A Torch in the Darkness: Strategic Risk Management

Leading the Way is a column written by PricewaterhouseCoopers professional staff. It appears in the Business section of the Bangkok Post twice each month. The column provides specialised advice to corporate decision-makers in Thailand on global and local business trends.

This article appeared in the December 9, 2008 issue of the Bangkok Post.

By Varunee Pridanonda and Suppavut Varutbangkul

The recent shakes or collapses of giant financial institutions have shocked the world. Despite the 700,000 billion US Dollar bail-out plan, further financial institution bankruptcies are still possible and investors have seen stocks slumping every single day. The SET index has plunged by more than half from 900 basis points in October 2007 to 380 basis points in October 2008. In Thailand, businesses are already feeling the pinch from the export market slowdown and this pinch could become a “punch” next year as the crisis expands. Domestic consumption and consumer confidence are also dampened by the never-ending political turmoil. The oil price reached a ridiculous peak around USD 145 per barrel in July 2008 then fell back to USD 60 per barrel three months later, causing volatility in inflation, interest rates, and purchasing power. All of these strategic risks can be very destructive and, therefore , should be monitored and managed.

Strategic risks can be either “external” or “internal”. All of the aforementioned risks are external and are considered strategic risks by their macro nature. Although these strategic risks are beyond a company’s control s , it is very important that management closely monitors them in order to manage their potential impact. Some internal risks can also be considered as strategic risks , as they affect the overall operations or company direction. Examples include dependency on a single supplier/market, engaging in the wrong partnership, unclear investment planning, insufficient skilled staff to expand a business, and so on. Theoretically, management should be able to, somehow, influence both the likelihood and the impact of these strategic internal risks.

Strategic risks tend to be the most damaging, if not properly managed. According to PricewaterhouseCoopers ’ analysis of the FTSE 100’s fall in share price, strategic risks caused 39% of those falls, while operational and hazard risks caused 28% and 19%, respectively. It’s no surprise that financial risks have the fewest occurrences at only14% , as companies traditionally tend to focus on financial risk management to prevent losses incurred from exchange rate, interest rate, and community price fluctuations. However, protecting shareholder value may not be sufficient to compete. Companies must find a way to identify and capture opportunities and that is where strategic risk management comes in.

Recently, Standard & Poor’s has announced that, in 2009, Enterprise Risk Management (ERM) will be incorporated into the credit rating of all non-banks. A good ERM rating will result in a better credit rating and lower cost of capital. The evaluation will focus on two areas. The first area is the risk management culture, generally considered as the most important factor for ERM to succeed, and the second area is strategic risk management.

In the strategic risk management evaluation, management is expected to share their views on the company’s strategic risks, associated rating, and risk mitigation approach. The frequency and nature of updates to these top risks will also be reviewed. In the volatile business environment, management understanding of the most up-to-date situation can make a vital difference in decision making. For example, one of the manufacturing companies has recently found radical changes to a company’s risk profile which developed just three months ago. Some risks become obsolete while some new risks emerge. As a result, management had adjusted risk mitigation plans accordingly to better allocate resources.

Management is also expected to demonstrate how strategic risk management plays a role in decision making. According to PricewaterhouseCoopers’ survey in 2007, senior management surveyed agreed that risk management must evolve beyond compliance into a more strategic function. It is also imperative that potential gains, threats, and compliance are viewed collectively when making decisions. One of Thailand’s largest companies identified “dependency on its European customer base” as its top risk two years ago and has consequently redirected their marketing efforts toward other continents in order to diversify and gain a new customer base. Although the company is still affected by the EU market slowdown as the subprime crisis emerges, the new customer bases have prevented it from being hit too hard. In this case, risk management has helped the company not only in managing risk to protect shareholder value, but also in shaping company direction , allowing it to capture opportunities from those new markets.

With the incorporation of ERM into S&P’s credit rating, companies with good ERM practice will certainly benefit from the better credit rating and lower cost of funds. This is, perhaps, the most quantifiable ERM benefit so far. However, it should not be the main driver behind a company’s ERM efforts. The lower cost of funds is not an elixir that fixes all sorts of business difficulties. Instead, having proper strategic risk management is like having a torch in the darkness. It enables management to see the path ahead, to manage risks and seize opportunities, and to shape the company direction out of the crunch.