Risk in Review: Global risk in the transformation age
Tim Cook, CEO
About Risk in Review
In today's business ecosystem, where organizations and markets form a complex, interlocking, global web, risks can emerge and metastasize quickly, cascading across markets. Companies are reconsidering their risk thinking and approaches, but they're also transforming to align with changing market imperatives-and in the process, exposing themselves to multi-directional risks.
Ongoing economic uncertainty
Executives realized last year that the market had entered a sustained period of global economic instability and structural change. The long-held assumption that emerging markets were inherently riskier than developed markets began to be called into question. Faced with low growth, heavy debt, and high unemployment in the industrialized world, economic influence was shifting to the emerging markets, which, despite greater operating difficulties, continued to gather strength as centers of economic activity.
Among the respondents to this year's risk survey, a major global economic downturn is again seen as the most serious risk over the next 18 months: Nearly two-thirds of respondents cited such a downturn as likely, and nearly three out of four said it would have a major impact on their organization .
"There is a danger that if executives stay focused on an economic downturn, they may not be able to move fast enough if a market upturn comes."
--Ken Coy, Partner, US Assurance GRC Leader, PwC
Regardless of where the economy heads, executives continue to fear that regulators will exercise greater influence over the next 12 mconths. They are most apprehensive about increased taxation in industrialized markets, which two-thirds consider a probable event with serious consequences. Similarly, about half of respondents view excessive government austerity measures as a powerful threat, particularly as more nations move to reduce their heavy debt burdens.
Political and Regulatory risk
Regardless of where the economy heads, executives continue to fear that regulators will exercise greater influence over the next 12 months. They are most apprehensive about increased taxation in industrialized markets, which two-thirds consider a probable event with serious consequences. Similarly, about half of respondents view excessive government austerity measures as a powerful threat, particularly as more nations move to reduce their heavy debt burdens. Executives also remain uneasy about the related risks of social or political change, including potential military flare-ups in the Middle East and greater social unrest in Europe, the latter stemming from record high unemployment rates and anger over government austerity measures.
Business transformation makes risk management more complex
To adjust to changing global market conditions, senior management teams will continue over the next year to transform their global business strategies, structures, and operating models. Our survey found that more than two out of three companies have undergone business transformation over the past 18 to 24 months, while another 10% are planning such changes over the next 18 to 24 months.
Digital transformation presents new risks
"As data continues to grow, leveraging technology to get instantaneous results through data discovery tools will be key," says John Sabatini, Partner, Advanced Risk & Compliance Analytics Services at PwC.
The continuing evolution and ever-wider adoption of new digital technologies across industries will expose individual companies to a broad range of risks in 2013. Close to 60% of executives think that business transformation will make their companies more vulnerable to technology risks in general. The danger that major IT programs will fail to deliver expected benefits was the biggest specific risk cited by survey respondents.
Social media has also led to new anxieties. While companies see social media as a valuable way to reach stakeholders and track opinion, they worry that it opens them up to brand or reputational damage. More than 40% of survey respondents say social media is likely to put them at risk in the next 18 months. The issue is especially pressing for banks, which face tighter regulations regarding the marketing of their products and services over social media.
Risk Strategies and techniques
In 2013, executives remain concerned about external market risks even as they retool their organizations to meet new challenges. Continued recessionary pressures, global financial shocks, increased taxation, and excessive government austerity are seen as likely risks that could have serious consequences for business in the year ahead. Widespread business transformation is adding further complexity to the global risk landscape, as senior executives respond to global market shifts by making fundamental changes to their companies’ strategies or operations via avenues such as mergers/acquisitions/divestitures, large-scale outsourcing/offshoring, enterprise-wide IT change.
"It’s not hard to think of industries whose business models are under stress or broken—big box retail, for example,” says PwC’s Dean Simone. “The big box format was transformative 20 years ago, but e-commerce and mobile technologies changed the game. Now, brands that once led the industry are either gone or struggling to evolve. It’s all about adaptation, finding the strategy that will allow you to thrive in today’s environment, and tomorrow’s. Some industries and companies have done it very well—the Detroit automakers, for example, and domestic oil and gas producers. They’ve looked down the trend lines, seen where their worlds are going, and made the right choices to ensure success."
Risk Assurance Leader, PwC
These changes in business direction can expose companies to new risks, including data security, IP abuses, and political and regulatory pressures in emerging markets, not to mention the possible failure of the new strategies themselves. Further complicating matters, the interplay of market and business transformation is creating complex risk linkages that can be unpredictable, fragile, and difficult to detect. Simultaneously, the demands and expectations of external stakeholders are gaining ever more power: Investors have less tolerance, customers are demanding more for less, and digitally empowered consumers are pushing companies on issues such as sustainability, fair-labor, and local sourcing. Such stakeholder influence further complicates the risk environment, and accelerates the speed and severity with which companies are punished for their mistakes, in both the media and the marketplace.
Our survey findings indicate that in the coming year, companies’ key strategic responses will relate to:
Resilience. Companies are pushing harder to build resilience to emerging risks. Over the next 18 months, more than half of our responding companies will be applying horizon scanning, early-warning systems, scenario planning, and flexible risk appetite statements.
