Miller starts by stating, ‘The strategic management field lacks a gen- erally accepted definition of risk.’ (Miller 1992: 311). The first requirement in any analysis of risk is an appropriate definition.
Perhaps a reasonable starting point is Culp (2001: 14): ‘Risk can be defined as any source of randomness that may have an adverse impact on a persona or corporation.’ The first half of the statement picks up the fact that the events, or relevant interactions, engender- ing risk are somehow unexpected. Risk is not simply a matter of ignorance, since it is possible that even expected events can have unexpected negative consequences because the enterprise does not turn out to have the capabilities its strategy makers think it has (Miller 1998: 508). The second half stresses the negative impact of such events – it is the downside that matters.
This rather general definition begs a number of critical questions. It is appropriate, and not unusual, to start such analysis with the distinc- tion between risk and uncertainty. Since there is still considerable con- fusion in the use of the two terms, risk and uncertainty, the ambiguity needs to be clarified. The distinction which is common in the literature goes back to Knight (1921). Knight argued that uncertainty lay within the province of the entrepreneur, not the insurer or hedger who dealt with risk. This is the source of the distinction between finance and business risk already discussed in the introduction. In the literature, the distinction between risk and uncertainty is usually made in a simple way.
• Risk is the set of calculable possible future outcomes for a relevant performance indicator, a known set of probabilities.
• By contrast, uncertainty relates to what cannot be known because it is in some sense unpredictable and therefore non-quantifiable.
Graaff has aptly commented, ‘Uncertainty is not to be thought of as a quantitative thing like the chance or numerical probability of a coin showing heads when tossed a large number of times. It refers to something qualitative. It is a description of a degree of knowledge, of lack of knowledge. It arises whenever one has incomplete informa- tion on which to act’ (Graaff 1963: 116). The distinction is further developed by Meldrum. He points to a continuumbetween pure risk and pure uncertainty, emphasising the distinction between an event whose occurrence is frequent enough to yield a statistical function amenable to probability analysis and one lacking these requirements.
‘For example, the probability of death from an auto accident qualifies as a risk; the probability of death from a nuclear meltdown falls into uncertainty, given a lack of nuclear meltdown observations. Many of the individual events investigated by country risk analysis fall closer Risk and Risk-generating Events 27
to uncertainties than well-defined statistical risks. This forces analysts to construct risk measures from theoretical or judgmental, rather than probabilistic, foundations’ (Meldrum 2000: 33–34). There is a natural desire on the part of both theorists and practitioners to trans- late uncertainty into risk in order to make quantification possible.1
Miller notes a more subtle confusion between two uses of the term risk – to refer on the one hand to a general lack of predictability in firm performance outcomes, and on the other to the unpredictability of organisational and environmental variables which have an impact on performance predictability, or simply a lack of information concerning these variables (Miller 1992: 312). Miller prefers to call the first risk, although he makes no presumption that it is quantifiable, and the second uncertainty. In this sense, risk arises because of the existence of uncertainty. This is the rationale for Olsson’s definition of risk, ‘risk is the uncertainty of future outcome(s)’ (Olsson 2002: 5).
In rejecting the Knightian distinction on the grounds that ‘it violates the intuitive interpretation of risk which is closely related to situations of unpredictability and uncertainty’ (Aven 2003: 39), Aven is taking the same approach. He argues that all probabilities are subjective assessments of uncertainty. Therefore ‘for the uncertainty situation we interpret the probabilities as measures of uncertainty, as subjective probabilities expressing degrees of belief. Alternatively, the probabilities can be interpreted as subjective estimates of true, under- lying, objective probabilities.’ (Aven 2003: 28) According to Aven there are two categories of uncertainty to go with these two interpre- tations – ‘stochastic or aleatory (= variations of quantities in a popu- lation) and knowledge-based (epistemic) uncertainty’. (Aven 2003:
17) The former is the uncertainty which can be expressed in exact probabilities, such as a toss of a dice (the alea). The latter reflects lack of knowledge about the world (i.e. system performance) in general and of observable quantities in particular. This lack can never be completely removed. In the words of Aven, ‘risk is uncertainty about the world’ (Aven 2003: 50).
Since the world is characterised by uncertainty, it is unsurprising that the problem of dealing with risk is rather more difficult than often assumed. The enterprise exists as a separate and well-defined organisational system within a single integrated environment but one which has many aspects – political, economic, legal, technologi- cal, and socio-cultural. It is critical to distinguish that environment from the enterprise itself. Instability is a property of that environ- ment and risk a property of the enterprise. There are certain relevant
events, of differing provenance, which occur within that environ- ment and constitute a significant part of that instability; in so far as they also have an impact on the operation of the enterprise they create risk.2
The level of uncertainty is never binary, there is never a simple either/or situation. Such a binary position grossly oversimplifies the world. In reality, there is neither zero uncertainty (complete certainty), nor on the other hand complete uncertainty (complete ignorance) (Courtney, Kirkland and Viguerie 1997). The world has regularities which are the basis of the possibility of meaningful strategy. Complete uncertainty is a situation which entails what Shackle calls ‘powerless decision’ and can be disregarded.
In terms of the managerial perception of these events and their outcomes there are four possible states of affairs (Kobrin 1979):
• a nearly definite future,
• a number of discrete alternative possible futures (scenarios),
• a broad but continuous range of possible futures with clear bound- aries which demarcate what is impossible,
• an ambiguous future fraught with unknowns, that is a nearly complete uncertainty.