Why Innovation Is Riskier Than Ever

  • Dr. Louis Gritzo vice president, manager of research, FM Global
  • Forbes April 18, 2022

Today's catastrophes—in the air, at sea, and on roads now traveled by driverless cars—are increasingly visible and complex. The root causes of such events, which disrupt business operations and erode shareholder value, can take months to identify, especially when the technology involved is new. You could argue that the root cause is instead a single one, and as old as humankind’s inventiveness: innovation. For all of its desirability, innovation often triggers unintended consequences.

“For all of its desirability, innovation often triggers unintended consequences.”

Dr. Louis Gritzo, vice president and manager of research, FM Global

In 2022, innovation often involves digital-based business technologies interacting with the physical world in fields like transportation, robotics, augmented reality, and remote monitoring and operation of industrial equipment. Stunning technology innovations like these are the Holy Grail of successful business, often propelling companies to new levels of profitability. But typically the focus is solely on the obviously foreseeable: revenue benefit compared to implementation cost.

That ROI calculation doesn't figure in risks that the innovation could backfire in unforeseen ways. A disproportionate number of disasters involve what is considered at the time as the "latest and best technology." Adverse events of this type are broadly classified as resulting from technological risk, i.e., risk due to the failure of a man-made system.

This is a type of risk that the actuarial models most often used by insurers and the financial industry can’t accurately assess. That's because these models by definition are based on past experience—that is, prior to the innovation arriving. The result is that the ability to transfer innovation-related risks via insurance is difficult and expensive, constituting yet another hurdle for innovators. (Of course, innovation in the insurance industry is subject to the same risks.)

An increasingly frequent subset of technological risk is risk due to failure of the core digital technology on which the man-made mechanical system relies. Autonomous vehicle software problems are an easy example to visualize, but the far greater relevance lies in the rapid automation of both physical and financial business processes. Practical examples include the collision of industrial robots with each other and/or other warehouse components. Past examples have included massive failure of power and financial systems, with impact far exceeding the system in which the technology was deployed.

Technological risk is further compounded by exposure to natural hazards, resulting in what is referred to as natech risk. A natural event can both provide the initiating event for the failure or amplify adverse consequences. The consummate example is the 2011 Tōhoku earthquake and tsunami in Japan, the costliest disaster on record. Natech risks for business owners could include a lightning strike that damages a system for digital processing and control, or more mechanical impacts such as wind/hail damage to solar panels or wind turbines that result in power outages and business interruption.

Losses like these increasingly cause cascading damage beyond the failed system due to highly interconnected components. The damage can disrupt business for months, potentially costing a company revenue, reputation, market share, and investor confidence. It’s not the return on investment that new innovation should provide.

Codes and standards are always too late, and maybe too little

Technological risk is now pervasive in large part because the latest digital and automated technologies have numerous points of potential failure: hardware, software, power supplies/inverters, batteries, charging systems, and all kinds of combustible materials that are increasingly used for lightweighting.

So how can technological risk be mitigated? Eventually by industry standards and regulatory codes. Yet innovations by definition are brand new. As such, they are always ahead of the standards and codes that make the technology more robust. (It's been that way since 19th-century textile mill fires revealed the need for commercial fire protection.)

It can take years for global standard bodies like ISO (the International Organization for Standardization) and ANSI (the American National Standards Institute), regionally focused bodies like the National Fire Protection Association, or industry bodies like the American Petroleum Institute to develop coherent standards. Bodies like these rely on the consensus of subject matter experts from all the requisite stakeholder groups—users, manufacturers, OEMs, consultants, government, safety organizations, etc.—to define what’s necessary and doable. Although some government bodies like the FAA are authorized to create regulations without waiting for a consensus-based body to propose a standard, those are typically in reaction to an unfavorable event.

The point? Since codes and standards lag, early-to-market innovation involves bigger risk than revenue loss, and far greater risk than waiting for competitors to do the innovating.

Four ways to manage innovation risk prior to standards development

Which is not to say that any company should avoid being the first to market. When innovation opportunities arise, it’s critical to do a few key things to manage the risk before consensus standards are developed, and well ahead of when those standards become accepted as regulatory code. Here are some ways to do that:

  • Take stock. If you’re a company leader, identify where your company is innovating—creating new technology or adopting someone else's. Then ask, who is identifying risks and managing them? What's the plan for risk mitigation? Is there even a plan?
  • Create your own standards. Long before you implement or bring an innovation to market, as early in the process as you can, identify subject matter experts who can advise you on the risks you may not yet foresee. For example, if your innovation involves physical automation, your advisors could be experts in computer science, robotics, power supplies, materials science, structural engineering, insurance, and occupational health. One could be your local fire chief. Have them sign nondisclosure agreements and invite them to critique plans and designs of the first minimum viable product that is being considered. Skipping this step is risky. A lone mastermind, however brilliant, is rarely able to get everything right for today's complex systems.
  • Follow the science. Seek out real-world data on technologies and their earliest applications. Don't over-rely on desktop simulations, which notoriously fail to predict real-world rollouts. Failures of this type have been among the most tragic. Use good computer models for insight, but make sure real-scale testing is done to ground the results in reality.
  • Manage the human element. Innovative technologies are replacing human workers, most notably on the factory or warehouse floor. Hence, there are fewer people to respond when problems evolve. Furthermore, the systems, and the solutions when anomalies occur, can be more complicated. About one-third of major commercial and industrial losses involve some type of significant human error. In most cases, the error involved a person doing what seemed to them to be "the right thing." Training, drills, and response plans are more important than ever.

In most cases, the error involved a person doing what seemed to them to be “the right thing.”

Dr. Louis Gritzo, vice president and manager of research, FM Global

  • Beware of conflicts of interest. Ultimately, standards need to be developed as soon as possible. Standard bodies need representatives from industry, but commercial entities need to be cautious not to overly influence the standard for financial gain at the expense of risk management. The consensus-based decision making process used by all respected standards bodies are in place for this reason.

Most companies typically have a good process in place to manage the expense and market risk of their innovation. The earliest, most thoughtful, and most agile adopters often reap the biggest rewards. During the pandemic, the acceleration of these innovations brought us more industrial robots (that don’t get sick) to ease the strain on manufacturing, made it easier to work from home, and got more packages delivered overnight. Companies need the same robust processes for managing technological risk.

With careful risk identification and mitigation as part of a well-developed innovation process, there will be fewer barriers to implementation, and far fewer devastating surprises afterwards.

As originally published in Forbes.

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