Leading the Way

In business, risk lurks at every turn: competitor innovations that threaten the viability of your products or services; new players in your market space; adverse trends in currencies, interest rates or the economy. Throw in potential disruptions to supply chains that, thanks to globalization, have been stretched across thousands of miles and country borders, and the opportunity for something to go wrong is, to say the least, worrisome.

It could get even more challenging, according to a recent study of 500 financial executives at the world’s largest companies in North America and Europe.

A majority of survey respondents expect the severity of their most prevalent business risks — competition, supply-chain disruption and property-related threats — to remain the same or intensify through 2009. [The complete findings of the FM Global study, entitled Managing Business Risks Through 2009 and Beyond, is available for download at www.protectingvalue.com.]

SUPPLY CHAIN RISK

In today’s highly competitive economy, the importance that financial executives ascribe to business risks such as supply chain risk, for example, does not come as a surprise. The emphasis reflects the significant changes companies have made to enhance their ability to compete. It has affected everything from the way companies procure raw material to how they produce goods.

As organizations strive to maintain a competitive hold in the marketplace, companies today outsource non-core activities, locate facilities in distant countries and rely on just-in-time inventory and other lean manufacturing techniques — all of which make the margin for error in the supply chain significantly smaller.

As such, a supply chain disruption can bring production and sales to a halt. A factory or office building rendered unusable by fire, flood or other disaster provides neither a place for employees to serve customers nor a space for them to build or assemble the goods that customers want.

Is it fair to suggest that the outlook of financial executives on risks such as competition, supply chain disruption and property-related threats represents a realistic outlook of what the future holds?

Certainly it is reasonable to believe that, for most companies, competition risk will either remain the same or increase. In a world in which the Internet, e-mail and instant messaging have dramatically increased the speed of people’s communication, the entire pace of business has accelerated, too. That means competition might spring up in new and unexpected places. This is a fact to which many makers of portable music players, cellular telephones and portable Internet devices might attest: they have seen computer manufacturer Apple Inc.’s iPhone challenge them in all three product categories simultaneously.

PROPERTY RISK OUTLOOK

By contrast, companies are reporting a rather benign outlook for property risk. Only 7% of financial executives expect such risks to increase. On the surface, this may seem encouraging, but it is out of sync with actual developments in the property insurance marketplace. This is especially true for companies that have been outsourcing manufacturing activities or acquiring manufacturing operations in other parts of the world.

North American-based companies, for example, operate in an environment in which public expectation and legislation have made some property risk control methods — such as the use of fixed sprinkler systems and adherence to building codes — common practice. But when such companies move offshore, either through acquisitions or joint ventures, they can find themselves in locales where the idea of taking proactive measures to prevent property loss is far less ingrained than it is here in Canada or the United States, possibly putting them at a competitive disadvantage in that local market.

This can be true not only in developing countries in Asia, Latin America, Eastern Europe or Africa, but also in some Western Europe countries. For example, although it is rare to find a supermarket or factory in Canada or the United States that does not have a fixed fire protection system, outside of these countries it is more of an exception than a rule to find automatic sprinklers protecting commercial, industrial and institutional buildings. Expanding a company’s operations into many developing countries can also bring with it increased legal and political risk, as well as increased exposure to natural disasters. Together, these factors affect the risk profiles of many large companies seeking to reap the benefits of globalization.

Unfortunately, companies willing to relax their property-related risk management standards also run the very real possibility of increasing their supply chain risk. After all, offshore facilities knocked out of commission by fire, natural disasters or other destructive events will not be available to help meet production goals. It is possible that if companies knew just how much their moves to offshore locations were increasing their property risk, then more would expect property risk to increase through 2009 — and more would be looking for increased risk on the supply chain front as well.

One reason companies may not be unduly concerned is that they just are not looking hard enough. In a recent survey of 443 manufacturing executives by consulting firm Deloitte Touche Tohmatsu, only about half of the respondents said their firms conduct a “very rigorous” risk review before entering an emerging market. While 57% assess security risk, only 51% consider geopolitical risk, and just 30% look at terrorism and the impact of natural disasters. Among those that do conduct “very rigorous” risk assessments, the Deloitte survey shows 86% are highly confident in their ability to manage that risk. Where risk assessments are less rigorous, only 68% of respondents felt highly confident in their risk management abilities.

THE CASE FOR ERM

Given that financial executives expect the severity of their companies’ most prevalent business risks either to remain at current levels or increase through 2009, there is a clear imperative for many such organizations to develop a strong, consistent, enterprise-wide risk management (ERM) program.

In pursuing this goal, companies would do well to begin by:

* identifying their top revenue drivers;

* pinpointing top threats to those revenue drivers; and

* distinguishing between those that are predominately downside risks (i.e., those risks that only have downside consequences) and those that are predominately variable risks (i.e., those risks that can have positive or negative consequences).

Companies may discover their risk management programs are most successful and effective when companies devote more of their attention to controlling risk than transferring it to insurance companies. And risks that can be most directly controlled — even eliminated, in some cases — are downside risks, such as those related to supply chain or property. For example, there’s never a benefit to running out of a key component because your supplier can’t get his or her hands on critical raw material, or losing a manufacturing facility to a fire or flood.

Such downside risks tend to be easiest to manage, because companies can take proactive measures to minimize or mitigate them. This might include building redundancies into a supply chain or installing fire protection systems in offices and manufacturing plants.

It’s become commonplace to hear companies indicate they have trouble finding the time, budget and people necessary to implement or maintain a strong risk management program. Skeptics question how much value should be placed on preventing loss from a disaster that might never happen. Additionally, risk managers frequently say that making a sound business case for having a strong risk management program has long been an elusive challeng
e.

Justifying the commitment to senior management effectively requires connecting the dots between risk management and the organization’s bottom line. Fortunately, many financial executives at the world’s most progressive organizations have received the message. Many reported in FM Global’s recent research that the Number 1 consequence of poor risk management is a loss of competitiveness.

By implementing an effective risk management program in your organization, you protect its ability to compete. Nothing is more fundamental to business success.