Global Risk Management

Global Risk Management Notes

Risk Management

  • Risk is defined as 'the variation from expected outcome over time' (Kallman, 2005).

  • It involves uncertain prediction about future behavior in a market or industry.

  • There's a possibility that the outcome could be detrimental to an organization.

  • The concept incorporates both opportunities and costs.

  • Risk management issues:

    • How to reduce risk exposure?

    • How to mitigate risks?

    • How to turn risks into opportunities.

  • Multinational Enterprises (MNEs) may have internal advantages, and becoming too risk-averse can be harmful to a firm’s success.

Risk in MNEs

  • Managers are affected by an inherent bounded rationality, i.e., making decisions that are satisfactory rather than optimal.

  • MNEs face uncertainty in complex internal and external environments.

    • Globalization of value chains (internal).

    • Deregulations of markets (external).

  • Risk management has to be a core competency of successful MNEs.

  • ‘Cost-benefit’ analysis sometimes fails to take relevant risks into account.

  • Risks tend to be over-simplified, or one type of risk tends to be over-emphasized (e.g., exchange rates, inflation at the expense of the risk of political instability).

  • The type, magnitude, and impact of risks changes across geographical locations, industries, and firms.

  • Some business environments involve higher levels of risk than others.

    • Examples: High-technology industries, pharmaceutical industries, oil exploration.

Relationship Between Country Risks and FDI

  • This section likely contains a graph plotting overall risk score against FDI (Foreign Direct Investment) for various countries, though the specific data points aren't directly represented in the text. Some countries listed are USA, UK, France, Belgium, Hong Kong, Sweden, Germany, Singapore, Poland, Japan, Australia, New Zealand, Mauritius, Panama, Brazil, China, Russia, India, Angola, Argentina, Nigeria, Lebanon, Sudan, Congo, Afghanistan, Guinea, Somalia, and Samoa.

Tools Governments Use to Promote FDI in High-Risk Environments

  • Tax reduction: Tax holiday, reduced tax rate, reduction in social security contributions, exemption from property taxes, income tax exemption, reductions for expatriate personnel

  • Imports and exports: Exemption of import duties and value-added taxes for raw material, capital equipment, exemption from export duties

  • Financial incentives: Subsidies, guaranteed loans, export credits, equity participation

  • Competitive incentives: Monopolistic position, preferential purchases, capacity regulation

  • Operational incentives:

    • Preferential rates – rents, land, power, telecoms

    • Assistance for market studies

    • Utilization of public services or government agencies

    • Secondment of personnel

Types of Risks

  • Country Risk

    • Political Risks: Asset destruction (war, riots), asset spoiling (expropriation), asset inflexibility (transfer, freeze). Employees’ exposure: targeted abuse, gangsterism, harassment. Stakeholders’ exposure: Market disruption, labor unrest, supplies shortage.

    • Economic Risks: Taxes, economic growth, inflation, costs of inputs, exchange rates.

    • Competitive Risks: Business logics (corruption, cartels, networks). Infrastructure (power, telecoms, transport). Regulations (nationalistic preferences, constraints on local capital, local content, local employment).

    • Operational Risks

    • Shareholders' Exposure

Managing Risk in Global Value Chains (GVCs)

  • Economic Risk

    • Nature: Systemic shifts in markets – new technologies and innovations, changing demand, financial disruptions, exchange rate fluctuations, and so on.

    • Causal effects on actors: Loss of competitive position in cost and/or market leadership; reduction in financial returns and profitability; lower income and structural volatility to localities and regions.

    • Recent examples: Decline of Canada's RIM (BlackBerry) and Finland's Nokia in smartphone devices, 2013.

  • Product Risk

    • Nature: Quality, safety, branding, and efficiency considerations

    • Causal effects on actors: Negative views of goods or services by consumers and customers; greater demand for corporate social responsibility.

    • Recent examples: The demise of Arthur Anderson LLP in 2002 because of its criminal involvement in the Enron fiasco; Toyota's quality issues with its 'sticky pedals' in the USA, 2009-11.

  • Regulatory Risk

    • Nature: Political, public-to-private governance, and changing standards and norms.

    • Causal effects on actors: Disruption or termination of global production, existing industrial practices, and organizational arrangements.

    • Recent examples: EU's tough regulation of genetically modified organisms (GMOs) since 2003 and impact on GM crop-growers (e.g., Monsanto's MON810 maize).

