An introduction to risk resilience

Authors: Miles Everson and Juan Pujadas

In the first article in our series on risk resilience, we explore questions such as "how does risk-resiliency go beyond conventional risk management?"

Welcome to the first issue of PwC’s new journal, Resilience. Since new publications appear and disappear every day, you might legitimately ask, ‘Why does the world need another journal’? Our answer is that ‘it does because a fast-changing world is forcing executives to take ever more risks to create value for shareholders and the societies in which their companies operate.’ In this issue, our authors look at how your organisations can address such key questions as:

  • What does risk have to do with strategy?
  • How does risk-resiliency go beyond conventional risk management?
  • What are the best ways to manage the risk of expanding into new and unfamiliar markets?
  • How will increasing female literacy change society and generate new business opportunities?
  • What is the difference between ‘playing not to lose’ and ‘playing to win’?

“Seeking the same upside several decades ago tended to entail far less downside than it does today.”

Clearly, risk-taking has always been an inherent part of business, and the more risks you take, the more you stand to win or lose. This fundamental tenet hasn’t changed. What has changed is the quotient of risk needed to deliver the target reward.

Seeking the same upside several decades ago tended to entail far less downside than it does today, so risk management can no longer be an afterthought; it must be a full part of strategic management. Today’s unpredictable conditions also demand a resilient strategy that can adapt to uncertainty and change.

And while every society in every time period faces change, it is happening at an accelerating rate today. One indication of this is the length of time it takes for a new technology to be adopted by 25% of the U.S. population. As shown in Figure 1, on the next page, it took 50 years for the telephone, 40 years for electric lighting, 20 years for the television and only 5 years for the Internet. Another indication is volatility in commodity prices. When the rate of change is constant, companies can adapt to it. But when the rate of change is accelerating, the rate of response must change as well.

Figure 1: Mass use of inventions

Figure 2: Crude oil prices and key geopolitical and economic events

The accelerating rate of change underpins a large number of global developments that are forcing companies to adopt strong capabilities for risk-resilience, lest they fall behind their competitors and eventually fail. In particular, this journal will focus on four of the key developments that are transforming society; the global economy and the risk landscape that surrounds it; and the nature, impact and most effective responses to these developments.

The first transformational development is the divergence in the global economy as growth in the emerging and faster-growing markets continues to outstrip that of their more developed counterparts and represents an ever greater proportion of global economic growth (see Figure 3). This has profound consequences for executives who see more and more of their growth opportunities in markets that often entail much different forms of political risk. It also presents challenges in terms of corruption; lack of social (e.g., laws and regulations) and physical (e.g., roads and bridges) infrastructure; radically different demographic profiles and increasing levels of female literacy; and rapidly shifting social expectations. All of these create higher levels of risk. These challenges are compounded by the difficulties Western multinationals face in overcoming restrictions on outside investment and entrenched local competition in many emerging and faster-growing markets. Many corporations from these markets are also emerging as major global players in their own right.

Figure 3: Gross domestic product at purchasing power parity (current international dollars)

The second major development is the desire of governments in emerging markets to move beyond reliance on low-skilled production toward the creation of knowledge-based employment. They will want multinational investors to support this. Yet, at the same time, governments in developed markets are keen to keep skilled jobs in their own countries and even bring back (‘insource’) jobs that have been moved overseas. While clearly challenging, multinational businesses’ ability to support evolving government priorities is a key element of their ‘licence to operate’ and hence commercial prospects, as states play an ever more influential role in directing business. As suggested in Figure 4, these forces mean that CEOs’ priorities vary significantly across markets.

Figure 4: CEOs have broad objectives in their key markets

Figure 5: Number of planets needed to sustain a whole world at the level of national consumption (2009)

Figure 6: Increasing interest in CSR and sustainability

The third development is the growing pressure on energy, water, land, food and other resources. This may only become worse over time as consumption rates increase to developed market levels, as suggested by Figure 5. In the long-term, this will have profound social and political consequences. Nearer term, we are already seeing the effects in rising and volatile commodity prices. These prices not only wreak havoc in countries whose economies are commodity-based, but they also impair corporate efforts to predict and manage costs. Moreover, they contribute to very real concerns about the security of supply of the energy and raw materials needed to make products. They also create the potential for ‘stranded assets’, an example of which is oil and gas reserves. The value of these reserves will decrease as alternative forms of energy become more economical and as the price of using carbon as a basis of energy increases through regulation, taxes and emission trading schemes. The rapidly growing development toward resource nationalism (recent examples include the nationalisation of energy assets in Bolivia and Argentina) is adding further risk and creating economic quandaries for businesses operating abroad. The panic among governments to secure resources in order to assure their future prosperity has also led to another contentious practice — that of buying foreign resources, like farmland and food supplies. While some argue this is just good business sense, others claim that China’s deal to purchase farmland in New Zealand or Qatar’s objective to secure its food supply by heavily investing in agricultural projects abroad are evidence of rich nations securing their own future at the expense of those less well off.

The fourth development, which stems from the previous three, is the growing interest in ‘sustainability’ from governments and civil society, as shown in Figure 6. This term means different things to different people and is often used synonymously by some, but not all, with ‘corporate social responsibility’. In some places, such as the U.S., it is largely seen as a ‘green’ issue and manifests itself in programmes for better managing resources like energy and water and reducing the impact of the company’s operations, including its supply chain and its customers, on the environment. In other countries, the term has a broader meaning that includes social and governance (of which risk is an important part) issues as well. For us, sustainability refers to a company having a sustainable strategy that will enable it to create value for its shareholders and stakeholders over the long term. People are becoming more sophisticated in how they use technology to gather information and communicate their views and expectations. In responding to these demands, companies have no choice but to consider the ways in which they are or are not contributing to a sustainable society. This requires a careful balancing of many different commercial, social and environmental interests and creates yet another driver of uncertainty and risk.

