict enough to adequately tackle the identified risks.
In addition, employees unaware of the company’s risk appetite or the results of the risk assessment may misinterpret the purpose of the regulations, and be tempted to ignore or actively violate them. The successful integration of Generations Y and Z into the workforce requires the job to be aligned with personal values. Internal communications have to make these relations clear, including an explanation of the company’s philosophy, underlining the sustainability concept and risk appetite. This not only applies on a global level, but also to concrete regional decisions and actions. Efficient internal connections allow an adequate flow of information. Modern technology, such as video and text messengers, internal social media, wikis, chat-bots and micro-learnings, can support parties to overcome geographic barriers and allow access to small and remote locations. The better requirements are understood, the more precise employees can be, and are willing, to act.
Formula One champion driver Alain Prost was asked what went wrong at McLaren when he drove with Ayrton Senna on the same team, why the atmosphere became so toxic that the drivers drove into one another. His answer was that the problem developed due to management’s lack of transparency. The drivers had been unaware of the actual politics within the team, and which topics had been relevant for leadership. The consequences of this confusion were a loss of mutual trust and violations of internal regulations.
In 1976, the German racetrack Nürburgring was no longer fit for purpose, and appeared to be a relic from another era. Safety standards, in particular, had not kept up with the progress of modern Formula One cars. Niki Lauda was known to many as ‘The Computer’ because he was known for his emotionless ability to analyse a given situation and find the perfect setup for the car. He had a simple philosophy: “I accept every time I get in my car there’s a 20 percent chance I could die.” Later he clarified that this was not meant as a statistical calculation, but a general statement. Strong rains determined the weather conditions for the ‘76 Nürburgring race. Based on his risk appetite, it was no surprise that at the drivers’ meeting a day before the race, Lauda was the strongest supporter for cancelling the race. Nevertheless, the proposal was rejected as an attempt to pressurise the race’s organisers and sponsors. Even Lauda ignored his own philosophy and accepted a risk that was subjectively higher than 20 percent. The result was the tragic accident in which Lauda’s Ferrari went off the track and burst into flames, nearly killing him. The physical and emotional scars likely marked him for the rest of his life. He returned in record time to racing, but lost the championship to his rival James Hunt.
With the Argentinian driver Carlos Reutemann hired to replace him, and having watched Hunt on TV winning in the Netherlands, Lauda returned to the cockpit just six weeks after his accident. He scored three points at the Italian Grand Prix and four in the US before he went to the season’s final in Japan. The weekend of the Fuji Grand Prix started with pouring rain. Because of the rain, there was a lively discussion at the drivers’ meeting again of whether the race should be held. The result was the same as at Nürburgring and the race started as scheduled. Lauda again participated, but just for a few laps, he then went back to his garage and stepped out of the car. Based on his formula, the heavy rain made it too dangerous to drive. He watched the race until the end and saw his rival come third, overtaking him in the overall ranking and winning the 1976 world championship by one point. Taking the single race results, excluding the results from the German Grand Prix, Lauda scored an average 4.8 points per race. If he had complied with his 20 percent formula and skipped his participation at the Nürburgring, as he did later in Japan, he not only would have avoided the terrible accident, he probably would have won the championship.
Lauda’s experiences are a relevant example of how internal guidelines and processes should work. Adapted to an organisation’s risk appetite, they define the safe space where employees can act, while drawing a visible red line. Overstepping the line means that employees take a higher risk than their management is willing for them to accept. This can mean winning a single race, but most likely also jeopardising sustainability and losing the championship.
Different strategies avoid, reduce, transfer or accept risks. Conducting business always translates into taking risks, and all participants have to be clear about this. Of course, each stakeholder is responsible for reducing risk as much as possible. Compliance is responsible for managing its own risks, which includes protection against renegade employees who are planning a fraud for personal enrichment, but also protecting employees who want the best for the company and may be trapped by ethical blindness or a limited tunnel vision. Guidelines and tools should ensure that the company only takes on the agreed risks. As Lauda’s accident illustrates, such a deviation can jeopardise the health of the company until a failure such as bankruptcy occurs.
Employees have to be aware that continuous violations of guidelines may lead to disciplinary actions and other negative consequences that affect their career. Organisations want to isolate non-fitting parts to protect themselves, and this was Lauda’s experience. The accident in 1976 was the beginning of the end of his good relationship with Enzo Ferrari, who believed Lauda returned too early to the cockpit and jeopardised the team’s opportunity to win the constructors’ championship. Yet despite Lauda’s accident, the team won. During the next season (their last together), Lauda won a second world championship and the team won the constructor’s title again. In today’s business reality, an employee who knowingly deviates from internal guidelines or external laws would probably face a similar situation because for general management the sustainability of the company is more relevant than the fate of a single employee or a small group. Even if they perceived they had done this in the company’s best interests, they were incorrect. Accordingly, the company would turn against these employees to protect itself.
Patrick Henz, US Head of Governance & Compliance, Primetals Technologies.
Jul-Sep 2019 Issue
Primetals Technologies