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FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL ™ Emerging Risk Update January 2010 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Emerging Risk Update – Summary Introduction: The Risk Integration Strategy Council launched a Monthly Emerging Risk Survey in July 2009. We are pleased to present the results of this survey in the seventh edition of the Emerging Risk Update. The Top 10 Risks for January 2010 are: 1. Commodity Prices 2. Continued Recessionary Pressure 3. Political Trends 4. Increased Competitive Pressure 5. Strategic Change Management 6. Third Party Solvency 7. Lack of Investment in Product Innovation 8. Inflation 9. Talent Risk 10. Fraud Request for Ongoing Participation: Please click here to participate in the February Emerging Risk Survey. This survey will take less than 3 minutes to complete. Survey Methodology and Overview of Presentation: In our survey, executives were asked to identify the top five risks and also provide an estimate of probability, impact and velocity for each of these risks. In the following pages, you will find a summary of the top ten risks within the content of likelihood (likelihood is defined as the combination of how frequently executives marked these risks as their top five risks and the probability score for these risks). You will also find details of the top ten risks including risk description, indicators and mitigation strategies adopted by members. © 2009 The Corporate Executive Board Company. All Rights Reserved. 1 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Top Ten Emerging Risks – Likelihood, Impact & Velocity RISK VELOCITY High Very Rapid Continued Recessionary Pressure Impact of the risk would be evident in a month Commodity Prices Rapid Likelihood Political Trends Increased Competitive Pressure Third Party Solvency Fraud Low1.70 Impact of the risk would be evident in a quarter Strategic Change Management Slow Impact of the risk would be evident in a year Lack of investment in Product Innovation Inflation Talent Risks Impact High n=38 Methodology The top 10 risks were identified based on how frequently and on what priority executives marked these risks in their list of 5 top risks © 2009 The Corporate Executive Board Company. All Rights Reserved. 2 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Top Five Emerging Risks By Likelihood, Impact and Velocity TOP 5 RISKS BY PROBABILITY TOP 5 RISKS BY IMPACT TOP 5 RISKS BY VELOCITY Commodity Prices Commodity Prices Continued Recessionary Pressure Continued Recessionary Pressure Continued Recessionary Pressure Political Trends Political Trends Third Party Solvency Third Party Solvency Strategic Change Management Strategic Change Management Lack of investment in Product Innovation Inflation Political Trends Commodity Prices Methodology The top five risks by probability, impact and velocity were identified based on how high the respondents rated them on each parameter. 3 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks Overview In the current economic environment, Commodity Prices and Continued Recession are considered as the most crucial risks. However, members have indicated that Political Trends, Increased Competition, Strategic Change Management and Third Party Solvency are also high risk areas for their companies. Last month witnessed four new risks making it to the Executives’ top ten risks: Third Party Solvency, Lack of Investment in Product Innovation, Fraud and Inflation. 1. Commodity Prices 2. Continued Recessionary Pressure Risk Description Risk Description January 2010 has seen a shift from the trends of 2009. Crude oil prices briefly rose and then settled down to around $72. Gold was down 4.7% for the month but seems to be bottoming. The US Dollar Index is up 2.5% for the month. Fluctuations in commodity prices have disrupted companies’ forecasts and organizations are increasingly turning towards financial hedging strategies to manage this volatility. An increase in the need for commodity hedging has led many companies to adopt hedges that don’t qualify for hedge accounting. Even as the economy emerges from recession, policymakers and analysts doubt if the recovery will be robust enough to create many new jobs or pose a threat to inflation. According to Mr. Kohn, the Vice Chairman of Fed, unlike other recent recoveries, the current turnaround is likely to be more subdued because of “difficult conditions in the labor market and the consequent implications for household incomes,” among other factors Common Indicators Used by Members Common Indicators Used by Members • • • • • • Commodity Price Index Reducing margins Residual risk Oil prices and market fiber price Future pricing and volumes Third party data and trends • • • • • Spot and future rate movement Price quotes Energy complex LME trends Economic indicators • • • • • Noted Mitigation Efforts • Hedge through forward contracts, future contracts, options and alternate hedges • Buy substitute inputs • Trade finance solutions • Identify new credit facilities • Develop supplier partnerships • Buy and hold more inventory • Enter into fixed price contracts with suppliers • Evaluate pricing and discounts to maintain margins • Enter into long term agreements/contracts © 2009 The Corporate Executive Board Company. All Rights Reserved. S&P 500 index movement Country specific indicators Unemployment