Resilience is critical

How should executives respond to these developments? One way is to become much better at risk assessment and analysis and avoid actions that entail more than moderate degrees of risk. This approach can ensure survival in the short term since the company will avoid major disasters, but it will put its long-term survival at risk since it will lose out to more aggressive competitors who are successful in the risks they take. Instead, we are calling for companies to be strategic in the risks they take, doing so in an intelligent manner by becoming risk-resilient organisations. By risk-resilient we mean the ability of an organisation to recognise, take, and rapidly and effectively adapt to changes and the resulting risk. This requires rapid acquisition and analysis of vast quantities of information; generating knowledge out of this analysis based on recognising patterns; having a flexible and nimble organisation where local units have the autonomy to respond to changing circumstances; and having strong risk governance procedures at the board and executive level. Those organisations that are risk-resilient will prosper and thrive. The cautious ones will die over time. The careless ones will die quickly.

The opening two articles in this edition look at how to deliver corporate goals in a complex and unpredictable world by bringing risk management into the forefront of strategic planning and execution, and the board’s role in making this a practical reality. One of the key dilemmas is whether conventional enterprise risk management is fit for purpose in today’s world. The first article, ‘Building a risk-resilient organisation’, argues that it is the application and embedding process that needs overhaul. The second, ‘Sharpening strategic risk management’, goes further by outlining why ERM needs to extend its ambitions into areas that were once seen as too uncontrollable to feature on the risk register.

The next three articles examine strategic opportunities and their accompanying risks in new, emerging and fast-growing markets. ‘Managing the political dimension’ adds a new type of risk to those considered in the previous two articles. Political risk, which the authors define as the ‘risk that a political action changes the expected value of an investment outcome’, is a risk that can be heightened when investing in new, unfamiliar and potentially unstable markets. They suggest performing both a static and dynamic analysis when considering investment opportunities, with growth as one dimension and political risk as the other.

‘Dealing with the new world of multinational competition’ focuses on the large and increasingly promising emerging market of the ‘South’ and outlines some of the particular risk and opportunity issues that exist there. While most of foreign direct investment stock in the South still comes from the North, South-South trade flow is becoming increasingly important and is raising the level of competition for companies based in the North to pursue opportunities in the South. The authors provide six pragmatic suggestions for firms in the North wishing to do business in the South — such as engaging in strategic B-to-B partnerships, embracing transparency and being a model of ethics, and pursuing alternative sources of financing — and illustrate their relevance in the particular country example of Myanmar and the particular industry example of athletic footwear.

‘Get it right or stay at home: Managing risk in challenging markets’ focuses on the importance of risk assessment prior to making the decision to invest in an emerging market, asserting that ‘failing to prepare is preparing to fail’. The authors argue that all risks can be considered in terms of one of two types, reputational and operational, and that both must be put in political context, thus echoing the focus of the previous article. This risk assessment must be done on a holistic basis, looking for risk interdependencies, and at both strategic and tactical levels. Like the first two articles, they discuss the role of the board. They also analyse the situations in post-Gadhafi Libya and, complementing the previous article, Myanmar as it faces the 2015 elections, which will be the true test of current economic and political reform efforts.

The remaining articles each address a particular topic related to risk, strategy and sustainability. ‘Making the tough calls on growth’ picks up themes of a fast-changing world of opportunities and risks in a large number of emerging markets. The article provides a framework for exploring the decisions around growth under uncertainty in this environment and discusses advanced predictive modelling and simulation modelling techniques.

‘Tapping into female empowerment’ analyses the leading role of women in the Arab Spring and the role played by education and technology in spurring greater activism, emphasizing that it could not have occurred without rising levels of female literacy that leveraged a broad range of Internet technologies and social media. While female literacy and the Internet pose a clear political risk to country dictators, they also create vast commercial opportunities for companies seeking to enter the fast-growing and often wealthy markets of the Middle East. The author suggests that companies should take advantage of the social media sophistication of Arab women as a way of creating awareness of their company’s brand and its products. As this particular example shows, political risk for some creates economic opportunities for others.

‘Sustaining the supply chain’ focuses on the impact of more globally dispersed and complex supply chains. When combined with the growing social and environmental pressures from investors, employees, customers, governments and civil society, companies need to find more effective ways to overcome the vulnerabilities in their supply chain, both physical and reputational. The article outlines the supply chain management strategies that comprise a continuum from ‘play not to lose’ to ‘play to win’. Such strategies are how a company can become risk-resilient in its supply chain.

As this collection of articles makes clear, becoming a risk-resilient organisation that integrates risk, strategy and sustainability is not something that is easily done. But it is necessary to do so in order to thrive in a global economy that is creating opportunities across developed and especially developing countries. Through this journal, we plan to bring practical insights, frameworks, methodologies and examples that our readers can use to better manage their own companies. Contributions to this journal will come from both the professionals at PwC and expert practitioners and academics. So welcome to our first issue of Resilience. We hope you enjoy it and find it useful. We look forward to having you join our community.