™ Emerging Risk Update November 2009 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY...

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Emerging Risk UpdateNovember 2009

FINANCE AND STRATEGY PRACTICE

RISK INTEGRATION STRATEGY COUNCIL



© 2009 The Corporate Executive Board Company. All Rights Reserved.

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 fifth 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 November 2009:1. Continued Recessionary Pressure2. Cost Reduction Pressures3. Talent Risks4. Strategic Change Management5. Commodity Prices6. Increased Competitive Pressure7. High Cost of Capital8. Liquidity Risk9. Compliance10. Third Party Solvency

Request for Ongoing Participation:Please click here to participate in the December 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.

Emerging Risk Update – Summary

1



Continued Recessionary PressureCost Reduction Pressures

Talent Risks

Strategic Change Management

Commodity Prices

Increased Competitive Pressure

High Cost of Capital

Liquidity Risk

Compliance

Third Party Solvency


Top Ten Emerging Risks – Likelihood, Impact & Velocity

n=63

Very RapidImpact of the risk would be evident in a month

RapidImpact of the risk would be evident in a quarter

SlowImpact of the risk would be evident in a year

RISK VELOCITY

2

Methodology

The top 10 risks were identified based on how frequently executives marked these risks in their list of 5 top risks

High

HighLow

Lik

eli

ho

od

Impact




Overview of Top 10 Emerging Risks

OverviewIn the current economic environment, Continued Recessionary Pressures and Cost Reduction Pressures are still considered as the most crucial risks. However, members have also indicated that Increased Competition, Strategic Change Management, Compliance and Talent are also high risk areas for their companies. Last month witnessed two new risks making it to the Executives’ top ten risks: Liquidity and Higher cost of capital.

Continued Recessionary Pressure

Risk Description

Even as the economy emerges from recession, policymakers and analysts doubt that the recovery will be robust enough to either 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.

• S&P 500 index movement • Country specific economic &

financial indicators: GDP• Unemployment forecast• Client’s financial performance• Sales growth forecasts/ reported

customer expansion or contractions

Common Indicators Used by Members

• Financial results – own • Bad debt/delinquencies/loan

losses/ Write-offs• Earnings forecast• Housing market indices• Consumer spending & credit-

worthiness• Commodity prices

1.

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

Risk Description

With the economy showing signs of recovery, companies are optimistic about achieving higher revenue goals in the coming year. However, with uncertainty still looming in the market, a significant portion of the increase in profits may have to achieved through cost reduction. Our business executives’ sentiment index reveals that 56% of executives foresee higher revenue growth, with 63% of executives expecting cost pressures to increase in the next 12 months.



Cost Reduction Pressures2.

4

• Operating/profit margins• Cash flow• Budgeting and planning trends• Revenue and Margin growth• Budget projections• Expense trend line• Productivity ratio

• Competitor benchmarking• Client demands - Requests for

concession, rejection of bids• Slowing Top line• Consumer pricing• Analysts reports• Staff reduction requirements

• Plan for longer periods• Centralize cost-cutting to

maximize gains • Cascade cost-cutting objectives• Monitor disaggregated results• Use shared services• Benchmark cost-savings

• Evaluate impact of cost-cutting on strategic objectives & future growth

• Lock in business for longer periods at reduced prices

• Reduce COGS and SG&A• Assess forward order book




Talent Risks

Risk Description

Job losses in the U.S. slowed sharply in November, cushioned by seasonal adjustments and a budding economic recovery. Analysts believe that the labor market is edging toward stability and the deterioration in payrolls is in its final stages. A survey of 72 economists forecast that U.S. employers cut 130,000 jobs this month after reducing payrolls by 190,000 in October. The unemployment rate, derived from the Labor Department's survey of households, was seen steady at 10.2 percent.*


3.



5

• Turnover/ headcount fluctuations• Compensation• Absenteeism• Loss of work ethic• Industry salary survey• Age and experience level of staff

• Productivity levels• Number of complaints• Employees exhibiting

discretionary efforts• Ability to attract talent in

difficult times and retention risk

• 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/high risk employees

• Provide competitive remuneration

• Look for new sources of quality candidates

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.



