The combination of increasingly globalised supply chains and tighter margins, has seen risk management move to the forefront of many business strategies. Companies are more vulnerable than ever before and lack the funds to put in place multiple mitigation initiatives. In this context, the scope for error has been dramatically reduced. This situation was recently highlighted by events such as the ” horse meat scandal” and government regulations aimed at payday loans.
4C Associates brought together several leading finance professionals to share their views on what constitutes best practice when it comes to managing risk. A lively discussion followed, in which attendees considered the different types of threats in existence, how to mitigate against them and the situations in which taking risks is necessary.
What is Risk?
Risk is a very broad topic. Asked to classify the different types of risk, the attendees identified five main categories; strategic, regulatory, external, financial and expense risk. The first refers to the need to revaluate a business strategy in light of new developments. An example would be the emergence of a technology which enables new, low cost competitors to enter the market. Regulatory risk relates to the impact of government regulations.
“Mitigating risk means looking at everything on a case by case basis”
External risk covers natural disasters and other events such as factory fires and terrorist attacks. The earthquake which hit Japan in 2011, for example, caused a huge ripple in supply chains across the globe. Financial risk relates to instances of devalued assets and changing interest rates. Finally, expense risks are directly linked to spend and include the loss of a key supplier and rising commodity prices.
A Holistic Approach
Looking at recent risk related developments, the attendees concluded that companies often chose to focus on controllable threats. These include risks which can be insured against, such as the failure of a supplier to deliver. The horse meat scandal, however, appears to have genuinely caught many retailers off guard. Speaking on the issue, Ed Ainsworth, Managing Director at 4C Associates, suggested that risk must be viewed from a holistic perspective.
Many of the major food retailers incentivise their buyers to spend as little as possible. The risk associated with this strategy is that both buyers and suppliers may be tempted to bend the rules. This can lead to questionable or even illegal practices, such as labelling horse meat as beef. The food industry is not unique in this regard. A number of leading fashion and technology companies have found themselves embroiled in child labour cases.
“[The retailers] should have considered the behavioural risks of their bonus schemes”
In a different vein, payday lenders were recently informed of upcoming regulations which would affect their business models. The Financial Conduct Authority will be given new powers to enforce tougher rules on interest rates and advertising. Payday loan companies were prepared for these changes, however, one attendee suggested that in these situations companies should look to influence regulators as opposed to simply reacting to decisions.
One participant agreed and explained that his business was once affected by a similar change in regulations. One of the company’s secondary products which had previously been subject to tax breaks was deemed taxable. Speaking on the experience he pointed out that although in some industries it is possible to maintain a dialogue with regulators, in highly fragmented sectors this can be a real challenge.
Theory vs. Practice
A disproportionate amount of risk management literature focuses the theoretical side of the problem. One participant voiced his opinion that whilst it is easy to box different types of risk into various categories, it is more difficult to come up with practical plans to deal with them. In this context, it was suggested that, due to its very nature, risk management should not be turned into bureaucratic a process. Everyone within a company needs to play a part and constantly adapt to changing circumstances. Risk should not simply be allocated to a “risk team”.
“Even if you see a train coming, are you able to get out of the way?”
In terms of best practice, there was a general consensus that simulating various events constitutes the only way to test an organisation’s ability to adapt. Speaking from experience, one attendee described the process as a “humbling” but essential element of risk management. Frequent simulations ensure a business is prepared for upcoming challenges and not simply reacting to events as they unfold.
Balancing the requirement of sourcing less expensive products with the need for minimum quality, is one of the major challenges facing companies. Quality mangers are hired to assist in this process, but are often viewed as unnecessary or detrimental by buyers. Carrying out due diligence on all suppliers, represents the ideal approach, however, with supply chains spanning multiple continents this is not always possible.
“Regardless of the situation, the company with the highest profile will be the one singled out by the press”
The approach to managing reputational risk, varies significantly depending on a company’s position within a given market. When Google was criticized over its tax avoidance schemes, Eric Schmidt, Google’s Chairman, said; “I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate.” This unapologetic stance has had little impact on the number of UK Google users. The lack of an alternative to the search engine giant has left people with few viable options.
Starbucks also came under fire for its tax avoidance structure and offered an equally unrepentant response. However, unlike Google, the coffee chain operates in a highly competitive environment and customers can choose between a myriad of options. The company’s decision to not publicise UK performance figures for the 2012 Christmas period, suggests sales have been affected. Starbucks has since pledged to pay more tax, despite having no legal obligation to do so.
Balancing Flexibility with Solid Procedures
One of the key points to emerge from the discussion is the need to integrate a wide number of people in the risk management process. Simply putting together a team to manage risk, can result in a formulaic process which fails to evolve. Many threats and their eventual impact are in fact more predictable than they appear. By continuously monitoring changing markets, businesses can plan ahead and avoid having a costly, purely reactive approach to risk.
On the other hand, taking risks remains an integral part of business strategy and there are situations in which a risk is worth taking. One of the examples raised, referred to an oil and gas company with interests in Kurdistan. Despite the threats associated with working in the area, the company is able to keep its investors on board by effectively communicating the potential risks and rewards. In the words of one attendee; “If you mitigate against everything, you are essentially a government bond.”
On the evening of the 7th March 2013, 4C Associates assembled a group of finance leaders, from different industries, at 30 St Mary Axe – The Gherkin, London, UK. The event was chaired by Ed Ainsworth, 4C’s Managing Director.
Attendees included Teuta Bakalli, Chief Financial Officer at Pepper Europe, Ewan French, Chief Operating Officer at Barloworld Supply Chain, Siva Shankar, Interim EGM Finance for EMEA PM & Construction at Lend Lease, and Andrew Smith, Chief Financial Officer at Asperity.