No Innovation Without Ambition

The failures of risk management that led to the financial crisis need innovative solutions, say authors Vijay Govindarajan and Chris Trimble. For that, we need the full passion and unbridled optimism of our business leaders

By Chris Trimble and Vijay Govindarajan

In the year 2035 a techno-phobic cop investigates a crime that may have been perpetrated by a robot, which leads to a larger threat to humanity. That was the tag line for the 2004 thriller I, Robot. If the business of risk management had the same cinematic appeal as the business of robotics, we might also have watched Attack of the Killer Derivatives! Tag line: Mad mathematicians working in secret laboratories unleash a plague of arcane but lethal financial contracts on an unsuspecting marketplace.

Innovation gone awry is normally the basis for a sci-fi plot. But this tale was anything but a popcorn frivolity. A decade of aggressive innovation is usually celebrated. But this time, it nearly blew up the global economy. The risks of innovation are meant to be borne by innovators. In this case, we all suffered.

Learning Our Lessons

In the aftermath of this startling chapter, innovation continues to suffer. It is a tough time to think big. How do you make innovation happen? The details can be difficult, but the starting point is simple. Innovation is inspired by ambition—not any ambition, but one that just might be impossible. In other words, innovation begins with optimism.

Innovation only sometimes ends on an upbeat. Failure is inevitably a part of the innovation game. Post-failure, some companies tear themselves apart looking for someone to blame. Others dig for the right lessons learned and move on to fight another day.

We face the same choice now: not as a company, but as an entire economy. We can be weak in defeat, or we can be strengthened by it.

Which path will we take? There are reasons to be hopeful. Fears of a complete economic collapse have abated. The worst of the acrimonious finger-pointing has passed. The environment may now be favorable for all of us to be able to take a collective deep breath, figure out what went wrong, and set about fixing it. And if we believe we can fix it, then optimism will stage a comeback.

Risk Management Can Be Fixed

The business of risk management is indeed worth fixing. We may have created a runaway monster, but that does not mean that we should throw away a decade of advance. Risk management is a centuries-old industry, and the benefits of innovation in risk management are enormous. It has helped farmers stabilize their income in the face of volatile commodity prices. It has aided exporters by giving them the means to protect against currency fluctuations. It has enabled mutual funds to reduce risks for individual investors. Done right, it can even lower the cost of mortgages and help more people buy homes.

Furthermore, innovation in risk management supports innovation in all other industries. The activities of every company can be divided into two simple categories: ongoing operations and innovation. There is only so much uncertainty that a business can tolerate in total. When uncertainty in ongoing operations is high, innovation is diminished. But when a company can transfer day-to-day risks elsewhere, it can invest more in innovation, and we all stand to win. For example, when an airline can off-load the risk of rising fuel prices, it can invest more in experimental new services.

Can the risk-management industry be fixed? Of course it can. The three central lessons from the crisis are anything but mysterious. First, all risk management must be regulated. This has long been understood in mainstream insurance businesses. Without regulation, the temptation to insure risks that you cannot cover is too great. Nobody was watching at AIG. Second, to manage risk well, you need good information. All of the mathematical sophistication in the world is useless in the face of bad data. When mortgage originators stopped verifying information presented by prospective borrowers, risk management failed. Third, good risk management spreads risk; bad risk management concentrates it. Allowing just a few financial firms to carry so much of the risk of a broad decline in the national real estate market was foolish.

Derivatives contracts are complex. These lessons learned, however, are clear, and the problems are imminently fixable. Risk management will come back fitter, stronger, and better than ever.

The Fundamentals Are Strong

As soon as we recognize this episode for what it is —a bizarre story of innovation on steroids gone mad —we will have the courage to move on. We will acknowledge that the trajectory of progress is never a straight line, and we will stand up again.

When we do, we will see that there is nothing fundamentally wrong with ourselves, our culture, our economy, or capitalism. We had something akin to a technical failure in the central computer system, and it brought us all down. But we built that central computer system, and we can certainly repair it.

Despite substantial collateral damage beyond the financial centers, we have plenty to build upon. We have the same factories we had before the crisis. We have the same workforce. We have the same talented scientists, engineers, and creatives, ready to chase dreams, ready to innovate

All we need is the full passion and unbridled optimism of our business leaders. Today, however, too many are hunkered down, waiting for the outlook to brighten.

Wake up. If you are a business leader, then your mood is the outlook. We await your call, your fighting spirit, and your belief in progress and possibility. Innovation begins with optimism.

Chris Trimble and Vijay Govindarajan are on the faculty at the Tuck School of Business at Dartmouth. They are the authors of Ten Rules for Strategic Innovators—from Idea to Execution.

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