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FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL ™ Emerging Risk Update September 2009 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Emerging Risk Update – Summary Introduction: The Risk Integration Strategy Council recently launched a Monthly Emerging Risk Survey. We are pleased to present the results of this survey in the third edition of the Emerging Risk Update. This initiative is an effort to leverage the power of our network to create a “risk sensing engine” capable of identifying risks emerging over the horizon. The Top 10 Risks for September 2009: 1. Continued Recessionary Pressure 2. Cost Reduction Pressures 3. Increased Competitive Pressure 4. Talent Risks 5. Political Trends 6. Strategic Change Management 7. Commodity Prices 8. High Cost of Capital 9. Liquidity Risk 10. Lack of Investment in Product Innovation Request for Ongoing Participation: Please click here to participate in the October 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 Continued Recessionary Pressure High Cost Reduction Pressures Political Trends RISK VELOCITY Commodity Prices Very Rapid Likelihood Impact of the risk would be evident in a month Increased Competitive Pressure Talent Risks Rapid Impact of the risk would be evident in a quarter Strategic Change Management Slow Impact of the risk would be evident in a year High Cost of Capital Lack of investment in Product Innovation Liquidity Risk Low Impact n=44 High Methodology The top 10 risks were identified based on how frequently 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 Continued Recessionary Pressure Liquidity Risk Liquidity Risk Political Trends Lack of Investment in Product Innovation Cost Reduction Pressures Commodity Prices Political Trends Commodity Prices Cost Reduction Pressures High Cost of Capital Political Trends High Cost of Capital Commodity Prices Continued Recessionary Pressure Methodology The top five risks by probability, impact and velocity were identified from the list of top 10 risks by likelihood © 2009 The Corporate Executive Board Company. All Rights Reserved. 3 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks Overview According to a recent AMR survey, 44% Executives believe that the recovery cycle is the biggest risk in 2010 due to potential commodity price increases, employee disengagement, and capacity constraints. Continued recessionary pressure, cost reduction pressure and increased competitive pressure continue to be the top risks that organizations face. Last month witnessed three new risks making it to the Executives’ top ten risks: commodity prices, high cost of capital and lack of investment in innovation. 1. Continued Recessionary Pressure Risk Description Even as the worst recession in recent history shows signs of bottoming out, no one expects the U.S. economy to recover and return to its pre-recession state. According to our survey, a majority of executives expect economic conditions to either remain stagnant or worsen in the next 12 months. With the economy still vulnerable to price instability, companies need to be prepared for both the inflationary and deflationary scenarios. With the economy showing signs of recovery, companies are optimistic about achieving higher revenue goals in the coming year. However, with uncertainty still pertaining in the market, a significant portion of the revenue increase may come through cost reduction. Our business executives’ sentiment index reveals that 51% of executives foresee higher revenue growth, with 55% of executives expecting cost pressures to increase in the next 12 months. S&P 500 index movement GDP Unemployment forecast Sales growth forecasts Consumer spending • • • • • Financial results Bad debt/delinquencies Write-offs Earnings forecast Housing market indices Noted Mitigation Efforts • • • • • Cost Reduction Pressures Risk Description Common Indicators Used by Members • • • • • 2. Reduce market exposures Enter new markets Re-evaluate staffing Reduce costs Differentiate product/service • • • • • Improve collections Reduce inventory Segment customers Position brand effectively Effective cost management © 2009 The Corporate Executive Board Company. All Rights Reserved. Common Indicators Used by Members • Operating/profit margins • Cash flow • Budgeting trends • Competitor benchmarking • Client feedback in the form of requests for concessions and rejection of bids Noted Mitigation Efforts • Centralize cost-cutting to maximize cost-cutting gains • Cascade cost-cutting objectives and monitor disaggregated results • Use shared services • Benchmark cost-savings • Evaluate the impact of cost-cutting on future growth • Lock in business for longer periods at reduced prices • Reduce COGS in addition to SG&A 4 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 3. Increased Competitive Pressure 4. Talent Risks Risk Description The economic recession has altered consumer behavior, preferences and spending patterns. With the market for premium goods shrinking, companies are being pushed into competition with lower-cost players, thereby increasing overall competitive pressure in the market. In such times, companies need to be vigilant in sensing changing customer needs, monitoring competitor’ strategies and modifying their strategy accordingly. Companies that don’t do so will stand to lose competitive advantage. Common Indicators Used by Members • Competitive research • Competitors moving into new markets • Market share • Price trends • Customer base and revenue growth • Patent life • Supply and demand trends Noted Mitigation Efforts • • • • • • Reduce expenses • Prioritize customer service Innovate on products • Improve value proposition Differentiate brand • Focus on key competencies Acquire clients • Expand product suit Explore