  • Labour Risk

    • Nature: Struggles over working conditions and employment practices.

    • Causal effects on actors: Resistance and industrial action by employees; disruptions to global production and employment prospects; and potentially greater reputational risk.

    • Recent examples: Strikes in Foxconn's plants in China, maker of Apple's iPhones, owing to workers demanding for better terms and working conditions, 2012-13.

  • Environmental Risk

    • Nature: Natural hazards or human-made disasters.

    • Causal effects on actors: Accentuating the above four forms of risk and their causal effects.

    • Recent examples: Japan's 2011 Fukushima earthquake and production stoppage in automobile manufacturing owing to parts shortage.

Sources of Risk in a Supply Chain

  • Supply Risk

  • Process Risk

  • Demand Risk

  • Control Risk

  • Environmental Risk

Risk Fundamentals

  • A risk is an event that usually has a negative impact (it can create an opportunity as well) on tasks. In risk management, we try to know unknowns of future.

  • Three elements of risk:

    • The scenario (event)

    • Probability of occurrence

    • Size of impact

  • Risk in an event is calculated as: Risk=Probability×ImpactRisk = Probability \times Impact

Risk Levels (Types) and Probability

Types

Assessment

Interpretation

High

Is expected to occur, almost certain.

Greater than 80%

Medium/High

Will probably occur, measures may or may not exist to reduce likelihood.

Between 20 and 80%

Medium

Could occur, this is possible.

Between 10 and 20%

Low/Medium

Measures to reduce likelihood exist, but may not be fully effective.

Between 5 and 10%

Low

Might occur at some point in time. Conditions do exist for this to occur, but controls exist and are effective.

Less than 5%

Rare

Rare, may occur in exceptional circumstances. No or little experience for a similar failure


Risk Fundamentals Example

Risk levels and actions:

  • Low-Level Risks from 1 to 2: Accept

  • Moderate Risks from 3 to 5: Control

  • High-Level Risks from 6 to 9: Avoid

Risk Assessment Table:

Risks

Impact

Probability

P*I

Extreme weather

3

3

9

Cyber attacks

2

3

6

Financial crises

2

2

4

Terrorist attacks

2

1

2

Spread of infectious virus

3

1

3

Employment lawsuits

1

1

1

Illicit trade

1

2

2

Operational disruption

1

3

3

IT breakdown

2

3

6

P-I Matrix

  • This section visually represents risk assessment using a Probability-Impact matrix. The table maps different risks based on their probability and impact scores.

Risk Management Strategies

Four risk-management strategies and their implementation:

  • AVOIDANCE

    • Action taken before entry: Evaluate the consequences of entering – is a failure likely?

    • Action taken after entry: N/A

  • PREVENTION

    • Action taken before entry: Insulate against hostile forces. Negotiate with trustworthy parties. Build reputation.

    • Action taken after entry in response to a problem: Call up support previously pledged.

  • MITIGATION

    • Action taken before entry: Invest in rapid response measures. Take out insurance by sharing risks with partners.

    • Action taken after entry in response to a problem: Activate the pre-planned responsive measures.

  • WITHDRAWAL/ DIVESTMENT

    • Action taken before entry: Invest in liquid, mobile, flexible assets.

    • Action taken after entry in response to a problem: Sell, move, or transfer the vulnerable assets.

Criteria Relevant for Decision-Making

  • The ‘attractiveness’ of each option to the decision-maker.

  • The extent to which the firm is prepared to accept potential loss.

  • The estimated possibilities of success and failure.

  • The degree to which the decision-maker is likely to affect the success or failure.

So what steps to follow?

  • Clarify the risk involved – external environment vs. business.

  • Decide what to do

    • Retain the risk and prepare for eventualities.

    • Transfer the risk by switching to somebody else, diluting it, or insuring against it.

    • Regulate by investing to reduce it.

The Risk-Taking Organization

  • Characteristics that restrict risk-taking:

    • Centralized decision-making

    • Adherence to formal systems

    • A culture of caution

    • Early evaluation of new ideas

    • Mistakes being sanctioned too readily

    • Reliance on performance rewards based on pre-set plans

  • How can responsible risk-taking be encouraged?

    • Decentralization and informality

    • Projects that cut across firms

    • Rewarding staff and teams for new initiatives

    • Providing resources to develop new ideas

    • Encouraging and respecting learning

    • Trusting people