Strategic Change Management4.

• 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

• 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

*Source : www.reuters.com




Risk Description

The economic recession has altered consumer behavior, preferences and spending patterns. While the economic recovery is good news, now is not the time for complacency. Pricing power is limited and demand growth will be moderate. Competition will remain fierce and a firm eye must remain on controlling expense growth. Given this tough environment, businesses must constantly strive to improve efficiency and profitability. They need to be vigilant in sensing changing customer needs, monitoring competitors’ strategies and modifying their strategy accordingly. Companies that don’t do so will stand to lose competitive advantage.



Increased Competitive Pressure6.


6

• 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

• 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

Risk Description

Global commodity market fluctuation has been significant in 2009. While crude oil prices fluctuated to settle for a moderate increase, gold prices witnessed a sharp climb in month of November. The U.S. dollar decline has further contributed to the increasing volatility. 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.



Commodity Prices5.

• Spot and future rate movements

• Price quotes• Energy complex• LME trends• Economic indicators

• Buy and holding more inventory

• Enter into fixed price contracts with suppliers

• Evaluate pricing and discounts to maintain margins

• Enter into long term agreements/contracts

• Commodity price index• Reducing margins • Residual risk• Oil prices and market fibre prices• Futures pricing and volumes• Third party data and trends

• Hedge through forward contracts, futures contracts, options and alternate hedges (Delta, Collar)

• Buy substitute inputs• Trade finance solutions• Identify new Credit facilities• Develop supplier partnerships





6

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.

• Equity risk premium• WACC• Interest rates• Cost of issuing letter of credit



High Cost of Capital7.

• Optimize working capital management

• Alter WACC calculations to reflect market conditions

• Find alternate resources for financing

• Maintain strong credit and equity rating

• Credit ratings• Treasury bill• Financial indices

• Use a target structure that reflects seasonal variation in debt, and monitor it on an on going basis

• Optimize banking relationships• Reduce risk profile in

investment portfolio• Sell surplus assets• Improve cash flow


• Non-renewal of loan commitments

• Inability to access unsecured long-term funding

• Cash Shortage


Liquidity Risk8.

• Sell property at a discount• Manage Treasury operations• Shorten the duration of

underlying assets

• Cash flow forecasts• Loan repayment defaults• Net new business figures• Decrease in credit line availability

• Monitor cash flow daily• Reduce spend• Focus on working capital• Identify multiple sources

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.





7

Risk Description

The uncertain conditions and demands have forced compliance and ethics functions to make difficult resource trade-offs, rationalize cost savings and abandon long standing assumptions about risk management. In the US alone, organizations already lose an estimated 7% of their annual revenue to fraud. That number seems to be compounded by heightened government vigilance. We should witness more intense scrutiny and regulation of business practices in the near future, as this period of deep corporate distrust requires unprecedented compliance responsiveness with limited resources.



Compliance9.

• Political trends towards more regulation

• External scrutiny of operations • Regulatory Action• Operating Expenses &

Fines/Fees• Increasing external scrutiny

• Develop personnel and resources to ensure proper understanding of requirements

• Install strong project management capabilities to deliver on new requirements

• Develop new processes to fill any gaps

• Legislative development• Lobbing efforts• Industry reports• Congressional Action• Number of complaints• Quarterly audit status meetings• Internal operational risk matrix

• Monitor regulatory changes• Implement regulatory requisites• Develop Compliance

management frameworks• Examine business processes for

any gaps• Maintain constant dialogue with

auditors

Risk Description

In 2009, bankruptcies were expected to rise by over 50%, leaving organizations at higher risk for potential instances of supplier insolvency. In response to rising instances of critical supply failure, many organizations were 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.



Third Party Solvency10.

• 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

• 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

™ Emerging Risk Update November 2009 FINANCE AND STRATEGY PRACTICE RISK INTEGRATION STRATEGY...

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