People and organization. More companies are taking organizational measures such as developing risk-related performance incentives and conducting talent audits to identify skills gaps. Our survey respondents plan increases of 79% and 69%, respectively, in their use of these measures.
Technology. To address growing risks from digital technology and social media, companies will nearly double their use of intellectual property, brand, and reputation audits over the next 18 months and take measures to mitigate the risks that are uncovered.
Next-generation risk analytics. Across industries, companies will draw on more sophisticated techniques to identify hidden patterns and risk linkages in large sets of data. The fastest growing tools will include integrated risk data warehouses (whose use is expected to double) and risk dashboards (which will increase by 50%).
Have you developed plans to minimize risks?
Survey findings and analysis by your region and industry
Executives still consider North America, Western Europe, and developed Asia less risky markets for business. Nevertheless, the markets seen as riskier-particularly developing Asia and Sub-Saharan Africa-are projected to post the world's fastest GDP growth rates in 2013.
Findings for your region
Middle East and North Africa
Although Oxford Economics predicts a GDP growth rate of 4%, this region remains one of the world's most volatile, as the Syrian civil war rages and political transition in Egypt and other countries underlines the uneasy accommodation between Islamists and secularists.
According to Oxford Economics predictions, GDP in developing Asia will show the fastest growth in the world in 2013, climbing by 6.4%. While executives viewed the region as the world's riskiest in our 2012 survey, their assessment has improved ever-so-slightly this year, thanks to the reduced chance of a China hard landing.
Sub Saharan Africa
Oxford Economics expects this region to see brisk GDP growth of 4.9% in 2013, thanks largely to strong commodity prices. With long-term investment flowing from China into Africa's natural resources market, the continent may enjoy stable growth for some time to come.
Corporate executives were pleasantly surprised in 2012 by the buoyancy of several economies in the former Soviet bloc. However, concerns remain about the risk of doing business in the region, most particularly in Russia. Oxford Economics predicts GDP growth of 2.2% in 2013, down from 2.8% in 2012.
Latin America Carribean
While economic recovery in Brazil is tenuous, the country's linkages to other Latin American markets are relatively light, limiting any contagion effect. Meanwhile, the region's growing relationship with China is positive. Oxford Economics predicts a 3.3% GDP growth rate for 2013.
Economic prospects in 2013 are inconsistent across the region's economies. Oxford Economics projects negative growth of -0.4% for Japan and a modest 2.1% for Australia. By contrast, it anticipates that Singapore, Taiwan, and South Korea will enjoy GDP growth topping 3%, spurred in part by a continued recovery of regional trade.
Executives have a slightly elevated view of Western Europe's riskiness in 2013 compared to 2012. Oxford Economics expects flat growth this year, but its analysis of alternative scenarios projects that multiple Eurozone exits would sink the region into a deep recession.
Concerns about slower growth in the US were reduced by the January fiscal cliff agreement, which included mechanisms to raise revenues. With the US economy showing signs of improvement, Oxford Economics is forecasting a 2.3% growth rate in 2013, putting the country well ahead of other industrialized markets.
Findings for your industry
Systemic banking risks, global recessionary pressures, global financial shocks, and major regulatory reform top the list of external risks for financial services executives, while risks relating to data security and customer privacy are top-of-mind as their companies adopt transformative strategies to navigate today's technological landscape.
ANZ's Nigel Williams says digital risk, government regulation, and the influence of Chinese capital are the three critical risk areas financial services companies will face in 2013 and beyond.
"Executives at financial institutions are still coming to terms with a much more real-time, digital world-and most executives haven't fully considered the implications," says Williams, whose company last fall announced plans to spend A$1.5 billion on initiatives that make it easier to bank with ANZ, including improvements to its mobile banking services. "Fraud has basically shifted from cash and check fraud to Internet-based and mobile fraud. So a lot of financial institutions have tended to view these new tools as a risk, rather than saying, 'Is this an opportunity to understand our customers better?'"
The most immediate challenge for the healthcare industry centers on government reform. In the US, for example, the 2010 passage of the Patient Protection and Affordable Care Act triggered a multi-year process that will substantially redefine the nation's healthcare market. A staggering 98% of executives in this industry see major reform of healthcare legislation as a high risk, while more than 70% cite excessive austerity or cuts in public spending.
Similarly, almost three out.of four healthcare executives worry about major reform of data privacy and security regulations, by far the highest for any industry in our survey.Changing customer needs represent a high risk for over 66% of healthcare organizations, whose consumer bases are expanding due to healthcare reform, aging populations, and globalization. Technology, such as remote health monitoring, is playing a vital role in how the industry addresses these new pressures. It is no wonder that about 62% also cited technology-related risks from business transformation as a major threat.