M&A opportunities Increase product and service awareness © 2009 The Corporate Executive Board Company. All Rights Reserved. Risk Description Last year saw many organizations undergoing reorganizations and headcount reductions. An average organization faces a 7% productivity loss resulting from talent loss. While the trend of employee layoffs have reduced considerably, it has left behind high levels of disengagement. With the percentage of employees exhibiting discretionary efforts decreasing, companies that do not monitor and manage attrition and disengagement levels specifically amongst high-potential employees risk facing talent gaps. Common Indicators Used by Members • Turnover/ headcount fluctuations • Compensation • Absenteeism • Loss of work ethic • Productivity levels • Number of complaints • Employees exhibiting discretionary efforts Noted Mitigation Efforts • Conduct targeted training programs • Focus on succession planning • Conduct ongoing, systematic sensing and management of departure likelihood • Promote line-led retention management • Target tracking and retention efforts on key/high risk employees 5 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 5. Political Trends 6. Strategic Change Management Risk Description 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. 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 that undergo such business transformations 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 succeed. Common Indicators Used by Members • • • • • • Protectionism measures by U.S./Western counterparts • Government changes • Country-risk ratings New laws enacted Inflation Trade barriers News Lobbyist updates Noted Mitigation Efforts • Monitor the changing landscape (banking regulations changes, OTS impact etc.) internally • Stay informed and involved through meetings with key stakeholders • Review internal organization structure and placement of operations • Modify business strategy on an as needed basis • Review country-risk reports © 2009 The Corporate Executive Board Company. All Rights Reserved. Common Indicators Used by Members • • • • Performance measures Market share Profitability Market trends • • • • Compliance surveys CAPEX Medium range budget Industry-wide changes Noted Mitigation Efforts • Review change management process • Communicate change honestly and consistently • Assess employee reaction and morale • Utilize consultants to review strategy • Train managers on change management • Assign responsibility to create accountability 6 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 7. Commodity Prices 8. High Cost of Capital Risk Description Commodity price volatility has been increasing significantly in recent years, and this trend was further accentuated during the global economic recession. 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 lead many companies to adopt hedges that don’t qualify for hedge accounting. Common Indicators Used by Members • Commodity price index • Reducing margins • Spot and future rate movements • Price quotes Noted Mitigation Efforts • Hedge through forward contracts, futures contracts, options and alternate hedges (Delta, Collar) • Buy substitute inputs • Buy and holding more inventory • Enter into fixed price contracts with suppliers © 2009 The Corporate Executive Board Company. All Rights Reserved. Risk Description Credit crunch and high cost of capital are likely to persist till global credit markets stabilize. With bank loan markets shrinking and public debt and equity markets becoming tighter, the cost of funds is increasing. Credit providers are becoming apprehensive in extending capital and are expecting higher returns for the risks they undertake while lending. In these scenarios, it is becoming important for companies to be more forward looking and focus on long-term implications of cost of capital. Common Indicators Used by Members • Equity risk premium • WACC • Interest rates • Credit ratings • Treasury bill Noted Mitigation Efforts • Optimize working capital management • Alter WACC calculations to reflect market conditions • Use a target structure that reflects seasonal variation in debt, and monitor it on an on going basis • Optimize banking relationships 7 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY COUNCIL Overview of Top 10 Emerging Risks 9. Liquidity Risk Risk Description Though corporate credit markets are beginning to show signs of improvement, lending standards remain stringent. Banks are no longer treating investment grade facilities as “loss leaders”, and are focusing on credit risk for loan pricing rather than expectation of fee business. With the expectation that bank credit availability will remain limited, companies need to explore alternative funding sources to ensure adequate liquidity levels. Common Indicators Used by Members • • • • Cash flow forecasts Loan repayments Net new business figures Decrease in credit line availability • Non-renewal of loan commitments • Inability to access unsecured long-term funding Noted Mitigation Efforts • Monitor cash flow daily • Reduce spend • Focus on working capital • Sell property at a discount • Manage Treasury operations 10. Lack of Investment in Product Innovation Risk Description The slowdown has reduced availability of capital and lead 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. Common Indicators Used by Members • RD&E* spending as a percentage of sales • Number of patents applied for • RD&E employee headcount • Time to market • RD&E budget allocation Noted Mitigation Efforts • Improve cash management • Set up incubation cell for ideas • Identify incremental versus breakthrough projects • Reflect on probability of success for evaluation *Research, Development and Engineering © 2009 The Corporate Executive Board Company. All Rights Reserved. 8