forecast Client’s financial performance Sales growth forecasts/ reported customer expansion or contractions • • • • • Financial results – own Bad debt/delinquencies Earnings forecast Housing market indices Consumer spending & creditworthiness • Commodity prices Noted Mitigation Efforts • • • • • • Reduce market exposures Enter new markets Re-evaluate staffing Differentiate product/service Improve underwriting standards Improve collections • Reduce fixed expense • Reduce inventory / Match production to sales • Segment customers suitably • Position brand effectively • Manage costs effectively 4 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 3. Political Trends 4. Increased Competitive Pressure Risk Description Risk Description Globalization, along with opportunities, brings along difficult challenges. In periods of economic turmoil, there’s a greater likelihood of political and economic discontent, which amplifies political risks. With growing political instability and the expanding political risk universe, it is important for organizations to perform thorough country-risk assessments while expanding their operations and protecting their existing global operations Our research shows that decisions made during recessions and recovery periods can have lasting effects on firms’ prospects. Consumer spending has plummeted to new lows and the companies are now fighting it out for a share of a very shrunken pie. Executives need to innovate on products, prioritize on customer service, reduce expenses on their current offerings as well as expand their product portfolio. They need to explore all opportunities in the competitive space to ensure their companies are striking the right notes. Common Indicators Used by Members • • • • • • Inflation Trade barriers News/new laws enacted Regulatory actions Lobbyist updates EPA requirement • Protectionism measures by US/Western counterparts • Government changes • Country-risk ratings • Climate legislation Noted Mitigation Efforts • Monitor the changing landscape (banking regulatory changes, OTS impact etc) internally • Review country-risk reports • Stay informed and involved through meetings with key stakeholders • Communicate proactively with stakeholders • Review internal organization structure and placement of operations • Modify business strategy on an as needed basis • Monitor and make corrective actions as needed © 2009 The Corporate Executive Board Company. All Rights Reserved. Common Indicators Used by Members • Competitive research • Competitors moving into new markets • Competitive intelligence analysis • Market share • Price trends • Market feedback • Customer base and revenue growth • Patent life • Supply and demand trends • Market analysis & technical reviews • Strength of sales pipeline Noted Mitigation Efforts • • • • • • Reduce expenses and lead time Innovate on products Differentiate brand with quality Acquire clients Explore M&A opportunities Increase product and service awareness • • • • • • • Focus on customer Prioritize customer service Improve value proposition Focus on key competencies Expand product offering Support creative ideas Improve delivery performance *Source : www.reuters.com 5 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 5. Strategic Change Management 6. Third Party Solvency Risk Description Risk Description The recession saw many organizations undergoing changes by way of mergers, divestitures, portfolio rationalization and other strategic developments to ensure survival. These changes coupled with internal reorganizations are fundamentally altering the risk and control environment. Companies need to effectively plan for various scenarios, determine the impact of these changes on existing processes and monitor risk information related to strategic plans, in order to be successful in such business transformations. Corporate bankruptcies in 2009 were the greatest since 2002, leaving organizations at higher risk for potential instances of supplier insolvency. In response to rising instances of critical supply failure, many organizations are looking for ways to avert supplier solvency, continuity, and reputation failures before they happen. As the world economy pulls out of the recession, solvency of major suppliers will be the biggest risk. It is easy not to contract with insolvent vendors but what is worse is the ones on the edge that are hiding. Common Indicators Used by Members Common Indicators Used by Members • • • • • Performance measures Market share Profitability Market trends Ability of Executive Management to implement change • • • • • • Compliance surveys CAPEX Medium range budget Industry-wide changes IFRS Updates Internal planning trends Noted Mitigation Efforts • Review change management process • Communicate change honestly and consistently • Assess employee reaction and morale • Hire from outside to bring in new perspective when appropriate • Utilize consultants to review strategy • Train managers on change management • Assign responsibility to create accountability • Ensure proactive communications with leaders © 2009 The Corporate Executive Board Company. All Rights Reserved. • • • • • • Number of defaults Solvency of key suppliers Increased ageing Unusual billing requests Analyst reports/market intelligence Banking trends • • • • • • Timing of payments Industry feedback Credit quality of customers Delay in delivery Changes to contracting