Analysing Strategic Risks and How To Measure

Strategic risk, definition:

• an unexpected event or set of conditions that significantly reduces the ability of managers to implement their intended business strategy (Simons, 2000)
• uncertain future events which could influence achievement of the organisation's objectives, including strategic, operational, financial and compliance objectives (PricewaterhouseCoopers)

Operations risk: 

• breakdown in a core operating, manufacturing or processing capability, example: defective products, neglected maintenance leads to breakdowns, lost in customer packages.
• critical product or process failures, example: toxic substance mixed with a product formulation. 
• often triggered by employee error, mostly are unintended and/or accidental.

Competitive risk:

• results from changes in the competitive environment that could impair the business's ability to successfully create value and differentiate its product and services.
• Example: actions of competitors in developing superior products and services, changes in regulation and public policy, shift in customer tastes or desires (such as fashion fads), and changing in supplier pricing and policies.
• Porter five forces.

Asset impairment risk:

• when it loses a significant portion of its current value because of a reduction in the likelihood of receiving those future cash flows.
• 3 potential types:
• Financial impairment: result from a decline in the market value of a significant balance sheet asset held for resale or as collateral. Example: currency devaluation decreased the expected value of future cash flows, a long-term bond portfolio may sink dramatically due to a rise in market interest rates.
• Intellectual property rights impairment: related to intangible resources, example: due to unauthorised use of intellectual property by competitors (patent infringement), unauthorised disclosure of trade secrets to competitor or third party, etc.
• Physical impairment: dur to physical destruction of key processing or production facilities, because of fire, flood, terrorist, or other catastrophe. 

Franchise risk (reputation risk):

• when the value of the entire business erodes due to a loss in confidence by critical constituents.
• occurs when business problems or actions negatively affect customer perceptions of value in using the business's goods or services.
• can negatively influence public perception and drive away customers.

Risk Assessment Template:

• Risk factor, eg. price fluctuation, competitive rivalry
• Description, eg: 
• Oil, natural gas & chemical prices can vary due to changes in supply and demand for products.
• Product innovations, technical advances, intensifications of price competition by competitors, industry consolidation can impact operating results.
• Risk Category: operation risk, competitive risk, asset impairment risk, franchise (reputation) risk.
• Strategic impact: Low, Medium, High.
• Reputation Risk: Low, Medium, High.
• Uncontrollable --> Low, Controllable --> High.

The risk exposure calculators:

Analysis the pressure points inside a business that can cause strategic risks to "blow up" (occur).

If the pressure builds too high, operations risk, asset impairment risk and competitive risk can cause irreparable damage. High score --> high risk (1 = no risk, 2 = medium risk, 3 = high risk).

Three key analysis areas:

• Growth: --> fundamental goals of the business but also bears risk pressure
• Pressure for performance: 
• goals are set at demanding levels with high performance expectations (or else risk punishment or possible replacement).
• Rate of expansion: 
• rapidly expanding scale of operations -- companies grow bigger, but resources, people and system often work beyond their normal capacity. 
• As a result, mistakes and breakdowns may occur, operations error, increase credit risk, downgrade of product and services, etc.
• Inexperience of Key Employees: 
• growth also means hiring large number of new people, sometimes in the rush, background employee check may be waived and minimum performance standard and education qualification may be lowered.

• Culture: --> history and top-management leadership style bears risk pressure
• Reward for entrepreneurial risk taking: 
• individual are motivated to be creative in finding and creating market opportunities, although it's a good thing, but in the risk taking management, such as: investment may be made in risky asset, deals may be struck with counterparts who have limited ability to honor contract, commitment made but difficult to fulfil, or employees may engage in behaviours that damage the reputation of business.
• Executive resistance to bad news: 
• culture also influence the willingness of subordinates to inform superiors about potential risks in the business. 
• Early warning systems? How much employees fear in bearing bad news and communicate to senior management? Fear of sanction or other personal repercussions?
• Level of internal comparison: 
• cultures also foster spirit of internal competition, which bring a unique set of issues. Intense competition among subordinates targeting for bonuses or promotion. 
• To enhance short-term performance and advance own careers, individuals may gambling with business assets, credit exposure, firm reputation. The payoff and costs are asymmetric, the worst situations the employees could lose their job and business fall to financial loss.
• Information Management: -->
• Transaction complexity and velocity:
• high transaction volume and increased processing speed --> increase the possibility of operation risk.
• As transaction become more complex, fewer people may fully understand the nature of transactions and how to control them.
• Example: cross border agreement in international operations, creative financing, consortium agreement.
• Without fully understanding contractual obligations and the nature of cash flows, asset impairment risk will increase substantially.
• Gaps in diagnostic performance measures:
• management may be unaware of potential problems, cannot take remedial action to contain the risk. All type of risk need to diagnostic appropriately to track current risk level and early warning indicators about changes in competitive risk and franchise risk should be in place.
• may require specialised information processing system that can consolidate information across dispersed operations.
• Degree of decentralised decision making:
• In decentralised business, individuals are encouraged to make decisions autonomously and creates opportunities without constant monitoring and oversight by superiors.
• Due to freedom environment, operating rules and constraints may be neglected. Consequently, they may be able to engage in activities that increase risk without requiring approval from corporate level managers.
• Also, by decentralising credit approval, will increase the magnitude of credit risk.

Example: Case Study - Luvano Wine Group (Australian Wine Company)

• Growth:
•  Pressure for performance: 2 to 3
• intense competition and rivalry in Australia's wine industry.
• Profit and growth target increased.
• lots of competitors and very high competitive landscape.
• Rate of expansion: 2
• no rapidly growing, highly dependen to Australia wine market.
• but, there's an increase of intense to expand to new areas outside Australia, such as Asia, America and European market as they already has good relationship with international distributor and perform an international joint venture
• Inexperience of Key Employees: 1
• strong management teams and only employs 570 people, including highly skilled and experienced vintrepreneurs. 
• Culture:
• Reward for entrepreneurial risk taking: 1
• not enough information from case study
• Executive resistance to bad news: 1
• not enough information from case study
• Level of internal comparison: 1
• not have divisions, 
• not enough information from case study
• Information Management: 
• Transaction complexity and velocity: 2
• Medium, not very highly complex but not to simple, as they develop several international brands
• Gaps in diagnostic performance measures: 1
• Friendly and close related family business, not so hard to disclose bad news.
• Degree of decentralised decision making: 2
• Possessed subsidiary in England and US, not enough information about the constraint of operating rules and freedom of credit approval risks.
• Total score: 13 to 14

Risk Management and Controls (Simon)

• Belief Systems --> Beliefs and core values empower employees to make decisions that align with the company's interests. Help organisation to manage risks (what employee have to do)
• Example in Royal Dutch/Shell Group Statement of General Business --> "Shell companies insist on honesty, integrity and fairness in all aspects of their business and expect the same in the relationships with all those with whom they do business."
• Boundary Systems --> Boundaries for business conduct provide clear, enforceable sanctions.
• Example in Royal Dutch/Shell Group Statement of General Business --> "The direct or indirect offer, payment, soliciting and acceptance of bribes in any form are unacceptable practices". "Employees must avoid conflict of interest between their private financial activities and their part in the conduct of company business" 
• But, we can recommend to Shell to state enforceable sanction, in which not clearly stated in their Group Statement.
• Internal Control Systems --> Internal controls ensure any errors of omission and commission that do occur are detected.