Figure 7. Key external and business transformation risks: Healthcare(% responded high risk)
External risks Business transformation risks Major reform of healthcare regulation98.2Failure to meet changing customer needs and behaviors66.7Major reform of data privacy, security, and technology74.5Talent shortage for key business areas64.3Excessive austerity or public spending cuts70.4Technology-related risks61.9Increased recessionary pressures69.8Failure of new strategies and business ventures59.5Increased taxation61.1Negative consequences from organizational change and restructuring57.2
Consumer and industrial
Commodity price shocks were cited as a high risk by nearly three out of four executives in the consumer and industrial products and services sector, reflecting the interplay between energy prices and customer demands. PG&E, for example, found its profit margins squeezed by government requirements, volatile energy costs, and slack consumer demand following the 2008-09 recession. "We have to work hard to stay within the affordability range on prices," says Chief Risk and Audit Officer Anil Suri. "If we don't, we see huge customer pressure."
But consumer and industrial companies also feel vulnerable to a variety of economic and political risks, including the risk of increased recessionary pressures, greater taxation, a slump in world trade, and lingering fiscal uncertainty in the US following the fiscal cliff showdown. To deal with these rising risks, many companies in the sector are rethinking where and how they produce their products and services.
Figure 9. Key external and business transformation risks: Consumer and industrial (% responded high risk)External risksBusiness transformation risksIncreased recessionary pressures76.0Negative consequences from organizational change and restructuring64.9Commodity price shocks73.8Talent shortage for key business areas57.7Increased taxation64.7Failure to meet changing customer needs and behaviors54.5Global financial shocks60.6Entering new markets/geographies50.2Fiscal cliff in US58.8Failure of new strategies and business ventures50.2
Technology, information, communication, and entertainment
Companies in these sectors are perhaps the most dependent on new and innovative technologies. As a result, they arguably face the biggest and most urgent risks from business transformation. Technology has upended long-standing business models at many of these companies, and failing to replace them with more apposite and sustainable approaches has led in some instances to market erosion and business failure.
More than 75% of respondents in these sectors say coping with changing customer needs is a major danger of business transformation, and over 70% cite technology-related risks. Most telling, almost two out of three are concerned about the risk that new strategies and business ventures could fail, underscoring the thin margin for error many of these companies face as they attempt to transform.
What this means for your business
Risk imperatives for 2013
PwC Risk Assurance Leader, Dean Simone suggests that senior executives ask themselves the following questions to ensure their risk management approach is in tune with their business transformation imperatives.
Have you built risk resilience into your organization to respond to unexpected, cascading risks from market and business transformation?
In today's unpredictable, ambiguous, and fast-moving business environment, companies need structures that are resilient to risks when and where they occur. Successful organizations are forging stronger and more direct alignment between risk management and strategic/operational planning and execution to ensure that risk information is transmitted to decision-makers on a timely basis and used to set strategic direction and course-correct as necessary. CROs should increase their use of horizon scanning and early-warning systems to spot trends, and employ stress testing to identify key vulnerabilities. More flexible risk appetite statements, corporate-wide contingency planning, and a risk-aware corporate culture that challenges conventional wisdom can help organizations better manage emerging risks.
Have you adjusted performance incentives so that new, transformative business strategies do not expose your organization to undue risk?
Tom Colligan, a former PwC vice chairman and current board member at Office Depot and other organizations, explains the value of risk-adjusted performance incentives:
"All too often, performance-based compensation encourages executives to take actions that increase risk. For example, such incentives were certainly a contributing factor in the financial crisis." Creating a more balanced scorecard that includes risk-related performance incentives can reduce this threat, Colligan says, although it requires strong board involvement.
Does your risk management system address cyber-risks that can derail a new technology-enabled business strategy?
In today's digital world, business results can be hurt by a minefield of cyber-risks-from system failure and security breaches to intellectual property abuse and reputational damage from the viral effect of social media. Building digital risk into the CRO agenda and driving greater awareness throughout the organization is now crucial. Are you conducting intellectual property, brand, and reputation audits to ensure your assets are properly protected? Do you have programs in place to track and respond to unfavorable social media feedback? Have you set proper controls for new digital approaches such as cloud technology and bring-your-own-device arrangements?
"This is a transformational time for risk management. If companies can't learn how to mitigate unforeseen risks and new combinations of risks, especially, it can hurt customer, shareholder, and regulatory confidence. Business and risk managers will have to get used to using more sophisticated, objective, quantitative methods to handle this-it's not just about personal judgment anymore."
This study, carried out in November and December of 2012, is based on results from a survey of more than 800 executives and risk managers with businesses worldwide. The sample covered both public (64%) and private companies (36%) across a wide range of countries, with 325 headquartered in the US. The sample reflects a wide distribution of global annual revenue: 38% of responding companies had annual revenue below US$1 billion, 29% between US$1 billion and US$5 billion, and 33% over US$5 billion.
The largest category of respondents by industry was consumer and industrial products and services companies, which represented over 38% of the total. Financial services providers were the next largest group, representing more than 33% of respondents. They were followed by technology, information, communication, and entertainment companies (14%) and healthcare companies (7%, including payers, providers, and pharmaceutical makers). To understand the statistical trends and gain insights into changing risk approaches, we also conducted in-depth personal interviews with CFOs and CROs from a cross-section of industries.