terms Credit risk insurer assessments Noted Mitigation Efforts • Test Continuity plans • Set collection activity early in the cycle • Leverage IT to plug critical supply chain information gaps • Select reliable suppliers • Duplicate vendors • Focus on collection from debtors • Conduct due diligence of partners’ financial health based on clear financial and market metrics 6 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 7. Lack of Investment in Product Innovation 8. Risk Description Risk Description The slowdown has reduced availability of capital and led to budget cuts. In such scenarios, companies need to prioritize their investments to ensure business continuity and generate highest returns. As a result, product innovation has taken a backseat. In such uncertain times, it is imperative for companies to sense customers’ changing behavior and requirements and invest in product innovations to respond accordingly. . With the recession showing signs of recovery, the focus should move from near-term pressures to longer term strategic projects. The project portfolios should also display a healthy mix of incremental vs. real innovation With the influx of tax-payers’ money into the financial system through governmental injection of liquidity, inflation fears have resurfaced. The inflation rate year over year was 2.7213% (compared to 1.8383% for the previous month). Skeptics have continuously doubted whether the recovery from the latest recession is robust enough to allay inflation fears. Companies are being forced to enter into long-term contracts with suppliers as well as distributors to hedge against a possible inflationafflicted business period. Common Indicators Used by Members Common Indicators Used by Members • RD&E spending as a • RD&E employee headcount percentage of sales • Time to market • Number of patents applied • RD&E budget allocation for • Market share among niche • Number of new products product segments rolled out Noted Mitigation Efforts • Improve cash management • Set up incubation cell for ideas • Improve communication with internal and external stakeholders • Invest in co-creation © 2009 The Corporate Executive Board Company. All Rights Reserved. • Identify incremental versus breakthrough projects • Reflect on probability of success for evaluation • Monitor the pulse of the customer Inflation • • • • Market rates Cost indices Weakened supply chain Waning credit support from bank partners • Economic indicators • Base inflation rate • Supplier costs (if in a different country) • FX trends Noted Mitigation Efforts • Capacity dedication • Dollar-based fixed-price supply contracts • Monitor KPI of the economy • Increase responsiveness to changes in pricing with scenario planning and budgeting • Understand opportunities to increase sales in a regulated environment • Build flexible resource allocation and alternative cost frameworks 7 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 9. Talent Risks Risk Description The silver lining is that the U.S. unemployment rate seems to have started a retreat from the peaks that we saw late last year. Nonfarm payroll employment edged down (-85,000) in December, but the unemployment rate was unchanged at 10.0 percent, the U.S. Bureau of Labor Statistics reported. In December, employment fell in construction, manufacturing, and wholesale trade, while temporary help services and health care added jobs. Employment losses in the first quarter of 2009 averaged 691,000 per month, compared with an average loss of 69,000 per month in the fourth quarter. Common Indicators Used by Members • • • • • • Age and experience level of staff • Productivity levels • Number of complaints • Employees exhibiting discretionary efforts Noted Mitigation Efforts Turnover / headcount fluctuations Compensation Absenteeism Loss of work ethic Industry salary survey • Conduct targeted training programs • Focus on succession planning • Conduct ongoing systematic sensing and management of departure likelihood • Provide challenging/ engaging work • Promote line led retention management • Target tracking and retention efforts on key/hig risk employees • Provide competitive remuneration • Look for new source of quality candidates © 2009 The Corporate Executive Board Company. All Rights Reserved. 10. Fraud Risk Description Fraud has gained unprecedented importance in the current economic environment because of technological advances, growing complexities of organizations, increasingly transient employees and the economic downturn. This holds true especially for cases of employee misconduct which are related to the pressures of operating in a business environment of severe cost reduction demands. Research shows that businesses with the weakest cultures (where employees perceive a weak ethical culture) have experienced 5 times the amount of misconduct as compared to those with the best Common Indicators Used by Members • Oversight reports • Reports to the Code of Conduct office • Number and nature of frauds • Analysis of spending patterns • Fraud losses • Average claim costs and frequency • Internal Audit checks Noted Mitigation Efforts • Utilize internal controls group to provide oversight • Respond to acts of misconduct quickly and consistently • Background checks for new hires • Staff-rotation • Reinforce ethics training and policy • Anonymously communicate instances of fraud • Establish whistleblower hotline 8